It looks so easy! Buy a house, make a few cosmetic fixes, put it back on the market, and make a huge profit. Voila!
At any given time, a half-dozen shows on television feature good-looking, well-dressed investors who make the house flipping process look fast, fun, and profitable. Wannabe fix and flippers: proceed with caution. Don’t believe everything you see on TV.
You’ve likely noticed the real estate market is currently red hot! Low interest rates and extremely limited inventory are driving purchase prices way up. Most sellers who list properties receive multiple offers—many cash—and often well over asking price. In fact, I was speaking with an investor recently who offered $100K-plus above asking price, and he still didn’t get the house!
Given the circumstances, in my opinion, we’re experiencing a short window of time where savvy investors may want to consider implementing a fix and flip strategy. If you can land an OK property for a decent price right now and fix it up fast, there’s a great chance you’re going to turn a nice profit.
However, curb appeal and sold signs aren’t always the road to real estate riches—despite what you see on HGTV. Far too many newbies overlook the basics and end up failing. As a cautionary message, let’s discuss common mistakes beginner fix and flip investors make and how to avoid them.
But before we dive in, let’s quickly go over the fundamentals.
House Flipping 101: What Is Flipping & How Does It Work?
Flipping houses is a real estate investment strategy in which an investor purchases an outdated or distressed property with the intention of fixing it up and selling it for a profit in short order.
That profit is typically derived from price appreciation resulting from:
- A hot real estate market in which prices are rising rapidly,
- Capital improvements made to the property, or
Put another way, the process goes something like this:
- Purchase a fixer-upper in a hot neighborhood,
- Make substantial renovations, and
- Offer it at a price that reflects its new appearance and amenities.
Seasoned investors who flip properties concentrate on the purchase and subsequent resale of one property or a group of properties. During housing market booms, some investors attempt to generate a steady flow of income by engaging in frequent flips. However, given the uncertainty surrounding COVID-19, I’m not a proponent of this practice today.
So, how do you flip a house? In simple terms, you want to buy low and sell high (like most other investments). Contrary to the long-term strategy of buying and holding property, fix and flipping is a short-term strategy, wherein you aim to complete the transaction as quickly as possible. Here’s why.
Each day that passes costs you more money on expenses like the mortgage, utilities, property taxes, insurance, and other costs associated with homeownership. In order to obtain maximum profit, the focus should be on speed. This also limits the amount of time your capital is at risk.
How To Calculate Purchase Price
The first and best piece of advice is to limit your financial risk and maximize your return potential. In simple terms, don’t pay too much for a home. You can accomplish this by knowing what the property is worth and calculating the cost of the necessary repairs or upgrades before you buy. From there, you can figure out an ideal purchase price.
The 70% Rule
Here’s some quick and dirty math for arriving at an appropriate purchase price. The 70% rule states that an investor should pay no more than 70% of the after-repair value (ARV) of a property, minus the repairs needed. For clarity purposes, the ARV is what a home is worth after it is fully repaired.
Here’s an example. If a home’s ARV is $300,000 and it needs $50,000 in repairs, then the 70% rule
indicates that an investor should pay no more than $160,000 for the home.
$300,000 x 0.70 = $210,000 – $50,000 = $160,000
5 Mistakes New House Flippers Make
Warning: if you’re looking to get rich quick by flipping a home, you could end up in the poorhouse. Flipping houses is a business like any other. It requires knowledge, planning, and savviness—not luck—to be successful. Here are several common ways novice real estate investors get it wrong:
1. Underestimating the cost of the project
The first expense to consider is the property acquisition cost. While low or no-money-down financing claims abound, finding these deals from a legitimate vendor is easier said than done.
Also, keep in mind that if you’re financing the acquisition, you’re paying interest. Although the interest on borrowed money is tax-deductible, every dollar spent on interest adds to the amount you’ll need to earn on the sale just to break even.
It’s important to note that if you use a mortgage or home equity line of credit (HELOC) to finance your flip-house purchase, only the interest is deductible. The principal, taxes, and insurance portions of your payment are not.
