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Originally Posted On: https://www.dohardmoney.com/the-pros-guide-how-to-calculate-cost-on-a-fix-flip/

 

At first glance, it seems like figuring out the costs of a fix & flip deal should be pretty easy. Just talk to a contractor, right? In reality, a ton of different factors go into calculating these costs, which can make accurately projecting a deal’s budget challenging. As such, I want to use this article to explain how to calculate cost on a fix & flip deal. 

Investors need to consider several primary costs when analyzing a fix & flip deal. In particular, you must account for 1) purchase and closing, 2) holding, 3) direct rehab, and sales-related costs. When you add these all up and subtract them from the post-rehab sales price, you have your profit.

I’ll dive into the details of calculating these costs in the rest of the article. Specifically, I’ll cover the following topics:

• An Overview of Fix & Flip Costs
• Common Cost Calculation Mistakes Investors Make
• Fix & Flip Direct Costs
• Using the Advanced Deal Analyzer to Calculate Fix & Flip Costs
• Final Thoughts

An Overview of Fix & Flip Costs

When I first started flipping houses, I assumed calculating costs would be pretty easy. All you need to do is confirm your purchase price and talk with a contractor about your rehab budget, and boom, there are your costs. Turns out I couldn’t have been more wrong. 

Before doing my first flip deal, I’d been a real estate agent for a while. During that time, I helped plenty of real estate investors buy distressed properties to flip, so I’d been around the fix & flip world. And, I’d watched plenty of HGTV shows about flipping houses, and those make the flip process – and associated cost calculations – seem easy. 

Well, those shows absolutely do novice real estate investors a disservice. Yes, they’re entertaining. But, they also completely gloss over how to calculate flip costs. According to the numbers projected on the screen during those shows, all flippers need to know is A) purchase price, B) direct rehab costs (i.e. what you pay your contractor), and C) an estimated post-rehab sales price. In the world of HGTV, once you have those numbers, you have your flip budget.

While purchase price and direct rehab costs certainly are important, they are far from the only costs investors need to account for during a house flip. For example, the purchase price doesn’t include the closing costs associated with the purchase, which can add up to thousands of dollars. During the rehab process, you also need to pay loan interest, cover the utilities on the property, pay for insurance, and plenty of other holding costs – none of which are included in what you pay your contractor for construction. When you sell the house, you also need to pay thousands of dollars in transaction fees (e.g real estate agent commissions), which will add another major cost to your flip budget. 

Bottom line, calculating costs for a house flip may seem easy. But, when you dive into the details, you’ll quickly realize how complicated these cost projections can become. In other words, a house flip will cost you more than the sticker purchase price and contractor bid. 

How to Calculate Cost on a Fix & Flip

Related directly to my above overview, new investors often make the same mistake when doing their first house flip: significantly underestimating the non-rehab costs of a flip. That is, new investors tend to overlook – or grossly underestimate – all of the flip costs in addition to the direct rehab costs you’ll need to pay your general contractor (GC). 

Broadly speaking, fix & flip costs fall into the following categories. To prepare an accurate flip budget, investors need to first understand all of these cost categories. 

Acquisition Costs

The largest percentage of your acquisition costs will be the actual purchase price of a home. But, this purchase price doesn’t include the closing costs associated with the purchase. If you’ve ever bought a home – investment or primary residence – you’ve likely seen how many items a settlement statement includes. Just naming a few of these items, buyers will need to pay lender origination fees, title fees, hazard insurance, among plenty of others.

While some of these closing costs may only be $50 to $100, the total costs add up quickly. Every deal differs, but, for a ballpark estimate, investors should anticipate spending at least 3% of the purchase price on closing costs. For example, if buying a $150,000 distressed property to flip, this rule of thumb estimates $4,500 in closing costs ($150,000 purchase price x 3%). 

Direct Rehab Costs

Normally, these are the easiest costs for new investors to understand. Your direct rehab costs include the construction/renovation payments you’ll make to your general contractor. Broadly speaking, they include A) the direct labor costs of the rehab, B) the material costs, and C) the general contractor’s profit margin. 

