Warning: The Most Critical Step You Must Know When Flipping Houses for Profit
Flipping houses for profit is a very lucrative way to make money. The truth of the matter is that real estate transactions occur whether prices are appreciating or whether they're depreciating. You as the house flipper, make money on the transactions on both ends in the rehab in the middle.
However, of all the steps in flipping houses for maximum profit, there is one that is the most important of all.
2 Critical Benchmarks When Flipping Houses for Profit
Both real estate investors and realtors make a regular living by buying and selling real estate. Someone makes money on the sale of the property and someone makes money on the buying of the property. Simply put, house flippers look for a property for sale, buy it, rehab it and then sell it for a reasonable profit. Although flipping houses for profit seems simple enough, its by no means as quick or simple as it many may make it appear.
Of all the steps to house flipping, some would say that buying right is the most crucial step and in order to do this consistently, we use several metrics to do it consistently:
1. ARV
Our first benchmark is called After Repair Value (or ARV for short) to help us determine how much we can SELL the property we want to flip. You can do this by using the information when finding houses to flip using real estate agents - which they can get from accessing MLS.
The first step in buying right is determining your repair or rehab costs. You can do this by getting an estimate from the contractor you plan on using. Once you know your house flip repair costs, then you can start doing your ARV analysis to determine what you should buy the house for.
2. The 70% Rule
In order to make sure that you lock in maximum profit house flipping, you'll need to base your offer on a specific set of parameters and don't deviate from them. Just flying by the seat of your pants will not allow you to flip houses for profit...plan on losing money, and lots of it if you want to go about it that way!
There are a number of ways in which to do this – but the best way is to use the 70% rule. I've used the 70% rule countless times and it is rarely failed me in either avoiding a bad purchase or making significant profits flipping houses.
How the 70% Rule Assures You'll Be Flipping Houses For Profit:
For example, let's say you have determined with your real estate agent that the after repair value of a certain house is $200,000. There are several comps in the area, and indicate that $200,000 is a fair price, and these recent sales give you an extremely good set of data that shows that you can get the same price for your property.
1. ARV x 70%: Take the $200,000 and multiply it by 70%, which equals $140,000:
ARV=$200,000
70% rule: $200,000 x .70 = $140,000
2. Deduct Repair Costs: Then deduct your repair costs from that $140,000. In this example, let's say that your general contractor has told you that will cost $40,000 to do the repairs in order to make the house sell at $200,000.
So if the repairs are $40,000, then using the 70% rule, you have now determined that the maximum price you want to pay for this house is $100,000:
Repair costs = $40,000
70% rule = $140,000
Maximum buy price = $100,000
By using the 70% rule, you have now determined that the maximum you want to pay for this house is $100,000.
However, there's more…
3. Submit a Discounted Offer: $100,000 is not going to be your offer price. This is very important when learning how to start flipping houses for profit. As in most cases when performing any financial transaction, you make your profit on the purchase. That's why this is the most crucial step when learning how to flip houses for profit.
You may want to offer the seller a percentage below your 70% rule price. We typically use 20% or even 30% under what we want to pay to start the negotiations with the seller. So in this case, we offer $70,000:
Minimum Offer Price: $70,000
You'll most likely go back and forth with the seller, haggling over price and other concessions. But by offering a buy price of 20 to 30% below what you ultimately want to pay, this ensures that you'll be able to lock in a profit when flipping this house.
You may even find that the seller may accept your first offer, which happens a fair amount of times, especially if the house is distressed or seller is looking for a quick sale. Making sure that the offer price is structured correctly is very important to which will cover in other blog posts.
The 70% Rule Ensures That You'll Make a Profit When Flipping Houses
Think of the 30% gap in the 70% rule is like a safety net to minimize the likelihood of unprofitable deals while ensuring you make a profit on the sale. Often times, your closing and holding costs may leave you with only a 20% profit due to circumstances beyond your control. So the 70% rule safeguards you and cushions you from that possibility.
Exceptions to the 70% Rule
As always, there are exceptions to every rule, here are a few:
- Adjust Down on The Low End: The 70% can be adjusted to 60% if you get the sense that you may be able to offer a lower price. Why offer only with 70% when you might be able to make an offer at 60%? Every deal is different and as your goal is to be flipping houses for profit, make sure you lock in the maximum profit on the offer price when you can. This may happen on foreclosures, short sales or where there is an urgent need for sale from the seller due to relocation, divorce or some other emergency. To lock in maximum house flipping profits, be alert for any opportunities to maximize your profit.
- Adjust Up on the High End: On higher priced house flips, you can have the flexibility to go over the 70% rule and go as high as 80% or higher – provided that the dollar amount is substantial. At the end of the sale. What this means is that the higher the price a property, the more flexibility you have on the 70% rule. For property that has an ARV of $1 million, then you can go to 80 or even 85% potentially. But for most people starting how to flip houses, pick houses that are in the moderate to low price range and stick to the 70% rule. The more houses you flip, the more experience you will get flipping houses for profit, and accordingly the more flexible you can become with the 70% rule.
When you're first learning how to flip houses, stick to the 70% rule. This rule keeps you out of the bad deals and help lock in maximum profit house flipping.