Research your financing options extensively to determine which mortgage type best suits your needs, and find a lender that offers low interest rates. An easy way to research financing costs is by using a mortgage calculator, which allows you to compare interest rates various lenders offer.
Of course, paying cash for the property eliminates the cost of interest, but even then, there are property holding costs and opportunity costs for tying up your cash. The fact is, making a profit is tougher than it used to be. This doesn’t mean there isn’t money to be made—the average gross profit on a flip in 2019 was $62,900—but due diligence is required.
Renovation costs must also be factored in. To successfully flip a house for profit, the sale price must exceed the combined cost of acquisition, the cost of holding the property, and the cost of renovations. Consider that the $63K gross profit might have to cover a $25,000 kitchen, a $10,000 bathroom, $5,000 in real estate taxes, plus utilities and other carrying costs, cutting the gross profit number by around two-thirds.
Toss in an unexpected structural problem… your “cash cow” may quickly become a net loss. One more thing: even if you manage to overcome the financial hurdles of flipping a house, don’t forget about capital gains taxes. These, too, will chip away at your profit.
2. Underestimating the time it will take to complete
Perhaps the flipping process goes smoothly—but takes longer than expected. Changing market conditions could mean that every assumption you made at the beginning will be invalid by the end.
Renovating and flipping houses can be a time-consuming venture. It can take months to find and buy the right property. Once you own the house, you’ll need time to fix it up. If you have a day job, time spent on demolition and construction can translate into lost evenings and weekends.
Obviously, you can hire a contractor to do the work. If so, you will need to allocate time to supervise the project (unless you have worked with the contractor before and fully trust them).
Once the work is done, inspections are required to make sure the property complies with applicable building codes before you can sell it. If it doesn’t, you’ll need to spend more time and money to bring it up to par.
Next, it can be hard to predict how long it will take to sell the property. Right now, inventory may be flying off the shelf. But the market is truly unpredictable.
Plus, if you use a real estate agent, you will owe a commission. And if you go the for sale by owner (FSBO) route and sell it yourself, you’ll be responsible for showings. To meet prospective buyers yourself may entail spending lots of time commuting to and from the property and taking meetings.
3. Overestimating your skills
Professional builders and skilled professionals, such as carpenters and plumbers, often flip houses on the side in addition to their regular jobs. They have the knowledge, skills, and experience to find and fix a house.
If this is not your area of expertise, then you will need to establish a team with the expertise and skillsets to take your project to the finish line. However, assembling a team is never easy. Your best bets are to ask for referrals or leverage the network of a mentor.
4. Overestimating your knowledge
To be successful, you must know how to pick the right property in the right location and purchase it at the right price. In a neighborhood of $300,000 homes, do you really expect to buy at $200,000 and sell at $400,000? The market is far too efficient for that to occur regularly.
Even if you get the deal of a lifetime, knowing which renovations to make and which to skip is key. You also need to understand the applicable tax laws and zoning laws and have the wherewithal to cut your losses and get out before your project becomes a money pit. Again, your best bet is to leverage a mentor.
5. Failing to exercise patience & good judgment
Professionals take their time and wait for the right property. Novices rush out to buy the first house they see. Then, they hire the first contractor they meet, who makes a bid to address work they can’t do themselves. Professionals, on the other hand, either do the work themselves or rely on a network of pre-arranged, vetted contractors.
Novices hire any Realtor to help sell the house. Professionals rely on seasoned agents to minimize costs and maximize profits.
Novices expect to rush through the process, slap on a coat of paint, and earn a fortune. Professionals understand buying and selling houses takes time and sometimes profit margins are slim.
The Bottom Line
If you are thinking about flipping a house, make sure you have a realistic understanding about what it takes and the risks involved. Beginners often underestimate the time or money required and overestimate their skills and knowledge. The truth is, making a nice profit quickly by flipping a home is not as easy as it looks on TV.