How do I decide the right price to buy a house?

You’ve heard the adage: You make a profit when you buy the property.

Simple but powerful. Unfortunately, investors often forget that lesson and end up paying too much for properties.

If I am going to rehabilitate a property and commit funds for that project, it is essential that I know the correct price to pay (and then buy below that number).

The formula I use and have been using since day 1 is:

ARV – Rehabilitation – BSH- Benefit = MPO

ARV = Value after repair

BSH = Purchase, sale and retention costs

MPO = (Maximum Profitable Offer)

Determining the ARV is an art rather than a science. Of course, I start by looking for sold comps and focus on the properties that are closest to my property in question and most similar in bed / bath setup; square feet; age; location and general design. Although appraisers can go up to a mile away and up to a year in sales, I prefer homes that are less than a quarter of a mile away and that have been sold in the last 6 months.

The next step for me is to search the online listings for the compositions sold. You will often find a large number of images of those houses to determine how they looked inside. I look specifically to see if the other houses used granite or some other solid surface countertop instead of laminate in the kitchen; Are there any upgraded appliances? Did they use carpet, laminate flooring, or hardwood? Did you use fencing or fabricated tiles for the shower / tub? The bathroom floors are tile or laminate. I also check the exterior to see if the facilities have garages, carports, or just driveways; Are they brick, clapboard, or vinyl siding?

At this point, I now have a pretty good picture of the level of rehabilitation required to reach the same prices as comparable properties. I then review my property in question for anything that might make my home less buyer-friendly than offsets. Some examples might be that the house is near the railroad tracks or a noisy road; you are on a busy highway; it is adjacent to something less favorable than a neighboring house (cemetery; parking lot; retail store). If any of these, you may have to greatly reduce the ARV.

How much to adjust the ARV is largely a judgment call. I try to think like a potential buyer looking for two very similar houses. One is sitting on a quiet lot with neighbors on either side. The other house is located on a busy street. How much discount would it take to incentivize buyers to buy on a busy road? Certainly more than a $ 5-10,000 discount. You might also consider whether there are additional amenities that I can offer at my home that are not available at competitions. This will also help tip the balance, but it will also cost additional rehab dollars.

One last test I do before blocking an ARV is to review the properties that are currently listed. By the way, I am not a real estate agent and I do not have access to MLS; I do all of this research online using the same tools that you have access to. The properties listed tell me two things: (1) that prices are going up and sellers are not lowering their price; (2) how are the houses with which I will compete directly.

The determination of the amount of rehabilitation is based on what is needed to renovate the property in question to resemble the compositions. Be careful here. Remodeling at a much higher level than the offsets may not generate much additional price, but it greatly increases the costs of rehabilitation. On the other hand, not improving enough can make the home less buyer-friendly than competing homes.

BSH can easily be calculated as a percentage of the ARV. I’ve seen it run from 12% to 20% ARV. Most are between 15% and 18%. The big drivers are whether or not an agent is used and the cost of money. It’s a good idea to do a more detailed analysis of your actual BSH costs until you see where your percentage generally falls. Below is a list of the most common expenses that make up this category.

• Closing Cost – Buy
• Loan origination fees (points)
• Loan interest
• Risk insurance
• Property taxes
• Utilities
• Marketing costs
• Home warranty
• Closing costs – sale (paid on behalf of buyer)
• RE agent commission

My profit is the minimum amount I would like to make on this project for it to be worth it. Why am I not using a higher profit? Because it may exclude me from possible deals. I am calculating the maximum I would be willing to pay before abandoning the deal. Placing too many winnings in the calculation will reduce that number for bids to be accepted. With that being said, I traded as far below the MPO as possible knowing that every dollar I save is an additional profit. I also need to know the number to stay away from.

A quick litmus test for profit is to add the purchase price plus the rehab costs. Your profit must be equal to at least 15% of that sum.

Example:

DFO $ 90,000

Rehabilitation $ 30,000

Total $ 120,000

X 15%

Profit $ 18,000

So in this example I’d like to get at least $ 18,000 in profit (I’d round to $ 20,000). Otherwise this property may not be worth buying.

Once you have determined all of these numbers, the final step is to perform the calculations to determine the MAXIMUM profitable offer or MPO. In other words, the most you would pay for the property. It is not my desired price, it is the highest price to pay. My goal in the negotiations is to buy the property as low as possible from the MPO. Remember, every $ 1 purchase below the MPO is an added win on the deal.

The point I hope you walk away with is that there is more to consider in determining the correct price to pay than simply doing a few numbers. You must be smart and study the market and the competition. If you do the initial work, you will buy right, sell your rehab quickly, and make a big profit.

I require that each of my private tutoring students do this research and analysis before approving any offer. I don’t do it to give them extra work or to do something. I do it to make sure every deal is profitable. I want the same for you, so take my advice.