Why Is Your Fix and Flip Offer Wrong?

In the old days of a few years ago (smile), calculating fix and flip real estate offers was fairly simple. All you had to do was determine the after repaired value, give yourself a margin of error/profit, subtract off the repairs, and your offer was normally good to go.

Today it is a lot different. If you're into fix and flip real estate, the old equation read that your offer is be about 70% of the after repaired value, minus repairs. What this equation means is that about 15% of the gross profit would go to buy, sell, and hold costs, and 15% of the deal would be your net profit. Simple enough, right?

Today if you use that equation, you could be in for a real surprise. And that surprise is that you're probably not buying too many deals.

And why is that?

It is because the equation does not consider the changes in the market and the changes in the hard-money lending practices. Besides falling home prices, there have been big changes in hard-money lending practices--because many of them got crushed during the last three or four years of downward-trending housing market. So the lenders that do remain, are wiser, have tightened up their criteria, and are typically charging more points, interest, and fees.

Let's look at a couple examples to get an idea what some hard-money lenders charge today. In my area, a typical hard-money lender charges 15% interest, 4 loan points, and a $695 loan origination fee. Another lender, from a different area, quoted me (for a $100,000 loan) $5,500 in upfront fees, plus 2 percentage points per month, plus a $500 loan origination fee. Also keep in mind that the typical fix and flip deal usually takes around 5 to 6 months' time from initial purchase to rehab and resell. And we still have to add real estate commissions to sell at retail!

So let's break down the fees to see how close the 15% estimate is on the buy, sell, and hold costs. We'll go with the first lender: We pay 4 points upfront; we also pay 1.25 percentage points each month, for six months (plus the $695). Additionally, we'll pay approximately 6 points (3% on listing and 3% on buying) in agent commission when we sell the property on the MLS.

Therefore, adding 4 points for the buy, plus 7.5 points for the hold, plus 6 points for the sell, brings us to a total of about 17.5 points. Also note, that we have not included the costs of two closings (one, when we buy to fix and the other when we sell) and add smorgasbord of incidentals that the new buyer's FHA inspection report details. This could easily be another 2 points.

Perhaps one of the most painful things that we didn't include is the fact that the offers are coming in 2 to 3 percentage points lower, lately.

So the key to all this is to have a program, whereby the input variables and parameters can be modified such that offers are not based on hard set numbers. After years of doing these calculations by hand, my partner and I have developed an online real estate offering software to make our lives much easier. We can now crank out offers and determine the exit strategy in seconds.

The fix and flip market is still profitable today, even though we make less money than a few years ago. The key point is to understand that we have to be ever more diligent on calculating the offer. Note, formulas used to calculate offers on long-term hold real estate are not at all related to fix and flip formulas, and these deals are normally disastrous for the unsuspecting investor.

To Your Success,

Tom & Svein