This takes some experience and will come with time. You have to analyze recent sales in the area. To get this info you must have access to MLS or work with a Realtor. Don’t get confused with what’s currently on the market for sale (active in MLS), this is “pie in the sky” as anyone can price their house where they want but it doesn’t mean that it’s going to sell for that much. The market will always determine what a house is worth, not the seller or an agent. This said, a house will sell for only what someone is willing to pay. Once you have your list of Sold homes (called comps for comparatives) then you need to look at the ones located nearest to your home and that have the most similar features. You should first look at beds/baths then square footage. Coming up with an average price per square foot is helpful but not an absolute. Remember – buyers don’t buy based on price per square foot, they buy on emotion. Drive by these comparative homes and check them out from the street. Don’t expect to set the highest price with your new project but hit an average. Only use sales that occurred very recently. Markets can change drastically year over year and what someone got next door last Spring might not be what you can sell for this Fall. Make sure you are comparing apples to apples. While Realtors are a necessary evil, you have to realize that their income is soley derived from a sale. There is a built in motivation from them to exaggerate the comps or push you into buying something so they can get paid. Take anything they say with extreme caution and ask to see everything in the computer yourself and then make your own assumptions.
I’ve heard many investors cite the 70% Rule. What they are talking about is trying to get a property for 70% of the ARV minus repairs. What’s the ARV again? It’s Average Retail Value, or ARRV, After Rehab Retail Value. It’s not high retail value. You must get all the sold comps then find the average, not the highest sale. This is huge factor that is commonly overlooked in the greed frenzy or misrepresented by Realtors. Only count on selling your property for the average to be safe. If you hit the high then it’s a nice little bonus for your efforts.
This method of determining your offer is by determining ARV price – take 70% then deduct the repairs. So to use an easy example, if you find a fixer upper that you feel will retail for 100k after doing your repairs of 15k, your offer is: (100k X .70 − 15k =55k). Your offer should be 55,000. Many investors use this formula. What this means is that the 30k that’s missing represents your profit minus fixed costs. (Fixed costs are anything associated with holding and selling the property such as mortgage payment, insurance, utilities and sales commissions). While this is a good starting place it doesn’t always work so be careful. Your holding costs could easily be 5k. Make sure and consider everything and put it in your budget. To sell the house in some states could easily cost you around 10% of the sales price. (6% goes to Realtor fees then you have your share of closing costs). So, If you had 30k gross profits then deducted these fixed costs of 15k you might only have a net profit of 15k. This would represent a Return On your Investment (R.O.I.) of roughly 21%. (Cost basis of 70,000 X Profit of 15,000). This is a good return on your money. You can’t earn this from a CD, T Bill or Money Market Account. But wait, this does not however factor in the risk that you took! You can’t really put a number on risk but if you did it would be a big number. Just be aware that this is a very risky way to make 21% as anything could happen and at the worst you could be sitting with 70,000 in a house that you cannot sell.
Preparing your exit strategy would be a way to hedge this risk. Renting this house for an amount to cover your carrying costs would be one way. Wholesaling the property at a discount to another investor would be another way. With every house or investment you should always have an exit strategy in place for back-up and piece of mind.
When making your offer always leave yourself room to come up. Your initial offer should be so low that you are embarrassed to submit it. Don’t overpay for the house because it’s one thing that will blow it for you and no matter what you do from that moment forward it won’t matter. Finding homes with motivated sellers is also the key. We rarely write lowball offers on homes in MLS occupied by the seller. Vacant homes = motivation. Bank owned properties are also a good source of motivation.