Risk and what-ifs: lower sale price, repair overruns, a slower sale and tax
Pricing a house the investor way · 1 study hours
Bottom line: Test each guess in the deal, a 5% lower ARV, repairs 20% over and a sale 3 months slower, singly and together, then price the offer with a cushion and remember the profit is a before-tax number.
Bottom line first. A maximum offer is built on guesses: the sale price, the repair bill and the timeline. A what-if test changes each guess to see how bad it gets. If one bad month or one bad bid wipes out the profit, the offer is too high. Every number below is per house, from that house's own facts, and every one is a made-up example.
The base case
We stay with the made-up Aspen Bend Heights ranch (3 beds, 2 baths, 1,400 square feet). The buyer pays $280,000, the clean offer we built earlier. The plan: ARV $450,000, repairs $75,350 including contingency, holding $19,740 (5 months at $2,940 = $14,700, plus $5,040 of points), buying costs $2,150 plus a $28.00 documentary fee, and selling costs of $27,345 (5 percent commission $22,500, title and closing $1,800, concession $3,000 and the $45 documentary fee; C.R.S. 39-13-102(2)(b)). Profit: $45,387.
In these tests the price stays at $280,000, so the loan and the points stay the same. Only the thing we are testing moves.
Example with real numbers: one shock at a time
| What if | Extra cost or lost price | Profit left |
|---|---|---|
| Base case | none | $45,387.00 |
| ARV falls 5%: $450,000 to $427,500 | $22,500 less sale price, offset by $1,125 less commission and $2.25 less documentary fee | $24,014.25 |
| Repairs run 20% over: $75,350 to $90,420 | $15,070 | $30,317.00 |
| Sale takes 3 months longer: 3 x $2,940 | $8,820 | $36,567.00 |
Work the ARV row slowly: 5 percent of $450,000 is 0.05 x 450,000 = $22,500. New ARV = $450,000 - $22,500 = $427,500. The commission is 5 percent of the sale price, so it falls by 0.05 x $22,500 = $1,125, and the sale-side documentary fee falls from $45 to $42.75 (4,275 hundreds x $0.01), a drop of $2.25. The profit falls by $22,500 - $1,125 - $2.25 = $21,372.75, so $45,387 - $21,372.75 = $24,014.25. The ARV is the biggest number in the deal, so a small percent move there costs the most dollars.
Repairs: 20 percent of $75,350 is $15,070, so $45,387 - $15,070 = $30,317. Time: three more months of the $2,940 carry is $8,820, so $45,387 - $8,820 = $36,567. (The $2,940 includes loan interest and the other monthly costs from lesson 3; the points are paid once, so they do not grow with time.)
All three at once
Bad things come in groups. A soft market can raise holding time and a slow seller can come with surprise work. So add them up: $45,387 - $21,372.75 - $15,070 - $8,820 = $124.25. The deal technically still shows a profit, but only about $124 against a $45,000 target, a few tenths of a percent of the target. A fourth surprise would turn it into a loss. The single shocks cost $21,373, $15,070 and $8,820; the combined case costs $45,262.75, which is all of them added together.
Building a cushion into the offer
A cushion (also called a margin of safety) means choosing an offer that survives bad news. Suppose Marcus wants the $45,000 target to hold even in the combined bad case. At $280,000 the combined case leaves $124.25, so the shortfall is $45,000 - $124.25 = $44,875.75.
Lowering the price by $1 saves more than $1 here, because the loan shrinks with the price. In the combined case the loan is carried 8 months, not 5. Each $1 off the price saves $1 of price, 1.8 cents of points (0.90 x 0.02), 6.6 cents of interest (0.90 x 0.11 x 8/12) and 0.01 cent of documentary fee: about $1.0841 in all. So the price must drop by about $44,875.75 / 1.0841 = $41,394, to about $238,606. Round down to a clean $238,500, which is $41,500 below $280,000. Check it: at $238,500 the combined-case profit is about $45,114, and the normal-case profit is about $89,350.
Nobody has to pick the full cushion. A buyer might accept a $20,000 profit in the bad case and a bigger profit in the normal case. The point is to see the trade: paying more means the profit disappears faster. Notice, too, that this cushioned offer lands close to the 70% rule's $239,650. A rule of thumb is not useless; it just cannot tell you which house deserves the cushion.
Tax, in general terms
Profit is not all yours to keep. For people who buy and sell houses as a regular activity, the profit is generally taxed as ordinary income, meaning in the same way as pay for work, rather than as a long-term gain from holding an investment. That means the $45,387 in our plan is a before-tax number. We do not state rates here because they depend on the person and the year. Ask a tax professional how your own deals are treated and how much to set aside, before you pay for the house, not after you sell it.
What to do with the numbers
- Run the three single shocks and the combined case on every house, using that house's own numbers.
- Look for the line that hurts most. For most flips it is the ARV, so check it hardest.
- Decide how much bad news you can take and still be comfortable, then price the offer to that.
- Set aside money for tax out of expected profit.
An owner can use the same test. If a buyer quotes a low price, the likely cause is a cushion for exactly these what-ifs. The offer is lower than the base-case ceiling because the buyer is pricing the risk.
General education, not financial advice or tax advice. Every figure is a made-up example except the documentary fee rate, which comes from the statute.
Law cited
- C.R.S. 39-13-102
Key terms
- What-if test
- Changing one guess in the deal, such as ARV or repairs, to see how much profit is left.
- After-repair value (ARV)
- What the house should sell for once the repairs are finished.
