Week 4: Extensive Exploration: Underwriting a Residential Rehab Deal

How to figure out if it's truly worth it to "flip" that home

Rehab, value-add, flip, or whatever you want to call it refers to acquiring a property, adding value to it, and either holding it for cash flow or selling it for cash. I have written about this process here before. Today, I want to go deeper and go through my process for deciding whether it is a good deal that will make me money or if it is a deal that is not financially viable and I should skip it.

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Using Technology to Help

When I started, I used a spreadsheet to underwrite my deals, often forgot to add different costs, and was unorganized in my calculations. What resulted was inaccuracies in my numbers that led me to lose money and not maximize my profits. I also couldn't raise money very effectively because I needed to have accurate numbers for my investors that I could present. We created internal software to help my team, and I underwrite more accurately. After a few years of experience in underwriting deals, I finally decided to bring that software to the public so they could learn how to underwrite deals. Throughout this deep dive, I will use this software to help me underwrite my deal.

I want to illustrate this blog as a story where I explore a new area where we potentially want to rehab a home. I stare into my computer and think of all its possible costs and how I will make money off it. The journey begins...

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Property Information

The first thing that I do is gather information on the property that will impact its financials:

Market Comparable Sales and Rents

• Description: I analyze recent sales and rental prices of similar properties in the area to estimate the flipped property's potential sale or rental price.

• Target: To ensure what we can fetch in the market, I confirm that the comps are within 10% of my planned listing price for sales or rents, showing a steady or increasing trend over the past 6-12 months.

Average Household Income

• Description: This metric gives insight into the community's economic standing. Higher average incomes indicate that residents can afford higher-priced homes or rentals.

• Target: I look for areas where the average household income is at least 3x the annual cost of housing (rent or mortgage).

Vacancies

• Description: The vacancy rate in an area shows the percentage of unoccupied properties. A high vacancy rate can be a red flag, indicating low demand or other issues, while a low rate may suggest a healthy, active market.

• Target: I look for vacancy rates between 2% and 7%. Rates lower than this indicate a hot market, which can drive up prices, while higher rates suggest lower demand.

Inventory

• Description: This refers to the number of properties available for sale in the market. Low inventory can lead to higher demand and potentially higher prices, which is better for flipping. Increased inventory means more competition and lower prices.

• Target: An inventory supply of 3-6 months is considered balanced. Less than three months' supply might indicate a seller's market, potentially beneficial for flippers, while more than six months could signify a buyer's market, making it harder to sell.

Comparable Active Days on Market Averages for Sales and Rent

• Description: This metric shows how long properties similar to my target flip stay on the market before selling or renting. It's an indicator of market liquidity and demand.

• Target: I like to see a DOM of 30-60 days. Anything over 90 days suggests less demand for housing in that area, which commonly happens with higher-priced homes.

Economic Drivers

• Description: I look at where people in the area are employed. Regions with a mix of industries and prominent employers (big companies) tend to be more economically resilient, which is beneficial for real estate investments.

• Target: There aren't specific "target numbers" for economic drivers, but my goal is to invest in areas with diverse employment sectors (healthcare, education, technology, etc.) and established companies or institutions that offer stable employment. For example, we target areas that have hospitals or Amazon warehouses nearby.

I type my property information into the Acristo Engine and check out other resources to confirm the property is a good fit.

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Property Purchase

Next, I account for the expenses of acquiring the property.

Property Cost

• Description: The property's purchase price before renovations or repairs. Getting a good deal on the property is crucial to ensure room for profit after all expenses.

• Target: I want to purchase properties at a price that is below the current market value, often suggested as 70% of the ARV minus the cost of repairs (known as the 70% rule).

Closing Costs

• Description: These are the expenses of transferring the ownership of a property. They include title searches, attorney fees, property taxes, escrow fees, and more.

• Target: Closing costs can vary widely by location and property type but typically range from 2% to 5% of the purchase price for the buyer. 

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NOTE

The full deep dive is on a PDF below for my paid subscribers. You can subscribe here:

On another note, underwriting deals is a process that takes practice and attention to detail. Because of this, I created the Acristo Engine, a software to help real estate developers take their deals from 0 to 1. While still a prototype, I want to make the engine accessible to my subscribers so they can try it out and provide feedback. You can try it free here.

Here is what you can expect to receive 

• Access to the calculator for three calculations 

• Property Data (coming soon) 

• Comp Data (coming soon) 

• Automatic Local Material and Labor cost Calculations (coming soon, I'm overly excited about this) 

• AI-enabled chat for construction questions to help you proceed with your deals. 

• Exceptional Customer Service. 

Additionally, I am doing an underwriting class on Sunday, March 3rd, at noon (12 PM ET), which includes a one-year free access to the Acristo Engine. I will teach people how to do everything in this blog in a more in-depth way and provide examples. Subscribers get $100 off the full price through this link.

Here is a link to sign up