I’ve had countless newbie investors ask me how I decide whether or not to take on a flip project. For the most part, what they’re asking is, “How do you know if (financially) the numbers work out in your favor?”
Most investors have some quantitative analysis technique for determining whether to pursue a project or not. Some use analysis techniques that require spreadsheets and/or complex formulas; other don’t use any formulas, but just go off a gut feeling they may have for the property or the location. While I’m certainly not a fan of the “gut feeling” method, I’m also not a huge fan of the complex analysis method either. While this may surprise some people (especially those that know my tendency to sit in front of large spreadsheets for hours on end), one of the main goals of my financial analysis is to be able to do it in my head in less than 10 seconds while standing in the property I’m considering.
Certainly the whole analysis can’t be done in 10 seconds, but most of it can be. The goal of my analysis is to determine what’s the highest price I can pay for a property and still make my desired profit. If I can purchase the property for that amount (or less!), I’ll take the deal. If not, I’ll pass.
So, what’s my formula for the maximum purchase price (MPP) of a flip property? Here it is:
MPP = Sales Price – Fixed Costs – Desired Profit – Rehab Costs, where
Sales Price equals the conservative estimate of what I can sell the property for (not necessarily the price I’ll list it for!).
Fixed Costs equal all the costs, fees, and commissions that I can expect to pay during the project.
Desired Profit is the minimum amount of money I want to make off the project when it’s complete.
Rehab Costs are the material and labor costs required to rehab the property into resale condition.
As an example, let’s say that I have a property I’m considering purchasing. I believe I can easily resell it in rehabbed condition for $100,000. Additionally, I know my fixed costs to be about $17,000 (see here for my personal breakdown of fixed costs), my desired minimum profit is $15,000, and I’ve estimated the rehab costs to be about $18,000.
In this case (this is the actual analysis from The Red Garage House, btw), my maximum purchase price is:
MPP = $100,000 – $17,000 – $15,000 – $18,000
MPP = $50,000
So, if I can purchase this property for $50K or less, I’ll jump on the deal.
In the actual case of The Red Garage House, I purchased the property for $45,000, making it a deal I was very happy to pursue. In fact, see here for the full financial details and results of this project…I ultimately was able to purchase the property for $45K, rehab it on budget, keep my holding costs down, and sell it for $105K — I made over $28K in profit on this rehab.
Btw, a very important — and too often overlooked — aspect of this type of financial analysis is understanding your fixed costs per project. In this article I discuss fixed costs and how to determine yours.