On today's podcast episode, I talk about fixing and flipping houses and understanding how fixing and flipping houses works. 

When you want to fix and flip a house, before you get started it is important to understand who you are selling the house to. I always teach my students to look at a fix and flip in reverse - meaning understand who you are selling the house to first. 

Your biggest pool of buyers are going to be first time FHA buyers. Those first time home buyers are buying a home with just 3.5% down. The demographic of a first time home buyer is a couple looking to move from an apartment to a house. The average age for an FHA buyer according to FHA is 31 or 32 years old. 

The next thing you need to look at is affordability. A lot of beginners mess this up because they figure if they are going to be fixing and flipping then they may as well go for a higher priced house with bigger profit potential to make as much money as possible. I don't advise that you do this, because as you go up in price point there is a lot more risk. If you want to make $40,000 or $50,000 on a fix and flip, then fixing and flipping just two houses per year could replace your job.

The type of fix and flip you should be focusing on is the entry level bread and butter homes that are affordable. You should understand that these are the types of homes that first time home buyers are looking for. If you are fixing and flipping houses to first time home buyers who your potential buyers are, and what they look like is all about affordability.

The median household income in the U.S for a couple is approximately $70,000. Mortgage brokers say you should not spend more than 30% of your gross income on your mortgage so that works out to be around $22,000 per year. Let's round that up to $24,000 per year and that means that the average couple with the median U.S household income can afford a $2,000 per month mortgage payment. 

Imagine yourself as that buyer looking to buy a house with a $2,000 monthly payment. Use Google's free Mortgage Calculator, and calculate what the house price would be with today's 30 year fixed rate mortgage rate that would result in your having a mortgage of $2,000 a month. Maybe they can afford $2,100 or $2,200 or even $2,400. This is the price range you should be focusing on. 

This affordability issue is very important to understand. That is why you should look at in reverse focusing on your buyer (not you). As you go up in price there are less people that can afford a home. There are way more people that can afford a $500,000 home versus a million dollar home. And there are a lot less people that can afford a $500,000 home than a $300,000 home. Many people simply don't earn enough income to be able to afford a higher priced home. So if you are fixing houses to flip or sell to other people, then consider where your biggest pool of buyers would be. When you look at it this way, you realize how important affordability is. 

So the first thing you need to understand if you are looking to fix and flip houses is affordability You need to focus on finding a neighborhood or city or target market where houses are more affordable. Based on current 30 year fixed mortgage rates, A couple earning the median income of $70,000 per year can afford a home that is priced no higher than $250,000.

You may live in a big city where prices are quite a bit higher than that amount. But if you move away 30 to 45 minutes, in most cities you will find other neighborhoods that are more affordable that are not as close to downtown.  

Imagine you are the buyer and ask yourself this question. If I made $70,000 a year, where could I afford to live? You may have purchased your home years ago, and it may have increased in price substantially so you may view your neighborhood as affordable. But what you need to understand is a new buyer, buying today is looking at today's prices (and today's mortgage rates) not what you paid. So a neighborhood which may have been affordable ten years ago is no longer affordable today. So the key question is where can they afford to buy based on their current income?

Affordability goes hand in hand with understanding where people are moving to. You can look at demographic data from the U.S Census Bureau and companies like U-Haul that provide moving data to analyze where people are moving to. You are looking for cities that are growing, that have population growth, and that have job growth. For example, in the State of Florida, according to U-Haul more people are moving to the Melbourne, Palm Bay area of Brevard County than anywhere else in Florida. If you wonder why, look no further than affordability. People will move to places that are affordable where there are jobs. These places are growing. The Space Coast of Florida is a perfect example of this. It's more affordable than South Florida, the population is growing, and there are many jobs being driven by employers in the Aerospace Industry. 

So based on household income, the target market audience that can afford to have a monthly mortgage payment of $2,220 a month can afford to buy houses up to $250,000. So the question is where do you find houses like this? That takes us to the discussion on target markets. As I mentioned above, Brevard County is affordable relative to where I live. Unfortunately it's a 3 hour drive from me but that is where I see buyers moving to. 

The next thing to focus on is the spread between what you are paying for a house and what you are flipping it for. If you know you want to flip a house to a first time home buyer for $250,000, then a spread of $100,000 would mean you paying no more than $150,000 to buy this house. 

If you are buying houses from motivated sellers at a discount, then you can find houses like this. You are looking for vacant, boarded up houses, hoarder houses, and houses that have been inherited and have been neglected. These houses may be completely outdated and vacant for many years. Inherited and Probate Houses are usually our best deals.

These houses fixed up nicely could sell to a first time home buyer for $250,000. You should be paying no more than $150,000 to buy these houses from motivated sellers.

Another more exact way to calculate your maximum offer price is by using the ARV Formula. ARV stands for After Repair Value, or what a house would be worth fixed up. This is another way of saying what you could sell the house for or what it would appraise for. 

The ARV Formula for purchasing is 

ARV x 65% Less Repairs = Your Maximum Offer Price

For example let's look at a $200,000 ARV house that could sell for $200,000 (or that would appraise for $200,000). That's the ARV. So you take that ARV of $200,000 and multiply it by 65% and that would be $130,000. If it cost $30,000 to fix up this house, then $130,000 less $30,000 would give you a maximum offer price of $100,000. This is exactly $100,000 less than the ARV of $200,000.

The sweet spot that I like to buy at (and teach my students to buy at) is these lower priced houses that you can flip for $200,000 to $250,000. So these houses you are paying around $100,000 to $130,000 to buy them. And you have a spread of about $100,000 from your purchase price and what you could sell them for.

If you are buying these types of houses at a discount, you are not buying them with a mortgage. Since these houses need work, you would not be able to get approved for buying a house like this with a mortgage. It's doubtful that a motivated seller would wait that long to see if you could get approved for a mortgage. And if the house needs any repairs then you can definitely not get a mortgage. Also, your postcard that you mailed to the seller says something like "We Buy Houses For Cash" or "Cash Offer For Your House" so they are anticipating a cash offer and they know it will be lower than a regular conventional mortgage offer. That is why they called you and not a real estate agent. So your offer needs to be all cash.  

To buy these houses, you would need to use your own cash, or you would be borrowing money from a private lender like me who is using their own private funds as a private lender.

Typically these private lenders are going to want you to have some form of a down payment (at least $10,000). If the amount of repairs is $30,000 then that would be a total of $40,000 out of pocket, but keep in mind that these are not the only costs that you will have. You will have closing costs, points, fees, insurance, which may add up to $10,000 so that would put your out of pocket cash at $50,000. 

Also when you own the property while you are repairing it and before you sell it, you will have to pay monthly costs for mowing the lawn, paying the water, and paying the electric bill. You will also have a monthly interest payment to the lender which may be $1,000 per month. So you need to budget for, and factor all of these costs in to the equation.

A house with no damage that just requires cosmetic cleaning will cost less out of pocket. If repairs are $10,000 instead of $30,000, then in the above example you would only need to come out of pocket $30,000 instead of $50,000. Conversely, if the house needed a new roof, new air conditioner, plumbing or electrical, the repairs could be substantially higher. For this reason, if you are a beginner, I recommend you stick with cosmetic fix and flips only. Look for houses that have a good roof with no leaks, no plumbing or electrical issues and houses that already have central air conditioning. That way you only need to focus on repairing the interior (cosmetic repair). 

One self limiting belief that stops new investors is them reading this and saying to themselves "Well I don't have $30,000 to $50,000 so I can't fix and flip houses". I like to get my students to think creati