Several years ago, I became friends with a young woman who was just getting started in real estate. She became a real estate agent, and then started learning about renovation. She bought her first house, flipped it, and made a ton of money. Thanks to some exceptionally lucky circumstances, and some serious persistence on her part, she ended up on an HGTV show about flipping houses. She appeared in several episodes of the show, because she was part of an often-featured investor team in Atlanta.
I asked her one day if flipping houses was as easy as it looked on TV. After all, the show made it look very easy. You find a cheap home for sale. Put some money and sweat equity into fixing it up, and then resell the house for a huge profit. House flippers can make enormous profits on a sale. Could it really be that simple? She laughed, shaking her head. “We make it look easy,” she said. “But it’s risky, back-breaking work. It can be fun, but if you don’t know what you’re doing, you’re sunk.”
Enter the world of house flipping.
Flipping is a term used primarily in the United States to describe purchasing a revenue-generating asset and quickly reselling (or “flipping”) it for profit. Though flipping can apply to any asset, the term is most often applied to real estate and initial public offerings(IPOs).
The term “flipping” is used by real estate investors to describe “residential redevelopment”.
Real Estate Flipping
Profits from flipping real estate come from either buying low and selling high (often in a rapidly rising market), or buying a house that needs repair and fixing it up before reselling it for a profit (“fix and flip”).
Under the “fix and flip” scenario, an investor or flipper will purchase a property at a discount price. The discount may be because of:
- the property’s condition (e.g., the house needs major renovations and/or repairs which the owner either does not want, or cannot afford, to do), or
- the owner(s) needing to sell a property quickly (e.g., relocation, divorce, pending foreclosure).
The investor will then perform necessary renovations and repairs, and attempt to make a profit by selling the house quickly at a higher price. The “fix and flip” scenario is profitable to investors because the average homebuyer lacks the time and funds to repairs and renovations, so they look for a property that is ready to move into. Also, most traditional mortgage lenders require the home to be habitable with no significant repairs.
There are a lot of decisions to make from the beginning of flipping. Where should you buy? If you purchase a house in an up-and-coming neighborhood, you’re banking on the neighborhood increasing in value. If you decide to buy in a new development, you’ll want to attract higher-end home buyers who want the luxury features and space offered in the suburbs. If all goes well, you could make a nice profit. But if something goes wrong — faulty budgeting, timing issues, a crime spike in that up-and-coming neighborhood — you could be stuck with a house you can’t get rid of.
So much in house-flipping depends on the real-estate market, which we all know is cyclical. During a boom, flippers have the upper hand and can almost name their price in some areas. But during a slow period, many of these fixed-up homes can sit on the market for months.
Once you know where you want to buy, the next step is deciding what type of property you want to purchase. If you go for a fixer-upper, you’re committing to improving the home, which takes time and money. If you buy a foreclosed property in an auction or from a bank, you could get a bargain on a vastly underpriced house. But remember that if the previous owners couldn’t pay the mortgage, they probably couldn’t pay for the upkeep, either — so you might have to deal with a rodent infestation or a leaky roof.
Fixer-uppers and foreclosures are what most people think of when flipping comes to mind. Now there’s a trend toward trying to flip houses in new, high-end developments in outlying suburbs. If commercial and retail development (read: big-box superstores) spring up, it could bring in droves of residents. But if the situation isn’t perfect — if gas prices rise, for example, causing home buyers to shy away from big commutes — this kind of flipping becomes pretty risky.
So why do people flip houses? And what does the average buyer — and seller — need to know about flipping before investing? How much money can be made by flipping a house? And what kind of moral line do you walk by paying bottom dollar to people who have lost their homes? We’ll address all of these issues as we investigate the art of house flipping.
House Flipping Financing
The first piece of advice that most flipping experts give: Make a budget. While finding the perfect place and knowing your skill set (or having friends with skill sets) is important, budgeting is where new flippers most often fail. So where to start? First, get financing.
This step was fairly easy when subprime mortgages were hot. These mortgages allowed buyers to pay little or no down payment. In exchange, they were socked with higher interest rates — but when you’re planning on owning the house for only a few months, that’s a minor issue. When the market is flat, however, obtaining a mortgage for an investment property is more difficult, and sky-high interest rates empty investors’ wallets when a property sits on the market.
