A short summary
Flipping a house can be a great investment strategy, but the first step is to find a property to flip. This property will need to be at a price point that you can make a success out of, which means that you’ll need to figure out whether it’s a good deal before you make an offer, based on a few numbers. To help you with these, keep reading our House Flipping Formula – Beginner’s Guide.
Table of Contents
If you’re new to the business of flipping houses, you’ve probably heard of the house flipping formula. As one of the most talked-about concepts to do with flipping houses, the formula forms the basis of the key decision that real estate investors need to make before purchasing a property… will it be a successful deal?
The most successful deals are usually properties that are being sold below market value. The way to determine the likelihood of a successful deal, once you’ve found a home being sold at a good price is by using the house flipping formula. Let’s take a look at how it works, so that you can use this on your next house flipping project.
What is the house flipping formula?
The most important consideration when deciding on a house flipping deal is the numbers. When we say ‘the numbers’ we are referring to the house flipping cost breakdown; After Repair Value (ARV), repair costs and potential profit that you could make on the home. The 70% rule is most commonly used by real estate investors who are scouring listings to find a property, to determine whether they should make an offer on a property or not.
What is the 70% rule in house flipping?
To use the 70% Rule, you need to know the After Repair Value (ARV) of the investment property that you are hoping to flip. Once you have the ARV, you will simply multiply it by 70% and then deduct the expected rehab costs. The number that you’re left with is the maximum price that you should pay for the house. However, bear in mind that the 70% rule is just a general guideline and not a hard and fast number. There are factors that it doesn’t take into consideration, such as market conditions.
An example
If the estimated value for your ARV was $220,000, you’d multiply that by 70% (or 0.7) and arrive at $154,000. Then you’ll need to subtract the estimated cost of your repairs from this. Let’s say that your estimated repair costs are $30,000, you’d then be left with $124,000. According to the 70% rule, $124,000 is the maximum price you should pay for the house.
How do you estimate house flipping repair costs?
You’ll need to work out how much the house repairs could set you back, in order to reach your projected ARV. Different homes will need different levels of repairs, some might need all the flooring replaced and major renovations, while some may just need a new coat of paint and minor renovations. The types of repairs that may need to be done include:
- Roof and gutter repairs or replacements
- Landscaping
- Flooring replacements or cleaning
- Exterior repairs to windows, doors, decks etc
- HVAC repairs, electrical and/or plumbing repairs
It’s a good idea to make a comprehensive list of the repairs that need to be done and then partner with a general contractor to get an idea of the cost of each project. Alternatively, there are online repair cost estimators, and while they may not be as accurate, they will give you an initial idea of what your overall cost might be.
For those are new to real estate investing, working with a home inspector can be valuable in this regard as they can tell you what needs to be fixed in the home to bring it up to scratch, and if these are expensive repairs then it may even be best to consider another property. Home inspectors also have a good understanding of how much repairs usually cost, so they can help you with your total cost estimate for repairs.
How do you estimate the ARV?
Working out an estimate of the ARV for a house requires research and planning. There are 3 questions to consider:
- Which repairs will add the most value to the property?
- How will the house be able to compete with similar homes in the area once the repairs are complete?
- Where is the house situated?
It’s important to get as accurate as possible with the ARV, if you estimate too high, you could end up with less profit than you think when you don’t sell the home for as much as you had anticipated. Comparable properties in the area are a good place to start when determining the ARV of a house. These properties will give you an indication of the price point where you can place your house and how long it will take to sell.
To save you some time, there are useful online tools, such as New Silver’s free online ARV calculator that you can use as a quick way to get an estimate.
How do you calculate house flipping profit?
Many real estate investors would consider a 20% profit a success, with a 10% profit sitting at the low end. You can calculate the profit that you’ll make from a house flip by subtracting your project expenses from the project revenues. Your expenses include the purchase price, the cost of the repairs, buying costs, selling costs, financing costs and holding costs.
Another way to calculate house flipping profits is to use a loan calculator like New Silver’s hard money calculator. In order to give you an accurate estimate, this calculator requires the following information:
- Purchase price
- Rehab budget
- ARV
- Property taxes (per year)
- Loan to project cost
- Estimates turnaround time (in months)
- Interest rate (annually)
- Origination fee
- Closing costs
- Realtor fee
- Holding costs (monthly)
- State, recording and transfer tax
Does the 70% Rule Always Work?
The 70% rule often works, but not in every situation because it depends on the housing market in the area. For example, in a seller’s market where demand is high and supply is low, a seller might not accept the offer that you arrived at by using the 70% rule.
As useful as the 70% rule is, it’s always a good idea to research the real estate market in the area where you’re investing because this can have a big impact on the amount that you should be offering for a house. However, the higher you go above 70%, the less profit you’re likely to make on the deal, although in a hot market a risk like this could be worthwhile.
What happens if your offer is rejected by the homeowner?
Sometimes a seller will reject your offer, even if you used the house flipping formula to arrive at a fair amount. An offer can be rejected for a number of reasons:
- If it’s a seller’s market, there may have been serious competition and someone else may have made a higher offer.
- A seller may choose an offer with less contingencies so that the sale can go through quicker.
- If you haven’t got pre-approval on a loan, along with a proof of funds letter, a seller is likely to be wary.
- Sellers are sometimes specific about closing dates, and if you cannot fall in with what they want, they may reject the offer.
If your offer is rejected, the first thing you should do is figure out why it was rejected. Once you know the reason, you can bear this in mind for future offers. If it’s something adjustable, you could adjust the terms of your initial offer and make another offer, to see whether the seller would be more willing to accept it.
A seller could make a counter offer if they accept parts of your offer and not others, to which you can respond by either accepting it, rejecting it or putting forward your own counter offer. If the seller’s counter offer is something you’re willing to accept, then you can move forward with the sale. If it’s not entirely something you want to accept but you’re willing to negotiate parts of it, you can go back to the seller with your suggestions in another counter offer and see if you can close the deal. If the seller’s counter offer is simply not something you’d consider, you can reject it and continue on your property search.
Final Tips for using the House Flipping Formula
The house flipping formula isn’t a fool-proof formula, but it is an effective solution to help real estate investors who are serious about house flipping and finding good deals. The house flipping formula is a quick way to work out the maximum that you should pay for a property, so that you can make an offer that is a win-win for both parties, both fair to the seller and low enough that you can make a profit from the deal.