I am very analytical when it comes to real estate investing. As such, I use several formulas to ensure that I am making rational decisions. You cannot base all of your decisions on formulas. However, formulas do provide a stable method for ensuring that you do not veer too far off of you investing path.

I have already posted about the Rent Multiplier formula, which is the driving formula I use for buying investment rental properties. Another formula I use is what I call the Nickerson Formula. This derives from a book by William Nickerson entitled “How I Turned $1,000 into Three Million in Real Estate in My Spare Time”, which was published over 40 years ago.

While some parts of this book are outdated, it still presents a basic approach that should work well in today’s market. Nickerson’s approach was basically to make $2 in profit for every $1 spent on repairs. I do not use this formula for setting a purchase price. Intead, I use it to ensure that I get a better deal on properties that require more work. If the repair costs are higher there will be more work and risk involved in the deal, so I need to pay less for the property.

The basic formula is:
ARV = PurchasePrice + (2 X RepairCost), where ARV = After Repaired Value.

In order to determine the maximum purchase price you must first estimate the RepairCost. Then subtract twice the repair cost from the ARV to get the maximum PurchasePrice. This formula is:
PurchasePrice = ARV – (2 X RepairCost).

Assume you are presented with 2 options.
1. A house with an ARV of $100,000 that needs $5,000 in repairs and you can purchase if for $70,000.
2. A house with an ARV of $100,000 that needs $30,000 in repairs and you can purchase it for $45,000.

In both cases, you will have invested $75,000 for a house worth $100,000. Which is the better deal?

Let’s try the Nickerson Formula on both.
Option 1

PurchasePrice = ARV – (2 X RepairCost).�
PurchasePrice = 100,000 – (2 X $5,000).�
PurchasePrice = 100,000 – ($10,000).�
PurchasePrice = $90,000

Option 2

PurchasePrice = ARV – (2 X RepairCost).�
PurchasePrice = 100,000 – (2 X $30,000).�
PurchasePrice = 100,000 – ($60,000).�
PurchasePrice = $40,000

This formula shows that the maximum I would pay for option 1 would be $90,000 and the maximum for option 2 is $40,000. With option 1 I am actually buying at $70,000; $10,000 under the maximum. With option 2 I am paying more than the maximum. Using this formula I see that option 1 is the best deal.

Please keep in mind that I do not use this formula alone to get the maximum purchase price. (I want to gain equity from the purchase as well as the repairs.) I use other methods, such as the Rent Multiplier, to arrive at the purchase price. Then I make sure that number also meets the requirements of this formula. This acts as a safety net to ensure that I get a better deal if a lot of work is required on the property.

 

 

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