Take the Emotion Out of Flipping Houses

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One of the biggest obstacles to success as a real estate investor is emotion. It’s part of being human. Imagine you are shopping for a new car. You do your research on the internet, you read reviews in various publications, calculate exactly the highest price you are going to pay and head to the showroom. With a firm resolve you walk in the door and are greeted by the smiling salesperson you have vowed to ignore. Then he begins showing you the car you want albeit loaded with every feature you determined that you don’t really need. But why shouldn’t you get them, it’s only a little more? Your firm resolve has been overwhelmed by your emotions.

Emotions come into play when you’re making investment choices just as they do when you’re buying a car. As a human being you can’t eliminate them but you can take steps to control and manage them. Your likelihood of success as a real estate investor will increase dramatically if you remove the emotional aspect from your decision making. How do you do that? By using tried and true formulas that are often ignored when you allow your emotions to overrule logic.

Powerful Formula for Rehabbers

As a rehabber I used a simple formula that told me if a property was a winner or loser. It’s not magic – it’s math. I described it in greater detail in my book, A Rehabber’s Tale, but these are the basics. To use the rehabber’s formula you need to determine certain variables and that’s the tricky part. You need to know what you can really sell the property for when it’s repaired. That isn’t what you hope to sell it for but what you can really expect to get within thirty days of putting it on the market. You also need to know what it will cost to make repairs and you need to build in a contingency for the unexpected.

Your variables:

ARV: After Repair Value (what you can really sell it for)

COR: Cost of Repairs (be conservative here and estimate high)

The Rehabber’s Formula:

(ARV X 70%) – COR = Maximum Purchase Price

The 70% factor allows for your cost to acquire, sell, and finance the deal. When all goes well you can expect a 10-15% profit. The formula assumes that you will hold the property for no more than four to six months. For longer holding periods the percentage needs to be lower; if you are buying with your own cash the percentage can be a little higher.

Caution is Key in Flipping Houses

Keep in mind that the easiest person to fool is you. When you enter the world of rehabbing there are three things you can count on:

  1. The project will take longer than you think
  2. Repairs will cost more than you expect
  3. The house won’t sell for as much as you hope

I’ve done quite a few talks at real estate clubs on rehabbing successfully. Invariably after one of those speaking engagements someone will come up to me with a rehab horror story. Often they were convinced by a real estate agent that a property was a winner. Unfortunately most agents don’t understand a thing about rehabbing. They’ll assume a listing at 20% below market is a bargain when, in reality, it’s a guaranteed loser. Remember this – if you buy a loser the agent still makes his money, it’s up to you to find the winners.

Human behavior flows from three main sources: desire, emotion, and knowledge.Plato

Photo Credit: Images_of_Money

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4 Comments

  1. Richard –

    Great post. I believe that one of the hardest things to overcome when you are new, is the tendancy to see everything with too much optimism. Folks tend to do the numbers on that “top selling” price when they probably will sell it for less, and they almost always figure the repairs on the low side. Like you said, things always cost more and take longer.

    Even though I am primarily a wholesaler at this time, I still buy the property like I’m the rehabber. I have to get those cost right or I will never be able to sell the house.

  2. Over the years, I have dealt with almost every type of real estate investor. Only a fraction of them take my 12+ years of real estate advice at a top Baltimore real estate agent. Not to mention over 10+ years of experience rehabbing and selling properties in Baltimore, Maryland.

    Most investors will either look for the “big score” or real estate they can envision themselves living in. I always advise my clients to look at the carrying and renovation costs involved. It always surprises me that most people think I am crazy and say “I understand what you are saying but we (the buyer) think this house is a great investment – it’s 20k under market value!”. In reality, I know that after we settle they are in for a long and stressful journey ahead. Usually they realize that their contractor under bid the job by thousands or simply took their money to float another job and put their project on the back burner. Along the way, due to the increased costs, the investors will try to make-up the short fall by cutting corners and trying to skim on the fit and finish.

    Just remember this – time equal’s money and the cheapest contractor is not always your best bet. While you are renovating the property you will be paying holding costs. During the renovation you will be dealing with issues you did not envision or budget for (every project has a few). Both of the above variables can bankrupt the best real estate deal, so choose wisely.

  3. This is SO true:

    The project will take longer than you think
    Repairs will cost more than you expect
    The house won’t sell for as much as you hope

    We own a contracting business and have always had an interest in flipping houses. With today’s economy things have been tough all over. Haven’t been able to find the right fit. Any suggestions?

  4. great post. As a rehab lender in Chicago I think that your recommended formula is pretty accurate. We lend acquisition and rehab funds up to 60% of the ARV. Many rehabbers are far too optimistic about potential sale prices. Closing deals is getting tougher and tougher.

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