- Contingency
- Extra money inside the repair budget for surprises.
- Holding costs
- What it costs to own the house while you work on it and sell it, counted per month plus any points.
- Cushion
- Room built into the offer so the deal still works if the news is bad; also called a margin of safety.
- Margin of safety
- Another name for a cushion.
- Ordinary income
- Income taxed in the same general way as pay for work, rather than as a long-term investment gain.
- Target profit
- The profit a buyer needs for the deal to be worth it.
- Combined case
- Several bad outcomes tested together, such as lower ARV, higher repairs and a longer sale.
- Documentary fee
- A Colorado fee on recorded deeds: one cent per $100 of consideration, or major fraction (C.R.S. 39-13-102).
Flashcards
What is a what-if test?
Changing one guess to see how much profit remains.
ARV drops 5% on $450,000?
$22,500 lower, to $427,500.
Repairs 20% over $75,350?
$90,420, which is $15,070 more.
3 months longer at $2,940 a month?
$8,820 more holding.
Profit after the ARV drop alone?
$24,014.25 (commission and doc fee fall a little too).
Profit with all three shocks?
$124.25.
Offer that keeps $45,000 in the combined case?
About $238,500, which is $41,500 below $280,000.
What is a cushion?
Room in the offer so bad news does not erase the profit.
How is flip profit generally taxed?
Generally as ordinary income; ask a tax professional.
Which single shock hurt most here?
The ARV drop, $21,372.75.
Quiz: 10 questions
Tap an answer. It shows right or wrong and opens the reason. Your score is saved in this browser and counts in the study app.
ARV is $450,000 and falls 5%. The new ARV is:
- A $427,000
- B $445,500
- C $430,000
- D $427,500
Show answer and why
Answer: D. $427,500
5 percent of 450,000 is 22,500, and 450,000 - 22,500 = 427,500.
Aspen Bend Heights example (made up)
At the $280,000 offer (base profit $45,387), a 5% ARV drop leaves a profit of about (the 5% commission and the documentary fee fall too):
- A $45,387
- B $24,014
- C $22,887
- D $21,373
Show answer and why
Answer: B. $24,014
The sale price is $22,500 lower, but the commission is $1,125 lower and the documentary fee $2.25 lower, so profit falls $21,372.75, to $24,014.25. The tempting $22,887 subtracts the whole $22,500 and forgets the smaller commission.
Aspen Bend Heights example (made up)
Repairs of $75,350 run 20% over. The new repair bill is:
- A $75,370
- B $85,350
- C $90,420
- D $15,070
Show answer and why
Answer: C. $90,420
0.20 x 75,350 = 15,070, and 75,350 + 15,070 = 90,420. $15,070 is only the overrun.
Aspen Bend Heights example (made up)
The sale takes 3 months longer at $2,940 per month. The extra holding cost is:
- A $8,820
- B $2,940
- C $5,880
- D $14,700
Show answer and why
Answer: A. $8,820
3 x 2,940 = 8,820. The $5,880 figure is a 2-month delay.
Aspen Bend Heights example (made up)
Take all three shocks together on the $280,000 offer. Profit is about:
- A $45,387
- B $124
- C $24,014
- D $30,317
Show answer and why
Answer: B. $124
45,387 - 21,372.75 - 15,070 - 8,820 = 124.25. The three bad things together nearly erase the profit.
Aspen Bend Heights example (made up)
Which is NOT something a what-if test can do?
- A Show how much profit is left if one guess is wrong
- B Show which guess hurts the most
- C Help you choose a cushion for the offer
- D Guarantee what the house will sell for
Show answer and why
Answer: D. Guarantee what the house will sell for
A what-if test changes guesses on paper. It cannot know the future sale price; it only shows how exposed you are if the guess is wrong.
Aspen Bend Heights example (made up)
To keep a $45,000 profit even in the combined bad case, the offer must be about:
- A $280,000
- B $245,000
- C $238,500
- D $252,000
Show answer and why
Answer: C. $238,500
The combined case leaves $124.25 at $280,000, a shortfall of $44,875.75. Each $1 off the price saves about $1.0841 in that case, so the price must fall about $41,394, to about $238,606, or a clean $238,500.
Aspen Bend Heights example (made up)
Which statement about tax on flip profit is best, in general terms?
- A Flip profit is generally treated as ordinary income for people who flip regularly; the plan's profit is before tax, and a tax professional can say how much to set aside
- B Flip profit is always taxed at a low long-term rate
- C Flip profit is never taxed if you pay cash
- D Flip profit is taxed only if it is over $100,000
Show answer and why
Answer: A. Flip profit is generally treated as ordinary income for people who flip regularly; the plan's profit is before tax, and a tax professional can say how much to set aside
For people who flip as a regular activity, profit is generally ordinary income, like pay. Rates depend on the person and year, which is why you ask a tax professional.
Course example
Which single shock cost the most on this house?
- A The 3-month delay
- B Repairs 20% over
- C The 5% ARV drop
- D They cost the same
Show answer and why
Answer: C. The 5% ARV drop
The ARV drop cost $21,372.75, repairs $15,070 and the delay $8,820. The ARV is the biggest number in the deal.
Aspen Bend Heights example (made up)
A different house holds at $3,000 a month. A 3-month delay adds:
- A $6,000
- B $9,000
- C $3,000
- D $12,000
Show answer and why
Answer: B. $9,000
3 x 3,000 = 9,000. Use that house's own monthly figure, never ours.
Course example
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