Investing in real estate has paid handsome dividends to industry players. In recent years, it is house flipping that has been the game changer for many.
Countless success stories have been shown on TV shows where house flippers transform the property with confidence. Flipping is certainly not the cakewalk these TV shows make it out to be. What good is flipping a house if it cannot generate profit?
Calculating After Repair Value: The Why
What these shows miss is the important work behind the scenes that derives a critical calculation – the After Repair Value.
This calculation is very crucial to success and it comes down to one thing – knowledge and experience. And one golden rule – the 70% house flipping rule.
Whether you are a seasoned player or an amateur, this rule of thumb ensures that you are able to estimate how much profit you could earn on the property by calculating the After Repair Value.
Let us see how that works!
How to Calculate After Repair Value: The What
The After Repair Value is the estimated final selling price. It is less a calculation and more a research exercise. After determining your final square footage, bedroom count, bathroom count and level of finishes, scour sale comparables. These similar sale comparables will provide you with an estimate of value once renovations are completed.
You can use websites such as Zillow, Realtor, Redfin and Trulia as a source for “SOLD” properties or speak to a real estate agent. You can also use a local listing service. Have everything?
Now, let us see how that works!
How to Reach the After Repair Value: Here’s a Handy Guide
Step 1. Compare
Consider 3-5 comparable properties: Select similar properties and compare them with the investment property you are considering. These will be your price-reference points.
Type/style of the property: Multi-story homes should be compared with multi-storied homes, just like duplexes with duplexes, town houses with other town houses, ranch with ranch and single-family detached homes with single-family detached homes.
Size: Make sure to calculate above-ground square footage that is within 20 percent of the subject. Calculate the basement square footage separately.
Location: Select an area within one mile for an urban neighborhood and within three miles for a suburban neighborhood.
Age: Select a property that is constructed within 10 years of your chosen property. You can widen the age bracket if the house is over 50 years old.
Sale date: They must have been sold within the last six-months. Keep in mind that some banks prefer three months for appraisal purposes.
Bedroom/bathroom: Only consider above-grade bathrooms and bedrooms.
Step 2: Calculate
Calculate the average price per square foot.
For instance – You are comparing 4 comps in the same area that happen to have 4 bedrooms and 3 bathrooms and the average dollar per square foot is $X for these.
Now, multiply this amount by the new total square foot amount of your chosen investment property to estimate the After Repair Value of a fix and flip home.
Step 3: Here’ the formula for After Repair Value
Price per SF * new total SF
This should be your property’s ARV after the calculation.
Step 4: The 70% rule
Now that we have the After Repair Value, we have another formula – the good ‘ole 70% rule! The best part is that it shows you the potential 30% profit margin in the investment.
As per this formula, the buyer must pay 70& of the After Repair Value of a property subtracting the repairs needed.
|Maximum Purchase Price = After Repair Value * 70% – Estimated Repair Costs|
Step 5: The final value of the property
The 70% rule uses After Repair Value to calculate the property’s final value. However, it must be noted that it is only for the fix and flip investor.
The current owner of the property would get a different valuation as they might or might not take repairs into account.
So, you may need to negotiate with the seller to achieve the maximum offer price that you have estimated.
Loan Calculator: Using the After Repair Value
There are automated after new construction and rehab loan calculators that could help you for free.
You can use our Deal Calculator for a better estimate. Fill in the cost parameters and After Repair Value and let the calculator estimate the loan cost!
Whether you keep it as a hard copy or a soft copy, this ensures you have a detailed estimate of the repair cost estimates and expenses in one place.
House Flipping For Profit: Being Real
In many cases, investors may only want to give 60% of the After Repair Value, barring the repairs. In others, they may be willing to offer as much as 75% or 80%.
You must also include soft costs like the fix and flip loan, if any.
Keep in mind that repair costs and After Repair Value in a fix and flip property can make or break your bank, so do as much research as possible. Use the worst-case-scenario numbers as a default.
Also, market momentum should be considered, for better or worse.
You must remember that selling a flipped house doesn’t mean just fixing it. At the end of the day, there are a lot of factors. The market conditions keep changing and are a big factor in calculations
The housing crisis in the year of 2008 is an example. Another case in point is the pandemic.
(Source: ATTOM Data Solutions)
According to the ATTOM Data Solutions report, the rate of house flipping have decreased, but the gross profit on an average home flip rose in the first quarter of 2020 to $63,000 from $61,900 in the last quarter of 2019. Moreover, the profit saw a sharp increase in the last quarter of 2020.
The data in the report showed that the gross profit on house flipping in the country rose to $67,902 in Q2 of 2020.
So, yes, the graph above shows sales may have taken a small hit, but not the prices. Thus, real estate remains a valuable market. Learn more about it here.
Get in touch with BD Capital if you have more questions.