As a result, cash plays a much bigger role in getting that flip started. The bigger the down payment you can afford, the lower the interest rate. And, of course, it helps to have cash around for fixing up the flip.
House Flipping Tips
If you’re planning to buy a new-construction home, budgeting can be simple. It’s just like buying a home you actually plan to live in — you need to cover the mortgage, insurance, taxes, real-estate agent and lawyer’s fees, and that’s about it. However, in a softening market, the supply of houses is much greater than demand, so you may own that property for longer than you plan to.
If you’re working on a fixer-upper, the budget starts to grow when you consider the renovations you’ll need to make. According to most experts, you should add 20 percent to your estimate for the final cost. If you overestimate, you get a surprise windfall — but if you underestimate, you get stuck with unexpected bills.
Structural improvements — like plumbing, electrical, insulation, pest control, and HVAC — are typically the least sexy but most important improvements a flipper can make. New hardwood floors and coat of paint may get buyers in the door, but a termite problem can kill a deal quickly. If your technical skills are lacking here, you’ll have to figure in the cost of labor, too (that includes the time and money lost if you’re waiting on your brother-in-law to finish the electrical wiring).
Most real-estate agents advise fixing up the kitchen and bathrooms for the best return on your investment. In addition to the structural changes, this can include new cabinetry, counters, hardware, sinks, backsplashes, appliances, floors and lighting. Kitchen upgrades can be expensive, but they make a big impression (granite countertops and wine storage, for example). You could also decide to go green, which can add value to the house when the improvements are marketed as money-savers. Obviously, you’ll keep costs down if the house is in good structural shape and just needs updated paint and carpets — but things can quickly get pricey, especially if you’re using contractors and outside labor.
Another aspect to consider is curb appeal — the outside of the house. You might need to paint, landscape and fix up the driveway, which adds to the budget. If you’ve bought in a pricey neighborhood, mowing the lawn and repairing the fence may not be enough — there could be homeowners’ association fees. In up-and-coming neighborhoods, you might have to budget for security measures.
Flipping New Homes and Foreclosures
Once you’ve decided on what kind of house to flip — new construction, a fixer-upper or a foreclosure — you need to figure out the neighborhood. Don’t skimp on the research here. Make sure you really investigate the area — drive around during the day and at night, check recent sale prices and find out if any other flippers are sitting on empty houses.
If you’ve decided to flip a new home, your options are somewhat limited to what’s being built in the area — typically in housing developments. Some communities also have restrictions on buyers, requiring them to live in the house so the community doesn’t end up a ghost town.
If you’ve opted to buy a home in foreclosure, you’ll be buying from a lender — foreclosed homes are also known as REOs, or real estate owned by the lender. Purchasing an REO is a lengthy process, typically six to eight months. This is because for a bank to foreclose on a home, it must file court papers against the homeowner, which takes awhile. If it’s an auction, you’re ruled by that timetable. And because the home is sold “as is,” banks might not be as willing to hand out a loan.
But if you’re determined to buy a house in foreclosure, there are plenty of Web sites that list REO houses, often for a fee. And many lenders list the homes they have in foreclosure. A warning here: Many of these sites will let you search for homes anywhere in the country, but experts agree that one of the biggest mistakes flippers make is buying a house sight-unseen. The photo of the house may be pretty, but there’s no way to guarantee anything else. It doesn’t give you any clues about the neighborhood, and there’s no way of knowing how old the picture is.
Budgets can balloon quickly on fixer-uppers. If you decide to invest in one, you need a high tolerance for risk — and an exit strategy. The consensus from most home remodeling experts is this:
- You can make more money on a really cheap house that you turn into a nice house than a nice house that you turn into a premium house. All those expensive upgrades don’t offer nearly as much return on your investment as fixing a cracked foundation does. For most people, this means hiring workers, or having a lot of help.
- The more people you get involved, the more coordination is required. You’ll have to keep very close tabs on plumbers, electricians and handymen — or hire a general contractor (which means a big increase in your budget).
- Think local. If you’re remodeling a house in Massachusetts, use clapboard, not adobe bricks. The closer to home you stick for materials, the more experts you’ll be able to find to help you install them.
