Have you taken the time to accurately determine your real cost to acquire, rehab, and sell a project home? It's incredibly important to do this so that you can determine the Maximum Allowable Offer (MAO) for an investment project.
Your MAO is based on a formula you use to determine the profit you will make. Rehabbing is a relatively risky business requiring a large amount of capital. That means the risk/reward ratio should be high. The typical profit margin is between 35% to 30% or a purchase price that is 65% to 70% of the After Repair Value (ARV).
The MAO is calculated by taking the ARV (the price you will sell at) and subtracting out the expenses you will have during the rehab. The formula is:
Retail selling price - purchase price - rehab costs - carrying costs - holding costs - closing costs = Profit X 0.65 = MAO.
All of these numbers will vary not only by region of the country you're investing in but by exact neighborhood you are investing in. An experienced investor should have no trouble quickly determining the retail selling price. Carrying costs include your cost of capital (any loans you have to pay interest on). Rehab costs are the most challenging to calculate and I'll go into detail shortly. Holding costs include insurance, property taxes, and utilities. Closing costs include points paid for loans, realtor commissions, and a slew of other smaller fees.
Rehab costs vary both by region and materials used. You need to become proficient at estimating your own rehab costs. Don't use the numbers I'm going to give you. This is a technique for estimating rehab costs but you need to use numbers based on your location and materials.
Those include the basics for a typical remodel. However, don't forget to include other items such as garage doors, rebuilding porches, new asphalt on driveways, landscaping, new bathroom fixtures, drywall, and painting. In the end, add 10% to your estimate to be sure of coming in on budget.
You will be making this calculation frequently. Rehab investors typically have 20 offers rejected for every 1 accepted. You want to be both quick at estimating rehab costs and thorough. The best way of doing this is having a very detailed electronic spreadsheet. Include every conceivable cost to use it as a checklist. You want to automate the spreadsheet to capture all of the information needed to calculate your MAO. With experience, it should take you less than a half hour to fill out the spreadsheet for a possible deal. When the MAO pops out of the spreadsheet, you know exactly at what point to hold the deal or fold on the deal.
Author bio: Brian Kline has been investing in real estate for more than 30 years and writing about real estate investing for seven years. He also draws upon 25 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest in the Olympic Mountains with the Pacific Ocean a couple of miles in the opposite direction.