In an ideal world, you’ll estimate
But in practice, it can sometimes be difficult to accurately assess either one.
So if you could only ensure accuracy for one, which should you choose?
Hint: one is better than the other.
A 20% mistake with rehab costs
Let’s say you’re looking at a flip that you estimate will take $50K in total rehab costs. You bought the property for $200K and think you can sell it for $300K afterwards, for a $50K gross profit.
A 20% mistake on the $50K rehab budget is $10K.
It’s a costly mistake but unless you had no idea what you were doing, your project should easily allow you to accommodate the surprise $10K in additional rehab costs. Sure, your gross profits have dropped from $50K to $40K but your deal is still profitable.
But what happens if you made that same mistake with your after repair value (ARV) estimate?
A 20% mistake with the after repair value (ARV)
A 20% mistake here means that instead of being able to sell the property for $300K, you end up only being able to sell it for $240K.
That 20% mistake took $60K off your sale price!
And having purchased it for $200K and put in another $50K in rehab costs, this means you’re selling it at a loss of $10K!
A 20% mistake on the ARV is 6 times worse than a 20% mistake on the rehab budget.
Whereas one reduce your profits slightly the other completely destroyed your profits.
It is more costly to make an ARV mistake
Of course, how much more costly will depend on the specific economics of the deal you’re looking at and the % error you’re making.
But even for sub $100K ARV deals with sub $20K rehab budgets, the difference can still significant.
A $60K purchase with a $20K rehab budget with an ARV of $100K, meaning a target gross profit of $20K ($100K – $60K – $20K) will show that a 20% error is still 5X more costly on the ARV side than on the rehab budget side.
See for yourself with this simple calculator
So what tools or methodologies do you use to ensure you have an accurate ARV estimate?