Updated: Jan 20, 2021
Hello Money Talkers! This blog post on flipping houses is part 1 of the 4 part series on: 4 ways to invest in real estate.
So let’s get started with the topic of flipping houses. I am sure most of you are aware of what flipping houses is. Just turn on HGTV and you can see several shows on fix and flips. But just to give the full run down a fix and flip is where you buy a home that needs some work done, renovate it, and sell it for a profit. The general goal is to buy low and sell high. Sounds simple enough right? Wrong! The process of flipping houses is actually a lot more complicated than HGTV makes it out to be. So that is what today’s post is all about: How does flipping houses actually work?
Finding The Right Property
So we will start at the beginning, finding the right property. You cannot just purchase any property, you have to choose the right property to purchase. You have to make sure that the property you purchase needs a little TLC but does not have major issues such as foundational or water damage. You also have to make sure that the property you purchase is priced correctly to reflect the fact that it needs a little work done to it, and hopefully, you can get it for less than listing price because it's so dang ugly only an investor would give it a second glance.
So how can you tell if a property is a good potential deal? The general rule for investors is the 70% rule. 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. The ARV is what a home is worth after it is fully repaired; basically what you can ultimately sell it for after renovations are completed.
Here's an example: If a home’s ARV is $150,000 and it needs $25,000 in repairs, then the 70% rule means that an investor should pay no more than $80,000 for the home: $150,000 x 0.70 = $105,000 – $25,000 = $80,000.
So with that being said, it is imperative that you make sure that you calculate the renovations before you purchase the property to see if it is even worth making an offer on at all.
So how do you calculate an estimate of renovation costs? The answer to this is simple. Hire an amazing general contractor. You, the investor, are not a general contractor (unless you are, lol. In that case, carryon). So once you have chosen a bomb ass general contractor, and you have found a potential property to purchase, bring them with you to your showings and have them create a loose estimate of repairs. Your GC will be able to tell if there are any major expenses they notice, or if it will be an easy renovation. Having their knowledge on hand when you look at the property initially will give you the insight to know if that property is a bang or a bust. Once you are more knowledgeable you can create general estimates yourself based on experience. However, I always suggest bringing your GC with you for a more accurate estimate since they are, literally, a licensed expert.
Now that you have found the right property, estimated the renovation costs, and evaluated it to make sure it will have a good return on investment, you must acquire that property. You can do so without a Realtor, but I highly suggest that you work with an experienced Realtor who specializes in investment properties. A good Realtor will be able to negotiate for you and advocate on your behalf. If you have a good Realtor in your back pocket they may also be able to find deals for you as soon as they hit the market, or even before, so you have first dibs and can possibly get them at a better price this way. Once you have decided if you are going to go in solo or utilize a Realtor you need to make sure your funding is ready to go.
With funding you have two options: Pay all cash or finance. If you pay all cash, that is pretty self explanatory. If you offer $80,000 on that home, then you have $80,000 cash you will transfer over if your offer is accepted. Keep in mind if you go the all cash method that you will need proof of funds, so try to keep all of your capital in a bank and be prepared to show proof of how you acquired those funds (pay stubs, tax returns, bank statements, etc.) The good thing about paying all cash is that this can be appealing to Seller’s who don’t want to deal with a finance contingency, so you may be able to acquire the property at a discount just for buying with cash. Also, you will not have to pay any interest or mortgage insurance since you are not taking out a loan. The down side about buying all cash is that you have no leverage. If you used that same $80,000 and leveraged it you could finance two or three different properties instead of only acquiring one.
Side Note! You could also borrow the money to pay cash from a hard money lender or investor. So in essence you are financing it, but you have the advantage of an all cash offer. This gives you the ability to acquire the property at a possible discount and beat out other offers with someone else’s money.
If you decide to use leverage and finance then you will need an investor loan, since you will not be living in it and it will not be your personal residence. Investor loans typically require at least a 20% downpayment. The pros to financing is using leverage to put the least amount of money down and free up capital for your next investment. The cons of financing are that your offer may not look as appealing next to other similar offers and you will have to pay interest and mortgage insurance while you own the property.
