Flipping a house can seem like a walk in the park when it’s wrapped into a few montages during a half-hour television segment. Just find a rundown property, buy it, take out a few walls, paint, replace carpets, upgrade the kitchen and voila – you could make tens of thousands of dollars in just a short time.
Reality is seldom so straightforward. Flipping a home can be risky, and there’s no guarantee of profit.
Finding and buying the right house at the right price point can be difficult. The shows often start with the submission of a winning offer on a home. Actually, it takes a lot of work to determine what a potentially good flip looks like and find a property to match.
Experienced flippers have learned how to estimate costs and work backward. A rule of thumb in the industry is to take 70 percent of the potential selling price – what’s known as the after-repair value – subtract the renovation costs and use that as the maximum buying price.
It requires a lot of background information, including comparable selling prices of similar homes, to figure out the right numbers. The ability to be honest while estimating the cost of parts and labor is also important.
For example, if it is estimated that the renovated home could sell for $200,000, start at $140,000, which is 70 percent of $200,000. If the flipper calculates that the renovation costs will be $40,000, they’ll arrive at the maximum buying price of $100,000. The 30 percent margin that remains if everything goes according to plan isn’t entirely profit; there may still be expenses like closing costs or reimbursing investors.
Flipping home requires a lot of working capital. While paying cash for a home can expedite the sale and increase profits, it might not be an option for beginner flippers. However, traditional lenders don’t necessarily offer financing for flips, especially for trying to fix up a dilapidated home. Even when they do, it might not be enough to cover all the expenses.
Instead, some flippers turn to hard-money lenders, private individuals or companies that issue short-term loans backed by real assets such as the home they’re buying. With either traditional or hard-money lenders, expect the financing costs to be higher than what they’d pay for a mortgage if they’re buying a home to live in.
Keeping an eye on the total budget is essential. If a flipper borrows enough money to make the purchase but doesn’t have cash on hand to pay for the renovations and unexpected contingencies, they’ll be stuck before they even start.
In addition to the purchase price, they need money for renovations, upgrades, inspections and permits. Also, they must consider the cost of ownership between the purchase and sale. Carrying costs, including utilities, financing, insurance and property maintenance, can add up each month.
They have to move fast. One thing people pick up from TV is that time is of the essence. In competitive markets, they have to move quickly to evaluate a home and put in an offer before someone else buys it.
Successful flippers may have a real estate license or work with a real estate agent to get access to the multiple listing service, a directory of homes that are for sale. Others look for homes that are for sale by owner or use direct mail campaigns to reach out to prospective sellers.
Once they buy the home, there’s another race against time to complete the work and make a sale. Working with a trusted contractor and real estate attorney could expedite the project. Once a strong working relationship has developed, they may even want to invite others to join the team and contribute their work in exchange for a cut of the profits.
The bottom line is flipping homes can be profitable, particularly for those who have professional real estate experience, but don’t expect it to be easy money. Months of hard work can go into a flip without any guarantee of success.
Nathaniel Sillin directs Visa’s financial education programs.