Real estate investment is all about numbers.  If you want to be a successful real estate investor, you must make your money when you buy, not when you sell.  If you just buy at market price and wait for the appreciation to get you out of the red ink, you are not an investor, you are a speculator.

If you are a rehabber, or a wholesaler selling to a rehabber, you must first know how to estimate the after repair value of a house (by looking at recent sales of comparable properties).  You must also be able to accurately estimate repair costs (and factor in an extra 10% for intangibles).  Finally, you must take into account all costs involved, including closing costs, insurance cost, taxes, interest on loans, utilities, marketing costs, etc. during the repair period and during the time it takes to sell the house after it's being repaired.  You should consider an average of six months or more between the time you purchase the property and the time you sell it. 

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The following example will illustrate the process of calculating rehab profits:

Purchase Price

Suppose that you find a house that you want to buy.  First of all, you must find out how much is the house worth.  If your county has a website showing property sales figures, you can estimate the value of the house you want to rehab by looking at how much similar properties in the area have recently sold for.  You can also ask a real estate agent to prepare a CMA (comparative market analysis), or you can use an online service like ElectronicAppraiser to get an instant, automated valuation analysis complete with recent comparable sales, property history, tax assessor data, etc. Let's say that after analyzing the comps, you determine that the After Repair Value of the house is $200,000.  You offer $140,000 and the owner accepts. 

Rehab Cost:

You then do a walk-through inspection and determine that it will require $11,000 in repairs (actually $10,000 but you decide to consider a 10% cushion just in case). 

Loan Costs:

You find a hard money lender that will lend you 100% of the purchase price with an interest only loan at 12% interest with 3 points due at purchase closing. 

Holding Costs:

You purchase vacant house insurance policy for $200 per month and figure that utilities will run at $100 per month.  Taxes are $200 per month.  The monthly interest on the loan is $1,600 ($140,000 x 12% divided by 12 months)

Timeframe:

You plan to rehab the house in four months and sell it in two, giving yourself six months between buying and selling the property. 

Closing Costs:

You estimate your buying closing costs at 3% of purchase price plus the 3 points of the hard money loan (total = 6% of purchase price), and your selling closing costs at 2% of selling price plus 4% Realtor®'s commission (total = 6% of selling price).

Let's now look at the numbers:

Your estimated profit on this deal comes up to $16,200.  Now let's look at Return on Investment (ROI).

Return on Investment (ROI)

To calculate the return on your investment you have to divide your profit by the amount of cash that came out of your pocket.  Out of pocket expenses in this case are the closing costs to buy, all the holding costs and the rehab costs.  The closing costs to sell (including the Realtor® commission) are not considered cash out of pocket since they are deducted from the proceeds of the sale.  Your cash out of pocket is, therefore: $30,800.  Consequently, your ROI is 52% in six months.

Convert that return into a yearly ROI and you get: 131.04%.  Not bad at all, right?  Compare that to your typical 4% certificate of deposit return...

Wholesaling

After doing the numbers, you may conclude that you don't want to rehab the property but instead want to wholesale it (sell it to an experienced rehabber).  You set a $5,000 wholesaling fee for yourself, and assign the contract to a rehabber (basically, the rehabber will pay you $5,000 for the right to purchase the house at $140,000).  The rehabber will still have a profit of $11,200 (bigger than your $5,000 but rightly so, since he will be taking over the risk).  Plus, since rehabbers do most of the work themselves, he may be able to cut the rehab costs in half, to $5,500, which will drop straight to his bottom line.  Furthermore, he can decide not to use a Realtor® to sell the house, pocketing the 4% commission and further enhancing his profit.

A Word of Caution

Murphy's law is alive and well in real estate investing, so if something can go wrong it probably will.  Therefore, always work your numbers for the worse case scenario, just to be safe.  Also, don't be tempted to buy marginal deals that may force you to cut corners later on.  The best way to know if a house is really a deal is to run the numbers and to ask yourself this question: is there enough money in this deal to provide both myself AND a rehabber an attractive profit? If the answer is yes, go ahead, make that offer, sign on the dotted line and go make some money.