- Don’t overestimate your work. Sure, that paint job looks nice, but is it really worth a $20,000 markup on the property? Overpricing your property could just leave you with a house that people are wary of because it’s been on the market too long.
- Don’t get ahead of yourself. First-time flippers may see dollar signs when they think about buying multiple properties, but problems can quickly turn into bankruptcy if you’re using one house’s equity to pay for another’s repairs. Plus, each home requires attention, and unless you’re quitting your day job — which the experts also don’t recommend for newbies — you will probably have plenty to do for one house without thinking about your next flip.
- However long you think the renovation will take and whatever you estimate it will cost, just understand that it will probably be much costlier and more time-consuming.
- Nearly every upgrade you skimp on will haunt you, remodelers warn. From cheap carpet to cheap electricians, quality of workmanship is something that flippers cannot fake in a softening market.
Depending on your goals and the extent of the renovations, fixer-uppers can take a few months (or less, if you’re really lucky) or years to turn around. If you want to live in your investment as you’re working on it, remember that there may be a lot of sawdust in your future. And while up-and-coming neighborhoods can explode overnight, there will also be fluctuations in crime rates, local business booms and school improvements, all of which can affect your property’s value. Patience is key when waiting for a neighborhood to take off.
What Makes a Good Real Estate Investment?
So what should you look for in a potential house flip?
- Location. Expert house flippers can’t stress this enough. Find a home in a desirable neighborhood, or in a city where people want to live. In a down market, like the one that exists today, finding a superior location can be a challenge. Start by researching local cities and neighborhoods. Look for areas with rising real estate sales, employment growth, and other indications that the town will rebound from the recession.
- Sound Condition. You don’t want to tear the house down, and start rebuilding it from scratch. Look for structurally sound homes. You may not have the opportunity to have a home inspected, especially if you buy the home at a real estate auction. You need to learn what to look for, or bring someone knowledgeable about building, electric, and plumbing with you to look at the home, to determine if the home is structurally sound.
- Good Schools. Homes in a good school district sell more quickly.
- The Right Fixes. A home with old carpet and wallpaper featuring pink poodles may be easy, and cheap, to update. Other home repairs to tackle might include installing outdoor motion sensor lights, replacing old kitchen linoleum, and replacing hollow doors with six-panel doors throughout the home. A house that hasmold, needs a roof replacement, or needs rewiring, requires some serious time and cash to update and sell. Make sure you know which updates and repairs you can afford to fix, which repairs you can’t afford, and which home improvements will increase the selling price of the house. When you estimate the cost of any job, experts advise that you add 20% to the final estimate. Why? It’s always going to cost more than you think it will, say the experts. Always.
- Close to You. You will work on this house daily in the weeks and months to come. Do you really want to work all day, and then drive an hour to get home?Don’t invest in a house too far away from where you live; you will spend more money on gas, and it will take longer to fix up the house.
- Analyze the Kitchen. The kitchen is the most important room in the house. Pay close attention to this area when you buy a house. Most experts recommend you focus onremodeling the kitchen, and then look into bathroom redesign ideas. Analyze how much you will have to spend on the kitchen in order to make it appealing for future buyers.
- Value. Make sure the price of the home isbelow its value in the local market. Otherwise, you will not make money. Try to buy the worst house in a great neighborhood, versus the best house in a lousy neighborhood. The worst house in a great neighborhood has nowhere to go but up in value, due to the value of the other homes in the area.
Although you can search the web and see millions of foreclosed homes for sale, never buy a home without seeing it in person. This is the biggest mistake new flippers make. Keep in mind, the online photo gallery only tells part of the story: Old photos, an awful neighborhood, and black mold are just a few of the horror stories of foreclosed homes online. Always investigate a property yourself before deciding to buy.
5 Mistakes That Make House Flipping a Flop
House flipping has become the day trading of the first decades of the 2000s. But in the rush to make a profit, far too many would-be real estate moguls overlook the basics and end up failing. We’ll look at the five biggest mistakes investors make in this market and how to avoid them.
1. Not Enough Money
If location, location, location is the mantra for all real estate, “do the math, do the math, do the math” should be the mantra for would-be flippers.
