How to Make Money Flipping Houses, Part One: Analysis
Updated: Feb 11
You've probably seen the shows on HGTV, right? Chip and Joanna find a dingy house and make it great for a buyer, and they make themselves a nice profit doing it. Documenting the process of house flipping makes for great TV, but the most important thing for a fix-and-flip investor to get right is in the numbers and analysis. You've got to do a good job of estimating expenses and the after-rehab value (ARV) of a property before you buy or you may find yourself losing money when you sell!
The process that I use to evaluate a potential deal is extensive and deliberate, and I've built a Microsoft excel spreadsheet to help make the process run faster. My typical analysis pipeline looks like this:
Find a deal, either on the open market or from a wholesaler.
Initial deal vetting. This is where I do some back of the napkin math using my knowledge of local property values and a rough estimate of rehab costs to determine if the deal merits further analysis. This usually only takes a minute or two. I can quickly eliminate bad deals this way so I don't waste hours of my time analyzing a deal that will never work.
Initial due diligence. During this step I'll conduct a more detailed analysis of comparable properties to get a more solid ARV. I'll look at pictures of the property to narrow down a rehab budget estimate, and I'll come up with line-item estimates of certain costs (e.g. closing costs, taxes, insurance, financing costs, utility and other holding costs, etc). I'll plug these numbers into my spreadsheet, and if the sheet outputs a ROI over 20% I'll do some more digging.
View the property. Now is the time to really nail down that rehab budget. I'll tour the property and come up with line-item estimates of all the work required and determine how long the project will take. I'll also be able to visualize the layout of the house when it's renovated, which will allow me to have more clarity on my ARV estimate. I'll plug updated numbers into my spreadsheet and then...
Write a contract. Do I offer to pay asking price, or do I negotiate down lower? That depends on the numbers. I have no problem paying the seller asking price if that price gives me a great ROI and will still allow me to at least break even if the ARV is 15% below my estimate and the rehab budget was underestimated. Otherwise, I'll negotiate the price down or walk away from the deal. Remember: in real estate, you make your money when you buy.
Get under contract, complete due diligence, and secure financing. I won't talk about this too much in this post -- stand by for follow up posts on these topics!
In The Weeds
Let's get into the details now. I'm going to include a screenshot of each individual sheet in my analysis model to show you what I'm looking for when I analyze fix-and-flip deals. I've set this sheet up to be a stand alone product that I can send to lenders and equity partners. Some folks use an uglier spreadsheet and put the pertinent information on a well-formatted PowerPoint presentation. Either method is fine, but I find that this way just takes less time, and time is money!
Above is our summary sheet, and it's the first place we'll start. All blue cells are inputs. We start with the purchase price. The holding period should account for your rehab timeline plus a factor of safety in case rehab takes longer than you think plus two months to market and close on the sale on the back end of the project. Discount rate is used when you're bringing other money into the project, and it's used to account for the absolute minimum return they might expect on their money. 11% is honestly probably a bit low considering most hard money lenders get 10% just to lend the money. Everything else is pretty self-explanatory. I include a link to photos and a map location for lenders or outside investors to get a feel for the investment.
This is the sheet i use to calculate the ARV. I've included four comparable sales here, and I adjust the sale price of comparable sales to account for differences in the subject property and the comparable properties. My model estimated a rehab value of 175k, but I'm going to input 169.9k as my ARV, partly to be conservative, and partly because we want to price these things to sell quickly so we can pull out our money and move on to the next deal. I'm not going to get into the methodology of a comparable sale analysis right now but feel free to reach out to me if you have questions.
Here is where we estimate our rehab budget. I've already built estimation factors for some common rehab items into my sheet to cut down on the time it takes me to analyze a deal. In this case, I've estimated a total rehab budget of $11.8k for new interior paint and flooring, fixtures, appliances, a new kitchen countertop, and other misc. items. These numbers work in the Savannah, GA real estate market, they might not be appropriate for your market.
Here we input soft costs related to acquisition, holding, and selling the property.
There are no input cells here, this is a sheet which calculates interest and principle payments each month. It allows for us to analyze two different loans. In this case, the first note covers 90% of the purchase price, and the second note covers 100% of our rehab costs. Total interest payments each month are $859.
Here is our cash flow statement. This is really just for reference and to run calculations that show up in other sheets. I'd like to point out that the renovation expenses in the top line are steady throughout the course of the project. That's not exactly realistic, and typically there will be no renovation expenses during the last two months when the property is on the market and under contract. Again, this model assumes a hold time of three months, so you see the selling related costs in the third month and investor payback in the fourth.
Back to the summary sheet. Now we see the important metrics. We see that the total equity required is $19,496 -- that's how much cash we'll need to bring to the table to close on and hold the property. We see in the middle block that our return on investment (ROI) is $25,793, or 132%. You also see a break down of general partner and limited partner returns -- more on that later.
We also see that in the worst case scenario that we cant sell the property that we will be able to rent it and still make some cash flow. It's important to make sure that we can rent the property and at least break even. Let's take a closer look at some contingencies below.
This is a very important sheet -- it tells us how much return (or loss) we will realize if everything doesn't go as planned. We want to see how our return changes if we either underestimated the rehab budget or overestimated the ARV (or both!) In our worst case scenario we lose $4,434 -- not great, but not the end of the world either.
Here's the sheet I use to calculate my rent return (or loss) if we have to refinance and place the property for rent. It assumes a 30 year note at 4.5%, and it assumes we refinance in a way which allows us to pull out our $19 thousand in equity and no more. Our cash ROI is 17% the first year - not bad, but a far cry from the 120% we expected to make!
Here's where I calculate general partner (GP) and limited partner (LP) returns. If you don't have enough cash to do the deal on your own, you will have to bring on LPs. These are usually wealthy people with money to invest, but who don't want to do the hard work themselves. In this case, we assume you can bring $5k to the table, and bring on a partner for the rest.
Look at the box in the top right -- this is how you will split returns, and it's called a "waterfall". In this case, we have five "hurdles." The first hurdle is for returns up to 11%. We will return invested capital and distribute returns up to a project ROI of 11% in whats called a pari passu structure. Pari passu means "at the same rate or equal footing". Basically, our limited partner contributed 74.35% of the capital, and he or she will receive 74.35% of the profit up to a total ROI of 11%. Now we see additional hurdles in which the GP (that's me) makes more return than the LP. This is how I like to get paid back for doing all the work, and LPs also like to see this because it motivates me to stay on budget and on time -- and to make sure I did a good job of estimating the ARV.
There's no set way for you to structure a GP/LP deal structure. Some folks like to take a set management fee. Really, it's whatever you and your LPs agree on. I'd also like to note that any partnership agreements should be done by an attorney.
I hope you found this post to be useful and enjoyable. If you have any questions, comments, or if you're ready to get started investing in flips -- give me a call!