Getting into the real estate business to fix up or rehab and flip property sounds great on so many levels. It can be a good way to make a living if you are successful and do it full time, a way to generate extra income outside of your 9-5, or just fun hobby if you have extra time, money and know-how.
It’s likely that anyone getting involved is looking to make money. Making money flipping houses isn’t that hard but making enough money to justify the risk and time involved can be. What do I mean by that? Consider an investor who has a full time job in sales, who wants to rehab a property for profit and has $250,000 to work with. Assuming this person completes a project with total development costs of $250K (for example $100K purchase + $150K hard and soft costs), he needs to resell the property in the range of $325,000 to net $50K or a 20% return (after typical closing costs). This is what professional investors or developers might target. Now, consider how much time this investor might put into the project, the likely hood of achieving a 20% return with little or no experience and the fact that $250K is put at risk. Make a few mistakes, miscalculate the resale price or the budget and you could watch your profits go up in smoke. In some cases, it could pay more to put in some overtime at the office.
Here are 5 steps you can take to protect your profits if you do venture into the house flipping business:
1. Buy right
It’s essential that you don’t over pay for the property. To determine a purchase price, work backwards from the expected resale price, subtracting your closing costs, construction costs, soft costs and required profit. If the profit meets or exceeds your requirements then it’s worth making an offer. Over paying by 10-20% thinking you can make up the difference by trimming your construction budget is recipe for disaster. You might get lucky but it probably isn’t worth the risk. Another deal will come along.
2. Determine an accurate
Determining an accurate ‘market value’ for the product you deliver or ARV (after repair value) as some people like to say, is just as important as buying right. If you’re rehabbing residential houses you need access to the MLS, there simply is no better tool. Make contacts with local real estate brokers who understand the market and the type of product you plan to resell. You can piece together enough information to be dangerous from all of the real estate sites that syndicate MLS listings but that information isn’t there to help you determine property values and become a successful investor; it’s there to turn you into a lead for their paying subscribers.
If you’re using other people’s money to fund the project I would expect them to require some solid analysis supporting the resale price. If you're using your own money, you owe it to yourself to do the same legwork. Look for similar sold comps within an acceptable radius of the property, dating back 6-9 months max. If you can’t find solid comparable sales you could be pioneering (gambling), over-improving the property or miscalculating the market value. Find out what the market will pay for your product before getting involved.
3. Cleary define the
scope of work required
For the example I used earlier, I assumed the investor is going to fully gut renovate the property. That won’t be the case for every flip. Some are light projects and require only cosmetic work (kitchens, baths, floors, walls, etc.) and some will be extensive projects. Clearly defining the scope of the project will allow you to estimate your budget which will allow you to analyze relevant comps to determine a resale price which will allow you to determine how much you can pay for the property when you subtract all of your project costs. You may just be looking for a project where you can update a kitchen and bath, repaint the walls and add new flooring. That’s great and having that scope of work in mind will allow you to focus only on properties that meet these requirements. You’ll save time and frustration by considering only those properties that fit your criteria.
Without a clearly defined the scope of work your budget is at risk of running off track. Construction budgets get bloated very quickly with add-ons, change orders, and unexpected material costs and finishes. If crown molding isn’t in the budget and it won’t impact the resale price or the marketing time then skip it no matter how nice is looks.
4. Establish a project
There is a cost to your capital whether you are borrowing the money or not. This makes knowing your project timeline very important. If you’re borrowing the funds, you are paying interest on the loan. If you are using your own cash, you have an opportunity cost associated with the funds i.e. where they could otherwise be used to create a return. Your delivery date may not be entirely realistic and the unexpected could cause delays but if you don’t go into a project with an understanding of how long it will take to complete, you run the risk of burning through profits needlessly or grossly overestimating the profit margin to begin with.
5. Market the property
to the widest audience
Whether you decide to hire a real estate professional to market the property or you choose to do it yourself, you’ll want to make sure to cast the widest net possible for potential buyers and that means listing on the MLS. If you plan to market the property yourself, you can pay a fee to list on the MLS.
Buyers in most markets choose to work with a real estate professional to assist them with what they often consider to be the biggest investment they’ll ever make. It’s not unusual for 90% of all buyers to have professional representation. You need to pay that professional to bring the buyer your way. That’s just how it works. That’s not to say you can’t be successful with a yard sign, some ads in the local paper and a posting on Craigslist. Since this is a business to make money and time is money, it just makes sense to budget the sales commission into your overall cost of the sale so you can give yourself every opportunity to sell faster and move on to the next project sooner.