Step 1: ARV (After Repair Value)
This is a very important number that will make or break the deal. ARV is what you believe you can resell the property for once it is fixed up and goes back on the market. It’s basically educated speculation. Remember, this business is about logic, not emotion. When emotion is high, logic is low. It is important to take a conservative approach to leave nothing but upside. For example, if the ARV is 250K. I would negotiate the deal around the ARV being 240k.
Step 1a: Find Comps
Research properties that would be comparable to the subject property you are looking to flip on the MLS. If you don’t have access to the MLS use Zillow or Redfin or realtor.com. When researching comps you want to make sure you are comparing apples to apples. Meaning, if they aren’t considered comparable properties, you could be determining the wrong ARV. You want to eliminate properties that are not in an after repair value condition. You want to look for properties that have been remodeled on the same street, community, or zip code. Use the criteria below to determine your comps.
Step 1b: Same Bed and Bath Count w/ Similar Square Footage
If you’re looking at a 2 bedroom 1 bath you will want to make sure that you are only using comparable properties that are also 2 bedroom, 1 bath. If you plan on adding value to this subject property by adding a bedroom and bath then you would be using 3 bedroom two bathroom comparables.
Step 1c: Within ¼ Mile of Subject Property
After you check for comps on the same street, neighborhood, and zip code. Expand your search criteria and go out ¼ mile radius from the subject property. If you still can’t find any good comparables try ½ mile radius. Continue to expand by ¼ mile until you find a few good comparables. Keep in mind, the further you go from the subject property the more risk you are assuming. Why? Because you are buying something that has less supporting evidence to support your ARV when hitting the market.
Step 1d: Closed, Not Active or Pending
When choosing comps to determine your ARV you only want to use houses that have closed. Active listing for sale or houses pending escrow cannot be used as supporting evidence because you still don’t know what they will sell for. One ninja tip for houses pending the close of escrow is to call the listing agent and ask them if they can share with you where they landed in price. Some will be comfortable with sharing while others will not. If not, you could ask if they landed above or below asking and when the Close of Escrow (COE) is.
Step 1e: Same School District
This criteria is often overlooked and can sometimes vary within the same zip code! You may be looking at comps close by within ¼ mile radius with similar square footage and same bed and bath count.. BUT… if it falls within another school district it can greatly affect the sale price of the property. Premium school districts can demand premium price points.
Step 1f: Closed Within The Last 6 Months
Only use comparables that have closed within the last 6 months. When you sell a property once it’s fixed up the new buyer’s lender’s appraiser will only be going back 6 months when determining value.
Step 2: Estimate Construction Costs
Estimate your construction costs by either using a construction cost estimator tool or building a relationship with a contractor and learning their costs. This is a very important variable that directly affects you MAO. It is better to be conservative and assume something needs repaired in the subject property. Remember to build in a contingency budget of 15% to cover unknown/hidden construction costs that will come up during the renovation.
Step 3: Estimate Closing Costs/ Commissions/ Carrying Costs
You need to account for the hidden costs involved in purchasing, holding, and selling the house. Closing costs and commissions will vary slightly depending on the deal you negotiate with your agent, but for me, I typically use 5%. When calculating holding costs, this is what I do. Let’s say for example your hard money loan was for $500,000. If your rate is 10% that means 10% annually. Lastly, don’t forget to calculate the points. The way hard money lenders charge you is not only the interest rate, but also ‘points’ which is a fancy way of saying ‘percentage’ – the difference is that points are charged upfront regardless of the hold time.
Having access to a Deal Analyzer Calculator will assist you in these calculations and will give you the ability to make these calculations much faster.
Step 4: Make An Offer
Nothing happens in this business unless you make offers. The more offers you make the more deals you will do. Even if the numbers don’t work based on the asking price of a property, don’t be afraid of making a low offer. It most likely won’t be accepted but you will be remembered if they accept a higher offer and that buyer backs out.
Step 5: Offer Accepted, Schedule Inspections during Due Diligence Period
Now that you are under contract you need to vet the deal from a construction standpoint. It is important to order a home and pest inspection. If something pops up on these inspections that you weren’t expecting or didn’t account for in your repair estimate, get the repair priced out and ask the seller for a credit for that item.
Step 6: Walk Property / Create Detailed Scope of Work (SOW)
Walk the property and make sure you have accounted for everything that needs repaired. Refer back to your construction cost estimator if you used one and transfer every line item that will be updated to your SOW. You will want to create a detailed SOW with every line item being updated or making repairs to. You will then give this SOW to a contractor to have them bid out each line item. This ensures you are getting comparable bids from each contractor!
Step 7: Remove Inspection Contingency and Move Forward or Cancel the Deal
Once you go from an estimate of your numbers to hard costs you will now have two options. If the numbers work you will want to remove your inspection contingency and get ready to close the deal. If the numbers don’t work you will want to ask the seller for a credit off the purchase price in the amount that the numbers now work. If they aren’t willing to do that then you will cancel the contract. If you do this within your inspection period you will get your EMD (earnest money deposit) back from escrow.