Middleborough Part 1 | When To Break The 70% Rule
Hey, guys. It's Mike, with House Flipping School. Welcome to this week's whiteboard lesson. We were recently talking about a property we picked up in Middleborough, Massachusetts. Now I want to go ahead and breakdown the numbers to show you how we arrived at the purchase price for this particular deal.
One thing I want to point out here right off the bat is by using our 70% formula, our goal would have been to buy this property at $115,000. I'll explain that in a minute.
We ended up getting the house for $120,000. Typically you hear me talk a lot about sticking with the 70% formula. Don't get away from that because you might get yourself in trouble by overpaying for a deal. What you're going to find out is markets start to shift and markets start to heat up. It might be a little more difficult to find deals, and sometimes, you might have to break away from that formula.
This is a perfect example of this that I want to share with you. You really have to make sure that your numbers are true, because it's okay if you do this, but if you're way over on your construction budget and you miss your ARV by a lot, then you basically missed on all 3 counts. That's what you want to avoid.
On this deal we had come up with an after repair value of right around $200,000; I still think that was conservative. We honestly thought we might be able to sell this house at $210,000. Nevertheless we took the conservative approach and we carried the $200,000.
How we arrived at that number is very important. It's not a number you just want to pick out of the sky or pick out of a hat, or get some information from Zillow, Trullia, any of those websites. All those sites are good for getting information and doing some research to help make numbers make sense to you. Yet what you want to do is what's known as a CMA, which stands for comparative market analysis.
Really, you want to rely on the experts in the industry. Get that CMA done by expert real estate agents. Arrive at what that selling price is, because if you get that wrong, you're going to be fighting uphill the entire deal.
If you're not a real estate agent, what you want to do is seek out a real estate agent that is good at running CMAs. Explain to them that you're an investor, and really tell them how important that ARV number is to you.
You don't want a number that's real high. Maybe you need to talk to 2 or 3 real estate brokers in the beginning, as you get comfortable in who you want to work with. I can't stress enough how important it is to get that number right.
From there, you may have heard me talk about the 70% Rule. All we're simply doing is taking 70% of $200,000, which gets us to a base price of $140,000. Then from there, we subtract our cost of repairs, which in this case was $25,000. In the next video, we'll break that down for you and show you exactly how I arrived at 25K.
That basically gets us to an ideal price, or maximum allowed offer. Maximum allowed offer would be $115,000. If you notice, the purchase price is $120,000. Why'd I break my own rule?
Like I said, inventory was disappearing at the time, and the market was heating up a little bit. On average, we're doing one property per month, and we needed to get some deals. We did not substantially overpay, as 120K was just slightly off from our target.
The reason why we went at the $120,000 is because we felt there was some competition on this particular house, and low and behold there were multiple offers. That's why we went as high as we did. We ended up getting house, but not by much. I think $500 less was the next highest bidder, so we just barely got it.
Understanding what the numbers are is very crucial. I think this property was listed at $99,000. A lot of the amateurs came in and were bidding $89,000, $99,000, or $100,000. As you can see, we bid $20,000 over asking, and we end up getting it.
What I want to show you here is how that breaks down to what our projections are for profit. You always need to know what that is going to be. We try to keep it simple here and basic, so you can understand where the numbers come from.
From the 70%, what's left over is 30%. That 30% is basically your profit in your soft costs that are not carried in your repairs. You got to pay attention to this because these add up. A lot of people forget about these.
We'll talk about the soft costs first, which is 10% of the after-repair value, which puts us roughly at $20,000. That gets eaten up really quickly, and I want to explain to you why. In those soft costs is our real estate commission for selling the property. If you just simply look at that and say, "What's 5% of $200,000?" That's $10,000 right there for commissions.
Then you have your interest on your money that you borrow. Let’s say you borrowed $140,000, and your cost of money is 10%, and you figure about 6 months. 10% of $140,000 is $14,000 for 12 months, so that would be roughly $6,000. We're at $16,000 right there, just for those two items, and another $4,000 for taxes and insurance. That can vary. That can be lower, that can be higher, but usually, it's right around that 10% mark.
The other 20% is usually where your projection is for profit. 20% of $200,000 is $40,000. Remember, we did not pay $115,000, we paid $120,000. If you notice over here, I put $35,000 to $40,000. Ideally, based on this formula, really our projection is $35,000.
That could potentially be $40,000, if you save a little bit of money in repairs and maybe sell it quicker, and might not have to pay as much on the interest rate. That's why we put that range in there. Based on that model, we felt it was a good enough deal to go after.
Now it was time to go ahead and do the repairs and keep our cost in check. We'll share more of those details with you in the next video. Hopefully, that helps you understand how we arrived at our offer and what our projections were for the net profit.