I got an email yesterday from someone who wanted to know how to flip houses and was paralyzed by fear.
He asked me to email him the two most important rules he needed to know when flipping houses.
I thought about going into the whole overcoming fear thing…but instead of getting into the whole “Secret” thing, I thought I should just give him the block and tackle stuff instead.
I still get calls from previous coaching students on deals they are looking to flip or buy, fix up and hold. And it seems like on every call, they ask me the same thing:
Hey Mike, in just this one case, can I break the rules?
I end up giving them the same answer over and over again: NO
Nobody really likes to stick to rules. It seems, people would rather break them. Sure, rules are necessary in society and in life, but nobody really likes them – nobody really likes to be told what to do. But when house flipping, these rules will keep you out of trouble. I still stick to them every day because they work – and I’ve used them hundreds of times to analyze hundreds of deals.
Now, let’s be honest here…these rules are not earth-shattering, unlock the secret of the universe kinds of rules. These rules will not help solve the crisis in the Middle East, nor will they help to further unravel the human genome…nor will they help discover other galaxies with distant life forms…
These are just simple rules that I learned – and always come back to when doing all my flips. And in the case of this emailer, assuming he overcomes the whole fear thing, if he stuck to these two rules and never made the mistake of breaking them, he would always stay in the money with his flips.
And surprise surprise, both of them come back to basic numbers.
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House Flipping: Purely a Numbers Game?
When it comes to flipping houses, it’s all about the numbers right?
Yes and no. True, the numbers don’t lie. But numbers become more meaningful with experience. After you’ve been flipping houses for a few years and have dozens of real estate deals under your belt, you’ll start to get a sense as to when you can and when you cannot slightly bend the numbers and slightly bend the rules.
I did say “slightly”…but this is only when you have experience.
But when you are first starting, NEVER deviate from these rules – because when you flip houses by the numbers with no insight and experience, the rules will just plain keep you out of trouble. These rules will both keep you out of the bad deals and keep you in the good deals. So for the record, adhere to two basic rules and NEVER deviate from them.
The Two Rules You Should Never Break When House Flipping
Rule #1: Stick to your ARV
ARV, which stands for After Repair Value is what the house is going to sell for after you fix it up. If you have a good real estate broker that can determine what that house can sell for after it is fixed up, you simply work backwards to determine whether it’s a good deal.
Have the real estate agent perform a market analysis to determine the potential selling price of your property. Although there are many online comp services that can give you an idea as to what the house will sell for – nothing beats the expertise of a good real estate agent.
Things to remember on ARV:
- Six months: Have the real estate agent to go back on the shortest amount of time, usually no longer than 6 months. The shorter the time period between sales, usually the better so you can eliminate market shifts and changes that may affect price.
- Compare: Once they determine what other properties have sold for, they will be able to tell you what your property will sell for.
- No Eraser Math: Don’t “eraser math” your ARV – make sure you stick to the number they give you and don’t deviate from it during the flip. As soon as you start “erasering” the number bigger to suit your needs, you can say goodbye to your profits!
The last point above is the one that most people want to break. If you get an ARV from your broker, don’t massage it until it makes your numbers work. The number they give you is the number (provided the real estate agent is a good one). So trust the number and stick to it…don’t break the ARV Rule.
Rule #2: Always Follow the 70% Rule
Once you have determined the ARV, the next rule in the house flipping process is the 70% Rule. The effectiveness of the 70% Rule all hinges upon your ARV – so you’ll need to determine that first.
The 70% Rule can vary with the market – but only if you really know what you’re doing. But put that thought out of your mind for now, just stick to the 70% Rule and you’ll be in good shape.
You use the 70% Rule to determine:
- How much you can spend on your rehab
- The maximum allowable offer for the property (known as the MAO)
How to use the 70% Rule:
Say the ARV is $200,000.
You figure out these numbers by using the 70% Rule using this simple math:
- Take the ARV ($200,000) and multiply it by 70%. This equals $140,000
- Deduct your repair costs from that $140,000. Let’s say your general contractor told you that rehab will cost $40,000
- Using the 70% rule, you have now determined that the maximum price you want to pay (or MAO) is $100,000
Using the 70% will give you a healthy profit margin minus finance, carrying costs and unanticipated expenses. Usually 10% is for financing, carrying and other soft costs, while the remaining 20% is for profit.
And if you go over on your expenses or maybe get a slightly lower ARV when you sell, the 70% Rule cushion will make it really hard for you to not be in the money.
As long as you stick to the rules!
House Flipping Rules Conclusion
Flipping houses can be a very lucrative way to make money investing in real estate. We all see the headlines and the reality TV shows that glorify it to a certain extent.
While all that publicity is great for house flipping awareness, it’s the Rules that keep you profitable. In a rapidly appreciating market, the appreciation will sometimes help you make the profit, but never count on it. The truth of the matter is that you can be successful flipping houses or investing in real estate whether prices are appreciating or whether they’re depreciating.
But only if you stick to the rules…
If you made it this far, please leave me a comment below! I’d love to hear about what you think about these two rules or any other rules you have that you stick to keep your real estate investing profitable!
Photo: David Curran