Many rules of thumb exist in real estate investing. An example is the 1% rule – meaning the monthly rent should be 1% or more of the purchase price for a property to cash flow.
Another rule is that your renovation cost should not be more than your purchase price. I get what this rule aims to do and the majority of the time it is correct.
If you buy a property for 100K that has an after repair value (ARV) or 200k you will for sure lose money if your renovation cost exceeds your purchase price.
Here’s the thing, you can make money on a property where the renovation budget is expected to be larger than the purchase price. You just need to make sure the numbers work, which will often mean the property is being acquired at a nice discount.
You make money when you buy after all, right?
When Renovation Cost Is More Than Your Purchase Price
The best way to give an example is to share one of our deals. One of the properties we bought last year is a single family in need of full renovation. I mean full as in all new plumbing, electric, drywall, etc.
When we were looking at the property it was obvious that it would need at least $75K in renovation. And that original estimate I knew could easily push toward $100K with one or two unexpected surprises.
Rule of thumb: The older the property, the higher the chance of a costly surprise.
This house was built in 1900 and had little to know updating over the past century, so surprises were more like expectations for us on this one.
I marked up the renovation budget to $95K and had an ARV of around $200K once we brought the house into the current century. My ARV was conservative as I saw new comps possibly hitting the market in the 220-225K range. However, didn’t want to count my chickens before they hatched.
We ended up purchasing the property for $60K and as expected there were some surprises. The renovation should be complete in the next two weeks and looks like we will land at a total cost of $90K, plus holding costs puts as at $95K
I am still ironing out the listing price, but it looks like we can legitimately ask $230K for the property as those new comps did in fact hit late last year and there have been a few fresh ones this year nudging things higher.
It is about the numbers
In the end, it didn’t matter that our renovation budget was higher than our purchase price because the numbers made sense. We were basically in the area of the typical flipping formula: ARV *.75 – Reno Costs = Purchase Price.
Now, make note. That formula should probably be tweaked with the recent hit to the economy. 70% of ARV is a better idea, maybe even 65% as you want to be more conservative in a time of uncertainty in the market.
But in the end, regardless of the market. If you buy right and the numbers makes sense you position yourself to make money!
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Absolutely fantastic how simple you made it look in this article. Real estate could be a bugger, I was an MnE Engineer with a real estate company back in 2014, most property our clients purchased and we renovate always exceed ARV. Few of our clients run as a loss, I had no idea why they bought something and spend ridiculous amount fixing and improvising it, I think they were just "money missroads" that needs to take some of this articles highlights has lessons.
Thanks! 2014 was also a great time because it was the early years of the real estate bull market.
I got my house in 2014. It's doubled in value. :D
What is up buddy! Hope all is well. Yeah, 2014 was a homerun time to buy! You have plenty of equity to put to work. Let me know when you are ready to invest. ;-) 8% return on private money with 1st lien on a property for my real estate deals.
Hello,
Thank you for recent votes. I have noticed that you delegate to ctime - mass abuser and hostile flagger of many respected Hiveians. How has this happened?