I’ll deep dive into how I develop these costs in the next section, but I also like to provide new investors some rules of thumb. As such, I’ve used my experiences to develop the below guidelines. I use these numbers to develop rough rehab estimates, which I then use to inform my decision making on how much to offer on a place. 

Each of the below numbers corresponds to a particular type of rehab:

• Light Rehab – $14/sq. ft. At the lower end of the rehab cost spectrum, you have your light rehabs. These properties don’t need a ton of major work done – but more than a surface-level, rental-type rehab. Assuming it’s a 2,000 sq. ft. home, I’d budget $28,000 for this sort of rehab. 
• Medium Rehab – $26/sq. ft. After light rehabs, you have your medium rehabs. These typically need more work, require higher-quality materials, or a combination of the two. And, these requirements boost the total budget estimate. Continuing the above example, I’d estimate a rehab budget of $52,000.
• Heavy Rehab – $37/sq. ft. At the far end of the spectrum, you have heavy rehabs. These are the high-end rehabs requiring a lot of work and top-notch materials. Rehab estimate: $74,000.

As these estimates illustrate, a 2,000 sq. ft. space could have an estimate ranging anywhere from $28,000 to $74,000, depending on the type of rehab you need to do. 

Non-Loan Holding Costs

In addition to the direct costs outlined above, investors need to account for the holding costs of a house flip. You can consider these indirect costs, that is, money you need to spend on a flip, regardless of whether or not you’re doing any rehab work. And, I like to break these costs down further into two categories: 1) holding costs not including loan costs, and 2) loan-related holding costs.

Non-loan holding costs include all of those items – often overlooked – that you need to pay just for owning a house. These include property taxes, utilities, insurance (if not prepaid at closing), and landscaping.

“But Ryan, why would I landscape a property under construction?”

Good question. The last thing you want is to get slapped with a municipal fine for an overgrown lawn, which can certainly happen. It’s better to just pay to keep the landscaping in decent condition during the rehab process. And, if you don’t let landscaping get too out of hand during construction, it’ll make the final landscaping to prepare for the sale all the easier. 

As with everything in real estate, the market and specific deal will dictate holding costs. But, as a rule of thumb, I estimate between $500 to $1,000 in non-loan holding costs for a house flip.

Loan Holding Costs

Unless you’re self-financing a deal (i.e. paying all cash for the flip acquisition and rehab), you’ll need to use a hard money loan. And, as with any loan, you’ll need to pay interest on these ones. To estimate these costs, you’ll need a term sheet from your lender that outlines interest rates, draw periods, and any associated fees. 

For instance, assume you find a hard money loan at a 15% rate (NOTE: hard money loans, due to their short-term nature and higher lender risk, charge higher rates than traditional, long-term mortgages). If your first draw for purchase and initial construction totals $100,000 and will take three months, you can estimate that initial loan interest with the below formula:

Interest Costs = Outstanding Loan Balance x Interest x Time Period Ratio

So, in this example, your estimated interest costs for the first portion of the rehab would be:

Interest Costs = $100,000 x 15% x 3 months / 12 months

Interest Costs = $3,750

And, you’d then need to run the numbers for each subsequent draw period for an accurate estimate of loan-related holding costs. Adding each of these interest segments up will provide a fairly accurate estimate of total interest costs. Furthermore, some lenders charge a fee for each draw. For instance, a $100 draw fee and five loan draws would translate to an additional $500 in holding costs. 

Sales-Related Transaction Costs

Lastly, investors need to account for the costs associated with actually selling a renovated home. In addition to more title-related fees, real estate agent commissions comprise the largest portion of this category. While you may be able to negotiate a lower seller-agent rate, the standard commission is 6% of the sales price, with 3% going to both the seller’s and buyer’s agents. So, if you sell a renovated home for $300,000, you can expect sales-related transaction costs of at least $18,000 ($300,000 sales price x 6% commission rate). 

Fix & Flip Direct Costs

Clearly, investors need to account for far more in fix & flip costs than just what you pay your contractor. But, this doesn’t mean that you can gloss over those direct costs. In addition to the acquisition costs, the direct rehab costs will make up the largest percentage of your total flip costs. Consequently, investors need a tried and true method for accurately determining these costs. I suggest the following approach. 