And we mean all the math.
For example, if you calculate a potential flip this way: Buy a house for $100,000, spend $20,000 on improvements, sell it for $150,000 and earn $30,000 profit, you clearly haven’t done all the math that’s needed.
What about the cost of borrowed money and the cost of selling the house? What if the contractor discovers, once he starts the work, that half the plumbing lines are rotted? What about the cost of insurance, utilities and property taxes while you own the house?
You must dig below the surface-level figures to paint a complete and accurate picture of the flipping opportunity. Only then can you determine whether it’s a sound financial move for you.
Dabbling in real estate is an expensive proposition. The first expense is the property acquisition cost. While low/no money down financing claims abound, finding these deals from a legitimate vendor is easier said than done. Also, if you’re financing the acquisition, that means you’re paying interest. Although the interest on borrowed money is tax deductible, it is not a 100% deduction. Every dollar spent on interest adds to the amount you will need to earn on the sale just to break even.
Paying cash eliminates the interest, but even then there are property holding costs, such as taxes and utilities. Renovation costs must also be factored in. If you plan to fix the house up and sell it for a profit, the sale price must exceed the combined cost of acquisition, the cost of holding the property and the cost of renovations. Even if you manage to overcome these hurdles, don’t forget about capital gains taxes, which will chip away at your profit.
-Usually- flipping houses is not for someone who has no money. While it is possible to borrow money to buy and fix up homes, doing so isn’t easy or cheap. Many conventional lenders won’t lend on homes in poor condition or to investors who can’t show reliable income and assets.
“Hard money” lenders finance flips, but the rates are high – perhaps 10 percent to 12 percent, plus three to four points in cash up front, Turner says.
He advises seeking loans from people who have money invested in lower-paying instruments, such as certificates of deposit, and offering them higher rates with a private mortgage or another kind of equity partnership. “Live a life of networking,” he advises.
Nationwide, individual investors bought 21 percent of the homes sold nationwide in February, and 73 percent of them paid entirely in cash, according to the National Association of Realtors.
2. Not Enough Time
Renovating and flipping houses is a time-consuming business venture. It can take months to find and buy the right property. Once you own the house, you’ll need to invest time to fix it up. Before you can sell it, you’ll need to schedule inspections to make sure the property complies with applicable building codes. If it doesn’t, you need to spend more time and money to bring it up to par. Next, you’ll need to invest time to sell the property. If you show it to prospective buyers yourself, you’ll spend plenty of time commuting to and from the property and meeting with potential buyers.
If you are able to make a 10% profit on a house that cost $50,000, you’ll make a $5,000 profit. For many people it might make more sense to get a good job, where they can earn that kind of money in a few weeks or months via a steady paycheck – with no risk and a very consistent time commitment.
3. Not Enough Skills
Professional builders and skilled professionals, such as carpenters and plumbers, often flip houses as a sideline to their regular jobs. They have the knowledge, skills and experience to find and fix a house. Some of them also have union jobs that provide unemployment checks all winter long while they work on their side projects.
The real money in house flipping comes from sweat equity. If you’re handy with a hammer, enjoy laying carpet, can hang drywall, roof a house and install a kitchen sink, you’ve got the skills to flip a house. On the other hand, if you’ve got to pay a professional to do all of this work, the odds of making a profit on your investment will be dramatically reduced.
4. Not Enough Knowledge
To be successful, you need to be able to pick the right property, in the right location, at the right price. In a neighborhood of $100,000 homes, do you really expect to buy at $60,000 and sell at $200,000? The market is far too efficient for that to occur on a frequent basis.
Even if you get the deal of a lifetime, you need to know which renovations to make and which to skip. You also need to understand the applicable tax laws and know when to cut your losses and get out before your project becomes a money pit.
“The ideal flip is also the ideal purchase,” Turner says. “You find what people are buying and look to create that.”
If you notice that three-bedroom, two-bathroom homes are popular, for example, that’s what you want to buy and sell. Turner looks for homes that don’t meet the ideal criteria but could with a small amount of work. If he’s shooting for the three-bedroom, two-bathroom home that everyone is snatching up in the area, a house with two bedrooms, two bathrooms and a bonus room would be a good property to target for a flip. A three-bedroom, one-bathroom home to which another bath could easily be added would also work quite well.
