Getting the math right is the single most important factor in successfully flipping a property. Without doing the numbers correctly, you are most likely to fall short of expectations. You will need to get a handle on your costs (including financing costs) and the profit potential for the property and its neighborhood. Your math will probably include the following:
- Loan-to-value (LTV)
- Total costs
- Profit potential
- Timelines
- Purchase price constraints
Let’s look at a couple of examples.
Loan-to-Value Ratio
An example of the type of math you’ll use is the loan-to-value calculation. The LTV ratio is usually calculated by dividing a property’s value into the loan amount. It represents the percentage of the property’s value that a lender will lend to the borrower. A traditional lender like a bank would use the property’s current appraised value to apply its LTV ratio and determine the amount it will lend. For example, a bank with an 80 percent LTV policy that appraises the property you want to buy at $400,000 will lend you $320,000.
Hard money lenders do it differently, in that they use the after-repair value (ARV) of the property rather than the current value. For example, if the estimated ARV of the $400,000 property is $500,000 and the hard-money lender LTV ratio is 70 percent, the loan amount will be $350,000.
Hard-money lenders can provide loans to rehabbers who don’t qualify for bank loans, and do so at competitive interest rates. In return, they set their LTV ratio a little lower that a bank would in order to protect themselves. By demanding the rehabber put more skin in the game, they give the borrower greater motivation to finish the project rather than walk away.
70-Percent Rule
Another type of math you can use is the so-called 70-percent rule:
- Estimate the ARV of a property, with input from a knowledgeable real estate agent who is familiar with comparables
- Multiply the ARV by 70 percent
- Deduct you estimated repair costs from the 70 percent figure
- The remainder is the most you should pay to buy the property
For example, for a $200,000 ARV with estimated rehab costs of $40,000, the rule says that the highest purchase price is:
(70% x $200,000) – $40,000 = $100,000
It’s just a rule of thumb, but a pretty good one.
You can do the math on a spreadsheet with a suitable template, and/or use a fix-and-flip calculator available online from a number of sites. These resources usually contain a comprehensive checklist of costs that you should adapt to your particular circumstances. You can download this good example of a spreadsheet, or try out this online calculator. If you are having trouble with some of the numbers, you can ask questions on a house-flipping forum or from a real-estate expert, like Specialty Lending Group.