While researching potential deals, I recommend making some “back of the napkin” estimates on direct rehab costs (see above rehab rules of thumb). If the deal’s numbers pass this initial test, you can move forward and put the property under contract. Then, during the due diligence phase of the contract, you’ll confirm exact numbers for direct rehab costs.

I recommend doing this by walking the property with your general contractor. As you walk the property together, you’ll talk about everything that needs to be completed during the rehab process. And, you need to document each one of these items (NOTE: I like to record these conversations on my phone, as I can use this as a reference when I’m building the below scope of work). 

Once you’ve completed the walkthrough, you’ll document every single item in what’s known as a scope of work form. This form will include a line-by-line description of every task to be completed, the quality of the associated materials, and – eventually – the cost per item. 

After you’ve added the tasks and materials to the scope of work form, you’ll meet with two contractors to have a pricing meeting. During these meetings, you’ll assign costs to each of the line items in the scope of work. The total cost for all of these items becomes your rehab budget. And, I recommend meeting with two contractors for pricing bids to solidify a primary and back-up contractor. This will give you flexibility during the rehab process in case one of the contractors A) doesn’t perform, or B) needs to back out for unforeseen circumstances. 

Additionally, meeting with two contractors confirms fair market pricing the project. You don’t want one contractor to significantly underbid and then nickel and dime you throughout the rehab. By getting two bids, you’ll have a clear sense of market pricing. 

Once you confirm pricing, both you and the primary contractor will sign the scope of work form. That way, if you have any discrepancies in the future, this form will serve as the final arbiter. 

With a scope of work form signed, you now need to sign a services contract with your GC. This contract outlines exactly how the GC will complete all of the items on the scope of work form. As a rule of thumb, I assume that, for every $1,000 of rehab budget, a contractor will need one day of work. So, a $50,000 rehab should take 50 days to complete, and then I add a 10-day buffer for standard friction (e.g. permitting delays, weather issues, etc.). 

Additionally, I recommend dividing the scope of work items into key milestones. Typically, I’ll look at the project and create 25%, 50%, 75% and 100% milestones. This helps ensure the project progresses on schedule. And, in terms of payments, I will only pay a contractor for a scope of work item when that item is 100% finished. This keeps GCs on task, as they know they’ll only get paid when they’ve completed an item to standard. 

At this point in time, you now have accurately calculated the direct rehab costs of a fix & flip deal.

Using the Advanced Deal Analyzer to Calculate Fix & Flip Costs

I stated it above, but calculating profit on a house flip may seem straightforward on paper. In reality, accurately estimating all of the above numbers can be extremely challenging for new (and experienced) investors. As a result, we’ve developed the Advanced Deal Analyzer, a house flipping profit calculator. This proprietary tool does all of the above calculations for you, quickly telling you whether a deal will be profitable or not. 

With our calculator, investors just need to enter a property’s 1) zip code, 2) purchase price, 3) direct repair cost estimates, 4) after-rehab value, and 5) earnest money deposit. The calculator then interacts with our massive database of properties and historical transactions to do everything else. Specifically, after entering these inputs, the Advanced Deal Analyzer will tell you: 

• A detailed, line-by-line breakdown of all of a deal’s costs
• How much hard money you can qualify to borrow for a deal
• Whether or not a deal will be profitable
• How much profit you can make

These results save a tremendous amount of time by providing a quick calculation of a fix & flip deal’s estimated costs and, by extension, potential profitability. And, when new investors use this software, they’re far less likely to make the mistake of overlooking the indirect costs of a fix & flip. 

Final Thoughts

Once again, HGTV house flipping shows may be entertaining, but they do new investors a major disservice. A ton of variables go into calculating costs on a fix & flip deal – far more than just purchase price and direct rehab costs. While investors can estimate these costs by hand, we highly recommend using a lender-integrated software like our Advanced Deal Analyzer. In addition to providing you a more reliable estimate of costs, using our software saves you a ton of time – time that you can instead devote to finding great deals!