5. Not Enough Patience
Professionals take their time and wait for the right property. Novices rush out and hire the first contractor that makes a bid to address work they can’t do themselves. Professionals either do the work themselves, or rely on a network of pre-arranged, reliable contractors.
Novices hire a realtor to help sell the house. Professionals rely on “for sale by owner” efforts to minimize their costs and maximize profits. Novices expect to rush through the process, slap on a coat of paint and earn a fortune. Professionals understand that buying and selling houses takes time and that the profit margins are sometimes slim.
House flipping: 5 tips for big returns
Home prices are rising at a fast clip, and for-sale listings are still very low. That makes flipping a house more competitive than ever today, but it also mean potentially record returns for investors.
If you’re ready to put in the work, there is certainly good money to be made. Just be smart, as emotion-free as possible and get ready for a real estate ride like no other. And no, it’s not as easy as it looks on TV.
1. Do the math
Figure out what you can spend on both the house and the renovation, down to the last dollar, and include how much risk you are prepared to take. Price out the cost of carrying a short-term loan (if you need one), taxes, utilities and maintenance on the home for up to a year. Price out your material costs and labor. Look at comparable sales in the market to see what the likely sale price will be and don’t expect a penny over. Once you have a financial plan in front of you, with a reasonable margin for risk, begin shopping for homes that meet that budget. Don’t let a huge fixer-upper with potentially larger returns muddle your math.
2. Know your market
Is this an already established area with rising prices? Is it a transitional neighborhood with good potential that may not be quite “there” yet? Is this an area with good schools that will attract families? Is this a community popular with retirees? Knowing your market will help you to choose the most desirable home and it should help you know what your profit margin will be. Every neighborhood has a not-to-exceed price. Know what that is. Doing your homework on recent sales and average days on market can give you an idea of how long to hold the property before flipping. Perhaps you want to rent it for a year or two until the neighborhood really takes off, or do a quick renovation because the neighborhood is very competitive.
3. Know your buyer and renovate with that buyer in mind
If this is a neighborhood with good schools, then your buyer is a young family. Older homes may not have the open kitchen/family room that these buyers demand. Spend your money making the family space open and inviting. Make sure there are enough bathrooms for kids and invest in a Jack and Jill vanity in the hallway bath. Finish the basement if possible. Don’t focus too much on the master suite, but make sure mom and dad do have their own bathroom. If this is a retirement area, look for a home with just one main level or a ranch style. If there are stairways, open them up and widen tight spaces. Make sure the home is easily accessible from the street—no big stairways up to the front door. And turn the yard into a patio for a maintenance-free outdoors.
4. Educate your buyer
You put in the work—make a list. Disclose every system that was replaced, from HVAC to electrical and any structural problems that were repaired. Take a snapshot of a new roof. Note which windows are new. List new appliances and fixtures and present a binder with all instruction booklets and warranties. Display instructions next to any new “smart home” features, like security, sound system and lighting controls. Let buyers know every detail of how this charming historic home is updated to today’s standards.
5. Don’t overprice
It’s tempting to look at your renovation, love what you’ve done, factor in all the sweat equity and overvalue the home. Remember, your buyer likely didn’t see it when you started. They didn’t know the kitchen was disgusting and the basement stunk. They have no idea how much stress you went through. They see the finished product only, and they have been shopping the market, touring the comparable homes. Every neighborhood has a general price point, and you need to stay within it. Underpricing slightly could result in multiple offers and a final sale price above asking. Better than having all your hard work sit on the market for months.
The Bottom Line
Before you get involved in flipping houses, do your research. Like any other business venture, flipping requires time, money, patience, skill, and it will definitely wind up being more difficult than you imagined.
Without a doubt, flipping homes offer great risks, and great rewards. A house flipper must be prepared for the possibility that the home won’t sell right away. House flippers also have to make tough decisions, like whether to accept an offer that is less than they wanted, but still for a profit. If you can handle all of the ups and downs, and you have an enthusiasm for fixing up and selling homes, then house flipping might be right for you.