A quick summary
The first and perhaps most vital decision when house flipping is deciding whether a property is worth investing in, for this purpose. Read on to find out how to determine if a house is worth flipping, and where the ARV and 70% rule fit into this.
Flipping houses has been made popular recently by the many entertaining shows on TV, however house flipping has long been a successful real estate investment strategy used by many. The strategy involves finding a house that is typically selling below market value, making the necessary repairs and improvements to the house, and then selling it again at a higher price to make a profit. It stands to reason then, that the most important decision for the house flipping process is the initial house purchase. Let’s take a closer look at how to determine if a house is worth flipping.
What do investors look for when trying to find houses to flip?
There are some dos and don’ts for investors who are looking to flip houses, and these can be deal breakers. After all, flipping houses is a business, and it requires a savvy and strategic approach to make good decisions.
Signs that a house is worth flipping
- Priced below market value: A house that is well priced for your purposes is the first kind of house you should consider flipping. The aim is to make a profit, so the lower the price the better, however, keep in mind that lower priced homes may come with larger repairs, so you’ll need to weigh up the good price with the work that is needed.
- Property records are suitable: Check out the history of the property to see what price it was sold for before, and how much it is selling for now. You can also make sure that there are no tax liens against the property or any outstanding issues.
- It falls into the 70% rule: We’ll discuss the 70% rule in more detail further on, however it’s worth noting that this tool is an effective way to determine if a house is worth flipping, and houses that don’t fall into this could be a waste of time.
- The ARV shows a good profit: We’ll talk about the ARV later in more depth, but if the property has a high ARV that shows you’ll make a good profit, it stands to reason that it’s likely to be a worthwhile investment.
- Repairs are minor: Minor repairs are a good sign; they show that the house has not fallen into disrepair entirely and you won’t need to spend too much getting it fixed up and ready to sell again. The less you can spend, the better, and the higher your profit will be if you can do the right improvements.
Signs that a house is not worth flipping
- Overpriced: If a house is priced above your budget, or far above market value then it’s more than likely not a worthwhile house to flip. You’re trying to make a profit with the flip, so any house that is priced too high will make that goal difficult or perhaps even impossible to achieve.
- High running costs: You may not need to keep the home for a long time while you’re fixing it up, but high running costs can be a deterrent. Particularly if there are outstanding bills. So, make sure to check the HOA fees, utility costs, property taxes and so on, before you decide if the house is worth flipping.
- Major repairs: A house that has major repairs could end up costing more to fix than is worthwhile. If you come across major repairs immediately, such as a damaged roof or any foundation problems, you may want to move onto another home as these will be costly to fix.
Viewing houses through the lens of After Repair Value
The After Repair Value (ARV) is one of the most important numbers to know when it comes to house flipping. This calculation will help you determine if a house is worthwhile flipping or not, based on what it will be worth once the repairs are completed. The ARV value is helpful for 3 reasons:
- Estimate how much the property will be worth once the repairs are completed
- Work out how much you should buy the property for
- Figure out how much you should spend on repairs and renovations
When you’re looking at how to calculate the ARV, you’ll need to:
- Estimate the house’s current value by getting it appraised or using another method. The ARV uses both the current value and the value of the repairs to estimate how much the house will be worth once the repairs are complete.
- Work out the total value of the repairs and renovations. First, you’ll need to work out the potential cost of the renovations, and from there you can determine the value of these renovations in terms of how much profit they will generate for you.
- Consider similar houses in the area, also known as comparable properties or comps. This is called a Comparative Market Analysis (CMA). These houses should be a similar size in square feet, have the same number of bedrooms and bathrooms, and be a similar age. From these properties you can get a good idea of what houses in the area are being sold for, and how long they will sit on the market. Make sure to look at homes that have been sold in the last 3-6 months.
The ARV is vital and something to keep in mind when you’re looking at a house to see if it’s a worthwhile investment. You can get a feel for what your ARV will be, by checking out which repairs need to be done and doing your homework on the ROI of these repairs. A quick way to get your ARV is to use an online ARV calculator such as the one New Silver provides for free.
The ARV is a crucial element of the 70% rule, so let’s look at what this is and how to use it when you’re evaluating a property to flip.
Learning how to use the 70% rule
Knowing how much money you can make in a house flipping project is crucial to the decision you’ll be making about whether to go ahead with the property or not. Once you’ve gotten to grips with the ARV, it’s time to use this in your next calculation which can help you determine whether a house is worth flipping.
The 70% rule is a general rule of thumb, which is a useful tool for real estate investors who are trying to determine the viability of a house for flipping. The idea is that investors should spend no more than 70% of the home’s ARV minus the cost of the repairs and renovations. This is not a hard and fast rule, but it does give real estate investors a good estimate of how much you should spend on buying the house.
Maximum Offer Price = After Repair Value * 70% – Repair Costs
Understanding the risks involved in any house flipping project
While house flipping projects can be a great way to make a profit, there are various risks involved. Here are some of the risks:
- Losing money: One of the biggest risks that investors take when flipping houses is that they could lose money. If you cannot sell the property quick enough, you may have to pay the loan or mortgage, or there may be large repairs that end up costing you a lot and taking away from your profits. Unless you do a full inspection of the property before you buy it, and you’re well acquainted with the market to make sure that it sells, you can end up losing out.
- Hidden costs: There can be hidden costs that pose a risk to investors because they can be detrimental to the deal. These hidden costs can come in the form of property taxes, insurance, utilities and more.
- Bad contractor: If you don’t hire a reputable contractor that comes with good references, you could land up in hot water. A bad contractor can cause your entire deal to fall apart if the work takes too long or is way over budget. Investors should get a detailed timeline for completion of the project upfront, along with a close cost estimate, to avoid this situation.
- Market crash: Some risks simply cannot be foreseen or planned for, such as housing market crashes. These can turn a great house flipping deal into a big problem if the market turns and the house cannot sell, or its value takes a dip. This is not something one can plan for, but it is something to keep watch on, during the process.
The bottom line
While there are some risks associated with house flipping, these can be mitigated by thorough research and strategic planning as much as possible. House flipping remains one of the most popular avenues for real estate investors to make money and can be a profitable avenue for new and seasoned investors both. Provided that investors the make the first crucial decision correctly, which is deciding whether a house is worth flipping or not.