by Jason Rose
We hear the word "margin" used quite a bit in regards to rehabbing real estate for a profit (a.k.a. "flipping"). But, it's very surprising to me how it's possible that so many people don't really understand what this very important word truly means prior to moving forward on an investment purchase.
As the leader of the two largest real estate investor groups in Cleveland, Ohio, and as a real estate agent who represents hundreds of real estate investors, I hear the stories each and everyday about how an investor "broke even" on his flip endeavor because of his "unexpected costs." When I inquire about these "unexpected costs" and try to make sense of the situation, I find that these costs are actually very normal costs associated with fix n flips. But, for some reason, which I will guess has something to do with reality television, most new investors simply look at margin as the amount of cash leftover after the property is bought, rehabbed & sold. That is what I would call your gross margin.
Gross margin is a quick math equation that I use to determine if the property is worth putting any more time into researching. But, it's by no means a number that one should use to determine if a property is a worthy investment. By making a move based on gross margin alone, investors are risking breaking even and losing money on every deal they do.
To really know if a property is a worthy investment, investors must instead look at the net margin. There are 4 factors to determine the net margin once you have found a potential investment opportunity & prior to moving forward with an offer.
1) Purchase Costs: This would include all the buyer costs on the settlement statement including the purchase price, closing costs, loan costs etc.
2) Rehab Costs: This would include all the costs of labor & materials to get the property in the condition needed to sell it.
3) Carrying or Holding Costs: This would include the costs of owning the property while it's being rehabbed & until it's no longer your property. These carrying costs include taxes, insurance, utilities, lawn care, HOA fees, etc.
3) Selling Costs: This would include all the costs associated with selling the property such as realtor fees, advertising, closing costs, taxes etc.
So let's look at an example of an investment scenario from the view of the gross margin approach compared to that of the net margin approach.
Gross Margin Approach
$100,000 purchase price
$50,000 rehab costs
$200,000 selling price
$50,000 profit
Net Margin Approach
$100,000 purchase price
$1250 upfront loan costs
$750 closing costs
$50,000 rehab costs
$1250 upfront loan costs
$750 closing costs
$50,000 rehab costs
$3000 carrying costs
$20,000 selling costs
$25,000 profit
Now I realize that when looking at this, it would seem as this very basic math equation would be common sense for anyone trying to take on such a big investment. But, you would be very surprised at how many investors do not consider the net margin approach prior to getting a property under contract or even afterwards. Many of them don't realize that they completely underestimated their project costs until their Realtor shows them the after sale breakdown sheet. At that point they are upset and feeling like someone else is taking advantage of them by claiming such a big piece of the pie that they were hoping to eat all on their own. Don't get so excited about what you think a property is worth that you forget to just sit down and crunch ALL the numbers associated with a real estate transaction.
I have a rehab spreadsheet that I use to determine all the costs associated with my transactions so I absolutely know going in that it's a great deal. No surprises for me! If you would like a copy of this spreadsheet, please don't hesitate to email me.
Good luck in all your ventures!
Jason Rose
www.SmartStartToday.com
Jason has been apart of over 700 flip projects in his 20 year investing career.
