Valuing Investment Property - The ‘Flip' Hurdle
A few days ago I made a rather lengthy post regarding valuing a property you intend to buy and hold. My point was that a property in a market that is not appreciating must pay for itself. No one wants an investment that eats while you sleep. Your investments must work for you - not the other way around. http://www.themcallisterteam.com/blog/2010/12/01/how-much-is-that-investment-property-really-worth/
An alternative method to valuing a property that has worked for us, and can be done pretty much on the fly, is a ‘flip' valuation. Essentially, if the property passes the ‘flip' hurdle, it is worthy of further scrutiny.
We work primarily in Springfield, Ohio so the arbitrary numbers used below may need to be adjusted for your market. However, the basic idea is the same. ARV below means ‘After Repaired Value'. MAO means ‘Maximum Allowable Offer'. Repair Costs are just that, your best guess as to what it will cost to get the property to resale condition.
Our basic formula for evaluating property valued at less than $80,000 is this:
ARV X .80% - $20,000 - Repair Cost = Maximum Allowable Offer (MAO)
Our basic formula for evaluating property valued at more than $80,000 is this:
ARV X .65 - Repair Cost = MAO
Either way, we aim for minimum $20,000 cash out at closing or when we refinance a property. (Cash out refinances obviously rare today, but I like the extra equity regardless.) We use 80% of ARV to cover the extra equity we would need in a property if we were to refinance, and if we sell, the extra 20% ‘cushion' should cover concessions and selling expenses.
We do not consider carrying costs or selling expenses in this quick calculation, it is just the first criteria a property must meet to warrant further evaluation. Having a quick and easy evaluation model that you can carry around in your head is a great tool to have in your investing tool box.
I look forward to your comments and questions. For more information please see us at www.TheMcAllisterTeam.com.