Underwriting

What it is

Underwriting is how you make sure a deal actually works before you close on it. Not vibes. Math.

The equation is simple: acquisition price plus project costs equals ARV, the after repair value. That’s what the lender is going to ask you too. Do you have the contract? What’s the rehab going to cost? What’s the after repair value? That’s your business plan. Not a 30-page pitch deck with neighborhood economics. Just those three things.

The 70 percent rule is the quick version — take 70% of the ARV and subtract the rehab. So if the ARV is $300K and rehab is $50K, that’s $210K minus $50K equals $160K max purchase price. That’s it. Is it perfect? No, it’s not even close to perfect. But it gets you to a quick offer on a house and it’s the first pass.

Why it matters

If you get a bad deal on the front end, you’re never going to make money off of it. That’s the truth. I used to beat my head against the wall trying to find ways to get cheaper renovations done. I thought that was the key — drive those construction costs down and then I’ll be a millionaire in no time. Not true. Defense is the rehab. The offense is getting great deals. A bad deal on the front end, nothing you do after closing saves you.

And when you’re doing the math conservatively, that means actually conservative. If I thought the rehab was going to be $50K, I need to budget for $60K or $70K. It’s always more than you think it’s going to be and it always takes longer. I’m experienced. I have managed hundreds of projects. It still happens. If I thought it was three months, plan for six.

The market is what the market is. If houses in that neighborhood are selling for $300K, you’re not selling yours for $330K. I don’t care how nice you make it. I don’t care how many HGTV shows you’ve watched. You put gold-plated backsplash in there, it’s still $300K. So the ARV you plug into the underwriting better be honest.

How it shows up

When I’m looking at a deal, the lender’s not going to care about anything except the contract price, the project costs, and the after repair value. A hard money lender looks at the strength of the deal, that’s it. They’re not pulling much credit. They want to know if the deal works.

What trips people up is the confirmation bias trap. Once you’ve walked a house and started imagining what it could look like, the inputs start drifting. ARV creeps up. Rehab creeps down. Holding costs get forgotten entirely. Underwriting only works if you’re honest with the inputs. And honesty gets harder the more you want the deal.

The Flippin’ Calculator does the underwriting properly. It breaks down rate of return on cash in the deal, interest rate, points on the loan, hold time. Under basic conditions — 12% interest, 4% points, 6-month hold, 15% rate of return — you get numbers dang close to the same numbers as the 70% rule. Under different conditions, you don’t. That’s why you actually run the numbers.

Related

70 percent rule, equity gap, arv, holding costs, fliporithm, range of comps, contingency