Today I’m going to show you how to calculate the maximum amount to pay when you’re doing a flip to be safe and make a healthy profit. Once you have identified a suitable property to fix and flip, there are a few things that you will need to know. Is it priced correctly, in the right area, how much will it cost to renovate, and what to offer? I will show you examples of calculating these costs and what to expect.
Firstly, this formula is best employed as a quick rule of thumb to calculate your figures. It is not exact, but it allows you to have a ballpark figure in your head when you go to negotiate a sale with the property owner. You must have an idea of the renovation costs, so I suggest you get a professional contractor to price the renovation even if you are good with refurbishment costs. A professional quote is helpful in negotiations and financial management of the project. I would also suggest that the property is kept in line and style with other properties in the area, don’t over or under-improve; it must sit right with the character of its neighborhood.
For illustration purposes, I have put together a presentation on my YouTube channel, which you can view here. In it, I have chosen two houses to explain the pros and cons of each property and how a lower-cost property may not return a bigger profit than a higher-cost one and vice versa. Several variants involve costs and refurbishments, but the most important is the ARV or after-repair value. This figure will identify the comparable value of the property in its specific area. You can find this figure by contacting a local realtor. This will give you an idea of its purchase and resale price after repairs. The repair cost of the property is another crucial cost to calculate. This can be tricky if you do not know the area well, but I usually categorize repair costs into small, medium or large projects. You will also need to calculate your closing costs, including legal fees, commissions, and kickbacks, which are expected to close a sale with the seller in some areas.
These costs will influence the MAO, the maximum allowable offer figure, which can be calculated by simply multiplying the ARV by 0.7. So you want to have 70% of the price of how much you will sell it for. And then you’re going to deduct all the renovation and closing costs. And that will give you the magic number you want, which is the maximum allowable offer you will pay. So that’s how much you must purchase that property to be profitable. Here is an example using a property with an ARV of $300,000. If we sell this property for $300,000 on the market, my repairs will be $45,000. The closing cost is $10,000. Using the formula, we multiply $300,000 X 0.7, deduct $45,000 and then $10,000. This is going to leave us with $155,000. This means we must purchase this property for $155,000 or less to make a reasonable profit.
You can negotiate many things here to ensure you realize a bigger profit by flipping the property. Maybe you can persuade the seller to pay for closing costs, or they make some other more extensive and more expensive repairs. Remember, this is a rule of thumb as there are other things to consider when negotiating.
In conclusion, the MAO is an easy way to roughly determine the price you should pay for a fix and flip property while still making a profit. Memorize this formula, and you can apply it over and over again so that you will soon get to know by looking at a property how much its worth. Until next time, invest wisely.
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