Once you have bought your investment property it is time to get to work on those renovations. You should collaborate with your GC to expand on their initial estimate to create a full renovation plan that includes pricing and time frames.
-Phase 1: 3 Days: Knocking down kitchen wall to create open concept floor plan $X
-Phase 2: Day 4-10. Refinishing bathtubs $X
-Phase 3: Day 11-24. Pull up all carpet and put down Vinyl flooring $X
-Phase 4: Day 25-26. Replace all appliances and fixtures $X
-Phase 5: Day 27-45. Paint all interior walls $X
-Phase 6: Day 46-55. Pressure wash exterior and driveway. $X
-Phase 7: Day 56-70. Landscape. $X
-Phase 8: Day 71: Clean $X
-Phase 9: Day 72: Ready for listing and showings
-Phase 10: Day 73-X On the market for an estimate of X days. $X
-Phase 11: Closing Day: Grand total of renovation expenses, team pay roll, and time property was held should be estimated: $X
Once your plan is in place your GC that you hired and his team will get to work (yes, you must pay these people, and their payroll must be a part of your budget). Hopefully, everything goes to plan, but keep in mind that once renovations begin other unknown expenses may arise. With this in mind, always give your budget a little extra cushion for surprises. It is always better to overestimate the renovation costs and not need the whole allotted amount planned on, then to underestimate the amount you will need and not have it.
Also keep in mind to properly calculate the cost of holding the property between acquisition and sale. This cost includes the mortgage, property taxes, utilities, insurance, HOA, etc. between both closing dates.
Now, I have explained the renovation section as if you were using a General Contractor, but you do not have to do so. If you chose to forego a GC and do the work yourself you may be able to save yourself some significant money in labor, however, sometimes do-it-yourselfers bite off more than they can chew or do shotty work since they are not experienced or take much longer to get the work done. So weigh the pros and cons of DIY versus hiring a professional. Also, try to stay on budget at all times.
This is another thing you can either do solo or with a Realtor. If you choose to go solo keep in mind that you will have to do all the advertising: Facebook, Instagram, Craigslist, Zillow, Trulia, Realtor.com, etc. You will also have to constantly be available to answer related phone calls, texts, and emails. Additionally, you will need to be physically available to show the property to any interested parties. And of course you will need to sort through the offers yourself and use your best judgement on who to choose. Plus, you will need to hire an attorney to prepare all of the closing paperwork.
If you choose to hire a realtor you will typically need to pay them 5%-7% of sales price in commission. However, they will make your life so much easier and they will probably be able to get a higher offer than you would be able to get on your own, basically paying for their services. A Realtor will handle all of the marketing for you and they will be able to place the listing on the MLS so that other Realtors have access to it and can bring a buyer faster. They will also answer any correspondence and handle all showings for you, so you can focus elsewhere. A Realtor may also be able to negotiate price or contingencies for you, sell your home for your estimated ARV or higher, and make the transaction a smooth process.
Once the property is sold… you did it! You have completed a fix and flip. If you acquired the property using the 70% rule, stuck to your renovation budget and timeline, and sold the property close to your ARV then you should have made an awesome profit! The amazing thing is you can use that profit to buy the next investment property you plan on flipping. The more houses you flip, the more capital you will have to be able to do more and make more money :)
So there you have it; the low down on flipping houses! Flipping houses is not easy money but it can be a lot of money. Flipping houses is an active form of investing. You must be constantly procuring properties, renovating, and selling them for profit over and over again to keep that constant money flow going. If you stop, your money stops. Some people love being active in this process and some people absolutely hate it. So keep that in mind. But if you think this is something you are interested in you could make a great living and have fun while doing so!
Get that money! :)
To listen to the Podcast visit: https://www.themoneytalk.net/podcast/episode/23f2ebf0/flipping-houses