I hear that investors like to find properties that can be bought for 60% of FMV (fair market value). Can someone tell me what this means? are they talking about 60% of what the property appraises for or 60% of what is left of the sellers mortgage?? ???
60% of FMV is 60% of appraisal.
the later is a short sale.
This needs to be more detailed.
The common rule here is that most rehab investors will buy a property for 70% of the ARV (After Repair Value).
The ARV is the true FMV minus the total costs of repairs/rehabbing (holding costs, closing costs, etc.)
FMV is NOT necessarily appraised value. Fair market value is an estimate of what the property should sale for in a reasonable amount of time (3 to 6 months for example), between two reasonable parties (no motivated buyer or seller).
Appraisals are done for all kinds of reasons and unless you have specifically ordered it yourself for determining the current FMV, then it’s hardly trustworthy. Refinance appraisals, for example, are routinely on the high side of FMV at best, and frequently, a greatly inflated opinion of value. Why? because it’s the lender that orders these and the higher the value, the higher the loan amount.
Unfortunately, many sellers use this appraisal as a basis for their selling price, so their property just sits on the market. And new investors use this appraisal as their starting point, and think that they’re getting a “good” deal when, in essense, they are buying at the true FMV.
Raj
Could you give us a “numbers” example of what you mean by The ARV is the true FMV minus the total costs of repairs/rehabbing (holding costs, closing costs, etc.)
Max
You find a property that, fixed up, would sell for $100,000.
You estimate that it’s going to cost $15,000 in rehab costs.
$100,000
- 15,000
= 85,000
$85,000 x 70% = $59,500. This is usually the max that a rehab investor would pay for this property. If you were planning on wholesaling, then you would have to purchase it for less than $59,500 in order to sell it to another investor.
Hope it helps,
Raj
Thanks alot Raj!! I needed that explanation.
Max
Thanks for the excellent explanation Raj! 
Do you know the reasoning behind the 70% rule? Is it to make it worth your time, or to hedge against cost overruns, market drops etc?
Thanks
In a word, Yes… to all of the above.
I’ll try to break it down some more. Maybe it’ll help.
If you figure the $15,000 rehab correctly, including all the costs it would probably look something like this:
$3000 in holding costs (taxes, insurance, & monthly payment estimated at $500/month x 6 months)
$5000 in closing costs ( about 3% for each closing, so $1800 on the $60K buy and about $3000 on the sell side, rounded up)
As you can see, this only leaves $7000 for the actual repairs, which would be relatively minor stuff, mainly PP&C (Paint, Patch and Carpet).
This leaves you with a $25K profit, right? I can make do with less, right? Well, let’s look at it more closely.
In most markets, houses do not sell for full asking price. In most markets, negotiation takes about 3-5% off. Using 5%, we’re down to $20K profit.
Most people do not successfully market and sell their properties themselves. If you use a full service agent (and unless you’re experienced in selling houses, I recommend that you do get a good, preferrably referred REALTOR), the average commission is 6%, so knock off about another $6000.
That leaves $14K in profit, which after taxes (rehab flips are taxed as ordinary income) you’ll take home about $10K or so, depending on your tax bracket.
Not bad, but that’s also if everything goes smoothly. What happens if you have a 15-20% cost overrun? There goes $2500.
9 months to sell? $1500 more gone, plus probably more because the longer properties sit on the market, generally the lower the price will be when it sells (seller becomes more motivated, and buyers start to wonder “what’s wrong with it”), so you might as well figure another $2000-2500 off as well.
Hope it helps,
Raj