Articles

This is one of many articles we will be writing regarding investing in Real Estate.  Today we’ll be looking at evaluating a distressed property for resale profit potential.   Traditionally, we call these “flips” in Real Estate terms.  Just a property you intend to purchase and sell quickly for profit after repairing.

Flips are very popular in the Real Estate industry.  It’s exciting to acquire a home and make some changes and then realize the fruits of your labor.   When done correctly they are quite profitable and a worthwhile venture.   However, there are many stories of failures by folks who didn’t quite know what they were doing and misunderstanding what was involved.

To properly evaluate a flip, we have to look at something called the After Repair Value (ARV).  ARV is an acronym you will see a lot of when talking about flips.   It’s a paramount number and its very important you get that figure correct because all of the calculations depend on it being accurate.  Once you know the ARV, you then have to calculate your HALF costs.  HALF stands for Holding, Acquisition, Liquidation and Fix-up costs.   Then you can simply calculate the profit.   ARV-HALF=PROFIT.   Let’s look at a quick example:

HUD Home for sale = $50,000
ARV = $170,000
HALF Costs:
Holding (6 months) = $2500
Liquidation = $17,000
Acquisition = $50,000 + $2500
Fix-up = $75,000
Total HALF costs = $147,000

Total Profit = ARV ($170,000) – HALF ($147,000) = $23,000

Let’s talk a little about the different HALF costs and how to calculate those.  

Holding costs would involve any expense incurred due to owning the home.   Property Taxes, Utility costs, Loan Payments, etc. all are a part of holding costs.  I know one investor who used a HARD MONEY loan to do flips.  They had to pay a premium every month they held the home PLUS share in the profits at the end.  The faster they worked the less holding costs they had so there was motivation to get things done quickly.

Acquisition costs are pretty straight forward.   The sale price of the home is the biggest part of this but there are closing costs a buyer pays when buying a home.  If you purchased a home at auction you might have to pay a buyer premium fee or title insurance costs.  There is almost always a closing fee of some kind.  With gas prices today, if you have to make several trips to the home in order to evaluate it and eventually close and if it is a good distance away, those trips could add up in costs.

Liquidation costs are simply the fees and taxes involved when selling any home.  10% of the ARV is a conservative number, but it could be less depending on the terms of the sale.

Fix up costs can be very dynamic and difficult to get perfect.  You really need an expert to help you if you haven’t done a lot of flips.   This number means everything and if you underestimate the repair costs you end up making much less profit or even taking a loss!  Costs overruns can occur in flips and sometimes you discover things that were hidden.  It’s all part of the risk/return on these ventures.