Rehab math in the Valley: ARV, repairs and the 70 percent rule
Most Valley flips that lose money don't lose it on the purchase. They lose it on a repair budget that was too optimistic and an after-repair value that was too hopeful. I've done both. Here's how I do the math now.
Start with an honest ARV
After-repair value is what the house will sell for once it's fixed. The key word is honest. Use sold comps, not listings, from the last few months, within a short distance, similar size and age, and on the same side of whatever street or school boundary changes prices in that neighborhood.
In Modesto and Stockton, a half mile can matter a lot. A remodeled house near a busy corridor won't sell like one three blocks into a quiet tract. If you only have one great comp and three mediocre ones, your ARV is the mediocre number.
For a sense of whether the market is moving under you, I check the FHFA House Price Index for the metro area. It won't price a house, but it tells me whether the last year was flat, up or down, which matters if your project takes six months.
Build the repair budget room by room
Walk the house with a notepad and price each item. Roof, HVAC, electrical panel, plumbing, windows, flooring, kitchen, bathrooms, paint, exterior, landscaping. Valley houses built in the 1950s through the 1970s have predictable needs: older panels, galvanized supply lines, single-pane windows, and HVAC that's been fighting 105-degree summers for twenty years.
Then add a contingency. I use 10 percent on houses I've seen inside thoroughly and 15 to 20 percent on houses I haven't. Something always shows up behind the drywall.
Pull permits. Unpermitted work can cost you at resale when the buyer's appraiser or inspector notices, and some buyers' lenders won't close on it. Check that every contractor you hire is licensed with the Contractors State License Board.
Don't forget holding and selling costs
Every month you own the house costs money: loan interest or the cost of your own cash, insurance, utilities, property taxes. On a hard-money loan, that can add up quickly. Estimate how long the rehab will take, then add a month or two.
Selling costs include agent commissions if you list, transfer taxes, escrow and title, and any credits you end up giving the buyer. Leave room for a buyer who asks for repairs after their inspection.
The 70 percent rule, and why it's just a start
The common rule of thumb says don't pay more than 70 percent of ARV minus repairs. On a house with a $350,000 ARV and $60,000 of repairs, that's $245,000 minus $60,000, so a maximum offer around $185,000.
It's a useful sanity check. But it bakes in assumptions about holding time, financing and selling costs that may not fit your deal. On a cheaper Valley house, fixed costs eat a bigger share, and 70 percent can be too generous. On a quick cosmetic flip with cheap money, it can be too tight.
I run the full numbers every time: ARV minus repairs minus contingency minus holding minus selling minus the profit I need. Whatever's left is my maximum offer. Then I compare it to the 70 percent number as a gut check.
Permits and the heat
Valley summers shape the rehab in a way coastal investors underestimate. Replacing an HVAC system in California usually requires a permit, and under the state's building energy standards that often includes testing the ductwork. The California Energy Commission's building energy efficiency standards set those rules, and local building departments enforce them.
Skipping the permit saves a few hundred dollars now and costs you later, when a buyer's inspector asks for the paperwork or a buyer's lender won't close. Build permit fees and testing into every HVAC and roofing line in your budget.
Also plan your schedule around the heat. Roofing and exterior paint in July are slower and harder on the crew, and a house with no working air conditioning is hard to show in August.
Taxes on the back end
Flips are usually taxed as ordinary income, not capital gains, and if you're thinking about holding instead, the rules on exchanges and dispositions in IRS Publication 544 are worth reading before you decide. Talk to a tax preparer who works with investors.
Where deals come from
Good rehab math is wasted on bad leads. I look for sellers whose houses need work and who'd rather not do it themselves, which is most of the Valley's older housing stock. If you work Stanislaus County, Modesto seller leads are where I'd start, and it's worth understanding the trade-offs between off-market versus MLS deals before you decide where to spend your time.
These are my working numbers, not a guarantee. Every house is different, and every Valley neighborhood prices a little differently.