How to determine profits on a fixer-upper
When it comes to answering the question of how much you should spend on a fixer-upper home, we need to understand how to calculate the value of the property in its as-is condition before repairs.
To find the max sales price, we take the ARV and subtract from it the cost of those repairs and updates, as well as any potential profit.
Some of these costs may include vendor fees or marketing costs. Keep in mind that you will not get this number straight away. Most importantly, keep in mind that your home is a business and not an investment, which will ultimately dictate how much money you make on the deal and where you SLEEP that night!.
Up to this point, the ARV will serve as a guide to help you calculate your overall max price. Not to worry—we have all the math and determine our home’s ARV beforehand.
Let’s get back to that bottom line. We now understand the more precise way to calculate the maximum sales price. By adding this element on, we are able to calculate the sales price at any given moment in time.
We typically adhere to certain margins for subject-to price, and we’re usually happy to lose a few percent here and there. When calculating subject-to price, keep in mind that what is based on is real world circumstances, and there will be a margin or maximum allowed.
Sometimes we’ll spend a few thousand dollars on an agent’s report or use an online site to determine the subject-to price.
Up to this point, we’re only been calculating a price by completing the work ourselves and selling the estimated product. This is a great way to get an exact price on the property, assuming we get a good deal on it and step away from other outside factors.
How Long Will This Likely Take?
It will most likely depend on the scope of work, the price range of where you’re buying, and the experience level of your contractor. Let’s say we’re rehabbing an older house, in this case.
Here’s an example:
Jerry upgrades the kitchen in his own home and charges his lovely wife Tracey $2100. She loves the kitchen, so she signs a three year lease, paying Jerry $1,475/month.
Jerry rehabs the kitchen of the house next door to his in perfect condition and sells it at this sales price ($525,000). He pocketed $200,000 as a profit on the $21,000 he spent on the wall.
Then, since Jerry has an existing mortgage on the property, he signs a new three year lease, paying $1,475.00/month in rent. Now Jerry has a $500,000 house that will now sell for $525,000.
How Do You Calculate ARV?
Using ARV as an estimate is an important step during the rehab process. We are comfortable using ARV because we have seen it perform.
Sometimes, however, there is a debate around ARV. This is what we need to understand.
The degree of disagreement on ARV can be from minimal difference to wide discrepancy. I’ve seen ARV’s range from $60,000 to over $70,000.
A cut-and-dry answer to commonly asked “how much should I spend” rehab questions is:
Attics and basements, in particular, pull in the most value. This is because people love to put stuff in attics and basements and want to live above the drawers and drywall. If utility lines run to the ceiling, consider deep-fault electric.
So what about adding a basement or crawlspace? Nobody is going to pay top dollar for bad smells, repainted walls/ceiling and added utility lines above the crawlspace.
Putting a garden in a basement? No way. A local pool or community pool that’s right on the property is going to be the default. I wouldn’t argue about an outdoor pool in a basement. They don’t add value to a house. The best pool is the free ‘ole public pool you can buy for cheap.
Here’s what it looks like for a modern home in the best condition.
So, in the best-case scenario, these five fixes and updates would cost over $130,000. However, there will often be concessions and fees associated with the deal, so I recommend estimating at least eight months’ worth of other improvements—such as freshly painted bath, updated foundations, and new kitchen floors.
What would happen if you added at least $100,000 worth of other improvements after rehab?
In fact, you’d be happy to sell to me today.