Investor's Profit Formula

Investor's Profit Formula

Here's the formula that I use - and most investors use some variation of this formula - to determine my net profit on the homes and small apartments that I rehab.

Net profit = sell price - closing costs - buy price - buy closing costs - rehab cost - cost of money

and then your Return On Investment (ROI) is (if you buy with a loan)

ROI = (net profit) / (downpayment + cost of money)

It's clear from the formula that the unknown variable is the cost of money because that depends on how long you hold the property if you're making mortgage payments. And it should also be clear that your ROI actually decreases the longer you hold the property.

In this economy it makes the most sense to buy and rehab with cash if possible, because of the uncertainties of the timing of resales, expected resale prices, and the length of your hold. If you have income from the property or if you can absorb the mortgage payments, you likely won't risk losing the property. But every dollar you pay out in holding costs comes from your net profit.

If you're going to rehab and resale, use the above formula. On the other hand resale prices have become so depressed (since all buyers want a bargain price whether or not the property is distressed) that it's hard to go into a rehab project with enough confidence on a profitable resale.

One universal exception, of course, is the high-end fixer upper or REO. There are plenty of those available at half-price or at 2003 prices before the bubble. If you can buy and rehab one of these for a total investment less than 70% of market value, then you can still sell it way below market value and make some significant profit. Or if you're willing to hold until the economy recovers, high-end rehabs almost always hold their value better than all other types of homes.