You will have to start with how much the house will be worth when you are ready to sell it. Then you work backward to calculate your opening offer, and also the highest price you would be willing to pay. The questions that follow will walk you through the process. Here is an example, so you can see the big picture.
An elderly widow in your neighborhood will be moving to another city to live with her daughter. She would like to sell her house quickly so she can use the money to remodel her daughter’s two-car garage into an efficiency apartment. Her home is fundamentally sound, but all the finishes are outdated, the appliances need to be replaced, the hedges should be trimmed dramatically, and the house has no central air conditioning despite typical summer temperatures in the high 90s.
You estimate it will cost you $30,000 to completely update the house, throw out the old furnace, and install central heat and air conditioning. Similar homes typically sell for $229,000. If everything goes according to plan, you can complete the remodeling in three months and then sell the house within three months after that.
According to your best estimates, holding costs (taxes, insurance, utilities, and interest) will cost you $1,000 per month. You plan to offer an open listing and pay 4% of the sale price to any broker who brings the buyer to the closing table. Your share of closing costs to purchase and sell will amount to $2,000.
This is what the calculations would look like if you wanted to break even. Breaking even is not your goal, of course, but we have to start with that and then work backward to your offer.
Sales price $229,000
Minus closing costs –$2,000
Minus sales commission –$9,160
Minus holding costs –$6,000
Minus remodeling expenses –$30,000
Maximum purchase price to break even $181,840
If the market is soft and it takes six months after completion to sell the house, your holding costs will increase to $9,000. In addition, repairs might be more expensive than originally calculated, so you decide to add a 10% contingency factor and increase that number to $33,000. Now, you have to buy the house for $175,840 in order to break even.
How much profit do you want to make on this flip? If you must make $15,000 in order to make it worth your while, you subtract that number from the $175,840 break-even figure to obtain $160,840. That is the new maximum price you are able to pay for this home. Deduct another several thousand dollars to arrive at your first offer, which gives you some room to negotiate, which should be around $156,000 in this example.