What I’m reading: Funny Money by Mark Singer
What does a good single-family fix-and-flip deal look like today?
A lot of deals I look at--particularly with less experienced borrowers-are thin. The margins are tight. Below I will share my guidance to potential borrowers when it comes to what they should consider a minimally acceptable margin in a flat real estate market. I landed on this formula because I’ve done a thin deal or two (or three) over the years and it stinks to work hard, to take on risk, and to get paid inadequately for it.
I like to see borrowers into a deal (their purchase price + renovation cost) for 75% of the fully renovated value, also called the ARV or After Repair Value. I call this formula the ARV Percentage.
The ARV percentage allows a borrower to work backward to determine a maximum acceptable purchase amount. Here are the steps:
1. Determine the ARV.
2. Compare this ARV to the seller’s bottom line asking price. If the seller’s asking price isn’t less than 75% of the ARV, work more on negotiating with the seller before wasting much time estimating repairs.
For example, if the ARV of a house that needs work is $300K and the seller’s bottom-line price is $225K (75% of $300K) you need to work more on negotiating before you waste any of your time estimating repairs.
3. If the seller’s bottom-line price is less than 75% of the ARV, then it’s time to estimate repairs. If you flip a lot of houses in the same market, this is easy. If you rarely flip, you’ll need the help of a licensed general contractor to build a budget.
4. Multiply the ARV by .75 and subtract your renovation budget. For a fix-and-flip, this is the maximum amount you want to purchase a house for.
This formula produces deals that have enough margin for a borrower to properly renovate a house without cutting corners and still make a solid profit relative to the risk they’re assuming.
What does a borrower do in a market where ARV’s are rapidly rising? Just adjust the ARV Percentage to reflect expected appreciation during the holding period. If you expect ARVs to rise 1% a month during your holding period, raise your ARV Percentage to 80%. If you expect ARVs to fall 1% a month during your holding period, lower your ARV percentage to 70%.
Common pushback I get on this ARV Percentage approach: “Bob you’re not taking into account escrow costs, title costs, your hard money related fees etc.”
My response: You want an approach that produces solid margins and lets you make quick offers, often over a kitchen table. If you’re buying deals using this approach, there’s sufficient margin to build a solid business without getting you bogged down accounting for smaller expenses most of which scale proportionately to the deal size, to begin with.
How can a borrower tell if their market is falling, flat, or rising? I’ll discuss this in a future Hard Money Monday.