I am a very analytical real estate investor and I find that formulas come in handy when evaluating investment property. These formulas help to ensure that I am making rational decisions that can be supported by concrete number. However, you cannot make all decision by using formulas. A formula should only serve as a guide to double-check your decision, or a screening mechanism to narrow down the properties you consider. In addition, a formula can provide a stable method to help ensure that you do not veer too far off of your investment plan.
One formula I use constantly is what I call the Nickerson formula. I got the idea from a book by William Nickerson entitled "How I Turned $1,000 into Three Million in Real Estate in My Spare Time". Despite the name, this is a great real estate investment book. It was first published over 40 years ago and has gone though many revisions. While some parts of this book are outdated, it still presents a basic approach that should work well in todays market.
The portion of Nickersons approach that I use for this formula is to basically to strive for a $2 profit for every $1 spent on repairs. Nickerson would find run down apartments to purchase at market value (which was low due to their condition). He would then renovate and modernize the apartment in order to increase the rent and get his $2 is profit for each $1 spent on the rehab effort. My approach is different, I attempt to purchase below market value, make the needed repairs, and then sale at the new market value.
The basic formula is:
ARV = PurchasePrice + (2 * RepairCost),
where ARV = After Repaired Value.
For example, if I find a house needing $20,000 in repairs and I can purchase is for $70,000 I would want the house to be worth $80,000 after the repairs are made (ARV).
70,000 = 30,000 + ( 2 * 20,000)
In this example, I spent $50,000 on a house worth $70,000 which gives me a 40% return on my money.
Of course, I am looking to make a decent profit on the overall purchase. If the same house cost $60,000 and need $5,000 in repairs it would meet this formula:
70,000 = 60,000 + (2 * 5,000)
However, the ROI would be too small for the risk involved.
I do not use this formula for setting the purchase price so that weeds out the problem in the second example. Instead, I use the Nickerson formula to ensure that I get a better deal on properties requiring more work. If the repair costs are higher there will be more work and risk involved in the deal, so I need to pay less for the property. To reiterate, I only use this formula as a final check not to set the purchase price. You still need a significant discount to market value to mitigate the risk of real estate investment.
For more tips like this, and general real estate investing discussion, see my blog at
RealEstateAdventurer.com.
