Experienced home flippers know that you make your money when you buy, not when you sell. In other words, if you want to have a successful fix and flip project, you’ve got to start with due diligence. That means evaluating both the upside potential of a property, and its downside risk. Not only do you have to be careful to account for every cost, but you also need to take a look at the overall market and stress testing the numbers should conditions change. Brokers and lending partners have even more to gain here; being an expert in the fix and flip space allows you to effectively reach more investors and grow your deal pipeline.
Do you want to learn how to analyze fix and flip deals like a pro? Here’s a quick guide with everything you need to know.
When flipping houses, After-Repair Value (ARV) is the most important number to get right. After-repair value is the projected cost of a property once all repairs and renovations are completed. It’s crucial to a successful fix and flip deal because it serves as the basis for nearly every decision you’ll make. An ARV that’s significantly above the property’s current value indicates that it’s prime for flipping. But obtaining an accurate ARV relies on a number of different factors, from property size & features to comparable sales and overall market demand. Although it can be difficult, it’s crucial that investors get this right. Unrealistic expectations can make it harder to secure financing, and there’s increased risk if market conditions shift and the deal is suddenly less profitable.
Brokers can offer their market expertise here to provide additional value to clients. Helping them evaluate deals before they move forward means they’re more likely to succeed, and it also helps you build stronger client relationships.
In order to determine the total cost of acquiring a property, you need to consider expenses beyond the purchase price and loan interest rate. Closing costs can add up to a significant amount, especially when you factor in title fees, escrow costs, and other legal expenses. Similarly, financing costs can quickly get out of hand if there are excessive origination points included, or the lender has high fees. These expenses all impact the profitability of a deal, but they often get overlooked by inexperienced investors. As a lending partner, you should encourage your clients to carefully consider each of these expenses.
The next step to evaluating a potential flip is getting an accurate estimate for the renovation work. Start by creating a list: the first items to tackle are the necessary repairs, then you can move on to value-add upgrades, and finally cosmetic improvements. Common areas to renovate include the kitchen, bathrooms, roof, electrical system, and paint & flooring throughout the property. After creating this list, go out and obtain multiple contractor estimates. This not only lets you compare bids but also helps you catch any red flags that you may have missed at first glance. Also be sure to establish a contingency fund, as unexpected repairs are fairly common during renovations, and this can help protect the deal’s profit margin.
Most investors don’t realize just how many costs there are with a home flip, even in the few short months they own the property. The main costs can be easily remembered with the PITIA acronym: Principal loan costs, Interest, Taxes, Insurance, and Association Fees (if applicable). With a home flip however, there are additional costs such as renovations, permitting, and utilities during the holding period. There are also costs associated with the sale, such as agent commissions, marketing expenses, and transfer fees. Including all these expenses in a budget is crucial for getting a more accurate picture of a deal’s true cost.
The key to determining the final sale price of a property is taking a look at the statistics in the local market. Start by finding comparable sales in the same market as the property to give you a good idea of the average sale price. From there, you can determine housing demand by checking inventory levels and the average number of days a property spends on the market. Local school districts and proximity to shopping centers or transportation hubs can also affect property values. And again, lending partners can offer their guidance here to help their clients better gauge demand in a specific market.
Once you’ve taken time to conduct due diligence, you can put all the numbers together to determine the deal’s profit margin. The ARV – Total Project Costs (Rehab + Resale) = Estimated Profit. From here, you can use the 70% Rule to check if the project has a healthy profit margin. This rule states that you should pay no more than 70% of a property’s ARV minus repair costs. Fix and flip pros use it because it ensures there’s enough of a profit margin in a deal to ensure it’s worth the effort, even if things don’t go exactly as planned. Market conditions can change quickly, but this helps manage risk and keeps investors from choosing less profitable deals.
If you want to provide your clients with a stellar lending experience, partner with a lender that has a proven track record in the real estate investing space. RCN Capital lends to real estate professionals, commercial contractors, developers & small business owners across the nation. We provide short-term fix & flip financing, long-term rental financing, and new construction financing for real estate investors and lending partners. If you are looking to offer fix & flip financing to your clients, RCN Capital has competitive loan options and an award-winning broker referral program available to partners.