65% of ARV: The Magic Number for Real Estate Investing
A common misconception in real estate investing is that you can buy residential real estate at 80 to 85 cents on the dollar and still have enough equity to flip the property for a profit. These numbers are way too high. I am going to break down exactly what you should look for on your next flip.
Your target purchase price needs to be around 65% of the completed resale value minus your construction costs. While your numbers can slightly defer, if you’re close to 65%, you will likely have plenty of profit in the project.
Let’s look at two examples to illustrate why 65% is the magic number.
Example 1) Profitable Deal
Assume the after repaired value (ARV) of the property is $200,000 and you can buy it at $100,000 and it needs $30,000 in construction costs. This comes out to $130,000, which is 65% of $200,000.
There are a number of additional costs on the front end to consider, which are estimated at:
• $6,500 in closing transaction costs (state/county transfer/recordation tax, title insurance, title work, property insurance, taxes.. etc..(~5%)
• $6,500 in lender fees, (~5%)
• $7,800 for lender interest (~6%)
• $2,600 in holding costs like electric and water. (~2%)
All of these costs come to a total of $153,400.
But we’re still not done. On the back end, your costs will be about $13,000 for realtor fees (5%) and transfer taxes/title costs (1.5%).
So your all-in costs are actually about $166,400.
In this example, if you sell the property for $200,000, you’re netting $33,600, which turns out to be a 20% return for the actual transaction. Not bad, huh?
It is important to note there can be additional costs to watch out for that could cut into your margin. For example, seller subsidy/credit on your resale could be up to 3%. Other possible costs include construction overages and holding costs if your resale timeframe is longer than expected.
So a quick recap – at 65% ARV of $200,000, the very best case scenario, you’re making about $33,600, which is a great return. Better yet, if you are using someone else’s money, like a hard money lender, assuming you only need about $13,000 in cash, your cash on cash rate of return will be through the roof (up to something around 300%).
Example 2) Non-Profitable Deal
Now compare the profitable outcome of the first example with the less profitable scenario of 75% of a $200,000 ARV. Assume a purchase price of $100,000 and construction costs of $50,000, which is 75% of $200,000.
Your additional costs would be:
• $7,500 in closing transaction costs (state/county transfer/recordation tax, title insurance, title work, property insurance, taxes.. etc..)(~5%)
• $7,500 in lender fees, (~5%)
• $9,000 for lender interest (~6%)
• $3,000 in holding costs like electric and water. (~2%)
• $13,000 for Realtor fees and resale costs (~6.5%)
All of these costs, including the purchase price and construction costs, come to a total of $190,000.
This leaves you with a net profit of just $10,000, very best case scenario. And this is assuming no seller subsidy, no construction overages, and no extra holding costs. If these extra costs are factored in, you’d just be breaking even or even losing money.
Considering these projects require a lot of time (usually about six months), work, money, and risk, if you’re only likely to make $10,000 best case scenario, the numbers just do not make sense.
So please remember, the magic number to buy residential real estate to flip is 65% of the after repaired value minus construction costs. Do this and you’ll be profitable every time and you will grow into a successful, rewarding business.