Hey all – I’d like your input on something I’ve been putting together over the past few weeks. After years of flipping properties, some very profitable, some not so much, I’ve been trying to put together a one-stop equation to add a little consistency to my company’s investing tendencies, as well as even automate the process a bit. I’d like to hear some input and suggestions from actual real estate investors such as yourselves as to your experience with anything similar, and whether you think it’s missing something. Hopefully we can all collaborate together and put something really solid together than can make all of us money…
The formula is pretty good, but the way you worded will require some algebra skills for some to understand
The issue most face is correctly estimating the ARV (your Y). They tend to assume the highest sold price, but then they take the cheapest repair cost. Repair cost is directly related to the sale price. I do like the idea of selling 2% below the sale price to get faster sale. Another alternative is to give higher commission.
Another thing I do is always assume 6 months plus renovation time as holding (your X) even if the comps show properties moving in 30 days. I take it as worse case scenario.
One time I deviate from this formula is if the house is priced nicely, getting it for no money down, and I know I can owner finance it.
Thanks for the input so far, all. I very much appreciate it.
Fadi: I really like your idea regarding the 6 month worst-case-scenario renovation timeline. As you may be able to tell, either from the formula itself, or from the article, we take a very conservative approach to investing, and worst-case-scenario planning is very much a part of that. I also completely agree with you regarding how most people evaluate their renovation costs, but that’s why I built in the 15% cushion in order to hopefully counter that. Do you (or anyone else) think I should potentially increase that number? In personal experience, our renovation costs typically range anywhere from a few percent under budget (because we’re so conservative with our budget), to 10% above. I’d like to hear if anyone thinks that should be increased.
Please keep the input coming. Much appreciated. Thanks!
I noticed you have correction factors of .98 and 1.15 for sale price and construction costs. I assume you have those tighter than someone less experienced (like me) might, as you have better judgement.
I’ve looked over a few properties now and catch myself thinking high on sale price and too low on renovations already. Maybe I should go with .90 and 1.25 respectively.
Other than that, the formula looks pretty good from what I’ve seen. It should be in a web page/spreadsheet!
Thanks very much for the input! You offer a very valuable point. Those corrections factors are likely based upon my own personal experience, however the future sale price factor should be a more stable, across the board number if you’re utilizing a high quality real estate agent. My company relies heavily on the advice of our two agents, and they have thus far proven to be very accurate in their estimations. You can certainly perform some due diligence of your own on their estimates as well, by researching comparable SOLD prices. I think many investors, beginning especially, focus on current listings for calculating comps. The problem with this, of course, is that, if that price is so accurate, then why is the house still on the market!?
Our agents take it a step further, and after identifying several very comparable sales, they call the listing agents to inquire regarding the actual sale price (because the recorded amount may include closing costs, concessions, or even furniture and etc.). We’ve found that a majority of listing agents are happy to provide this information.
If you’ve researched an estimated sale price to this level, then the .98 factor should be very accurate at helping you price roughly 2% below actual market price.
Regarding renovation costs, I think you’re right on. I hadn’t thought of that before, but less experience would likely require a bit larger buffer. I don’t believe I would suggest a 25% one, but upping it to 20% certainly sounds reasonable.
Thanks so much for the input, and please keep it coming!
I think a 20% pack on the rehab costs is good. I’ve had similar discussions with lots of contractors who when agonizing over a bid are afraid that they’re too high. I always say:
“How often does the job take longer than you expected.” The answer is: “Most of the
time.” Then I ask: “How often does it go faster”…“Not so often”. One time a general contractor called me and said that he was sending me some prints for a job he wanted an estimate on (for painting). He chuckled and said “I guess you do your take offs and then start to subtract, huh?”. I said " No. I do my take offs and then start to add." Needless to say I didn’t get the job. It seems he was one of those GC’s whose motto is “I make my money putting subs out of buisness”. Not exactly win-win. If a 2K bump on 10K of projected rehab costs is going to cause you to break your nose than there’s probably not much of a deal there to begin with.
Well, first, I’m horrified, but not surprised, by your story, abc123. That’s why our company does all it can to avoid General Contractors whenever possible. If we can hire and coordinate the subs, and pay them better accordingly, everybody wins.
I also wanted to respond to your last comment – simply to highlight it. You are absolutely dead on. If your margins are so razor thin that 5 extra percent kills you, then the deal isn’t right from the start. That’s why I built into that equation, above, a desired profit level. Therefore, if you miss by a few percent here and there in your calculation, you haven’t turned a deal into a money pit, you’ve just narrowed your profit margin a bit. That makes all the difference in the world.
Well, the equation results in the NPP, which is the negotiated purchase price (a.k.a the sale price). In a sense the equation is built to run backwards as it is, since it mimics the proper way of evaluating an investment property (starting with expected future value, subtracting all your costs, and ending up with a purchase price – instead of most investors, that start with a purchase price, then add on all of their costs and hope for a future value that is reasonable).
But, for purely mathematical calculation, you can check your math by simply running it in reverse, so:
This is simply a more detailed, and complicated, equation of the age-old golden rule of “70% of ARV minus repair costs.”
Both require that a) you have a solid foundation with an accurate ARV and b) that you have good numbers for your rehab costs.
Also, both have to be adjusted for your particular market and it’s current market conditions. A blanket equation rarely works everywhere. Here, for example, if I allowed only a 2% deviation on price and only 6 months holding time, I’d go broke real quick.
Thanks for the input. Much appreciated. I do have a few comments:
First, while the 70% ARV minus closing costs may have served investors well for the past decade, it’s not nearly detailed enough to assure consistent time after time success in today’s market. Profit margins are just too tight to try and lump closing costs, carrying costs, realtor fees, a buffered renovation budget, and an under-market sale price into a generic percentage calculation. My company has used the 70% ARV minus closing costs in the past, however have found that we simply can no longer apply it while maintaining a sustainable business model.
As for your comment regarding the 2%, that number doesn’t represent a deviation in market price. It assumes the investor has done their homework on anticipated sale price (and picked an accurate one), and then lowers it by 2% in order to price below the market for a quick sale in order to minimize carrying costs.
Finally, I don’t understand where you got the six months holding time from. The equation utilizes the variable X to represent “holding time.” That variable, similar to all the rest, is situation specific. I may have used 6 months in an example explaining the equation, but it was just for illustration purposes. In today’s market, we usually budget for 9 months holding time, which represents 2 months for renovations and 7 months of sale time. Of course, the 2 months renovation timeline is obviously job specific as well, and the 7 months sale time can varying even from suburb to suburb.
Anyway, thanks for the great input. With this much input from other seasoned investors, we’re collectively building a modern day formula that can benefit all of us now and down the road. Thanks!!
I am having trouble reconciling the CC. Where is the hazard insurance premium? Additionally, in the equation, CC is multiplied by X. In the supporting calculation, CC is defined as debt service and holding costs multiplied by X. One too many X’s.
Let CC = [Monthly Debt Service (your mortgage) + monthly utility bills + monthly insurance premium + monthly property taxes]
In the equation, CC (a monthly expense) is multiplied by X (days on the market). The multiplier should be months on the market, or. the multiplicand should be daily expenses.
Fix this by changing the equation’s carrying cost factor to (CC * X / 30)
All – I’m still looking for feedback on this equation (see first post in this string). I’ve gotten some really great feedback so far, and want to put something together that can be collaboratively created for better accuracy. Please let me know your thoughts on it, and share any similar such “property filters” you might use. Thanks!