How House Flipping Works
There are a ton of misconceptions about how house flipping works. Essentially, flipping houses is buying a house with the intention of selling at a higher price to make a profit. You need to be aware that that profit is dependent on several different criteria, primarily purchasing right. So, let’s look into that a bit.
Why Flip Houses?
Why do people flip houses? In my opinion, flipping houses has been made fashionable through T.V. Every home improvement channel you look at has someone is flipping a house. Most glamorize the hard work and effort that goes into flipping one properly. This leads to many inexperienced flippers losing money and never trying it again. But, all in all, they do it because it is, in theory, no more than a basic investment lesson- buy low, sell high. If done properly there is a lot of financial upside to flipping. If not, then there is a substantial financial loss associated with flipping.
Where to Buy
Where should you buy? House flipping profitably depends on the real estate market. In a sellers market, an upswing, flippers can nearly name their price in an up-and-coming neighborhood. Many will be banking on the neighborhood increasing in value, and so will their buyers.
To attract the high-end buyers, flippers will generally need to be buying houses in new developments where the homes are offering luxury features like granite countertops, island kitchens and giant master suites. These properties will generally be located in the suburbs with large lawns or more historic areas of town where the houses have tons of “charm.”
Don’t Get Caught with a House and No Buyer
If all goes well, the flipper will make a nice profit and the buyer will get a nice deal. But if things goes wrong – a bad budget, bad timing issues, unforeseen necessary repairs or just overdoing the finishes for the neighborhood – you could be stuck reducing the price of your flip where you will not make a profit or worse yet, not be able to get rid of it at all.
During a slow market sales period, or buyers market, many of these remodeled homes can sit for months without being sold. It might be a better strategy for the flipper to focus on a bit lower-end neighborhood and install finishes more appropriate for them. You may even want to focus on a different base of buyers as well. Landlords make up a huge class of buyers and many are only looking for cash flow properties. They don’t want to do repairs and many are even looking for turnkey investment properties that already have tenants in place.
What to Purchase
Once you know where to buy, the next step is deciding what to purchase. If you go for a fixer-upper, you are making a commitment to fixing up the home. This could take a lot of time, money and a certain amount of experience.
If you buy a foreclosure, whether an REO or through an auction, you might get a bargain on a underpriced house. The problem that presents itself here is that more than likely the prior owners couldn’t pay to keep the repairs up to date if they couldn’t make their mortgage payments. I would inspect these properties well, if possible, before making the purchase.
I personally find it a better practice to purchase a property that has not seen the market in many years. An investment property could be purchased from an owner selling their home themselves, FSBO, or from a reputable real estate wholesaler for deeply discounted prices. These properties tend to be a bit more affordable and with a lot less competition for the best price. You are also welcome to find off-market properties on your own through many other means, but that pretty much defeats the purpose of just flipping.
The downfall here is that many of these properties require a large amount of repairs in order to be able to compete on the market for top dollar. If purchased right, it’s very possible that you would have plenty of capital to work with in order to make those repairs.
Location would be key in making these purchases. If a large amount of commercial development springs up, it could become very desirable and bring in droves of potential buyers. These properties tend to be closer to town and in well-established neighborhoods, eliminating the need to budget more for gas and commute time to and from work or other amenities. But if the situation isn’t perfect, it could cause potential home buyers to shy away and spend more on their commutes.
What does the average investor need to know about flipping before starting?
Make a budget.
While finding the perfect location and knowing your skill set is important, budgeting is where new flippers most often fail. You want to find a house that is deeply discounted or in just bad enough shape that you can invest minimal time and money in it before selling it. There are people who have made huge fortunes out of buying very distressed properties and quickly turning them around for a nice profit. However, the first piece of advice that most flipping experts give is make a budget. You have to have a plan and a dollar amount that you just will not go over no matter what.
Where to start?
This used to be the easy part. You used to be able to purchase with very little down during the days of subprime mortgages. Well, you still can. You just won’t be using conventional institutional lending. In order to get your money and financing in place, you as the flipper will need to seek out “hard money” or private lenders in order to maximize the amount of capital you can use towards the purchase and rehab of a great property.
These lenders will vary in criteria that they will demand. Some will lend less towards the LTV (loan to value) and others will want more in the way of points upfront at closing. Others will loan the rehab cost while others won’t. Some might fund the whole project at a certain flat rate of interest and others may do interest-only payments with a balloon payment on the back end. But one thing is for certain, you will want to do your due diligence and establish a relationship with your lender. The better the relationship the better terms you are going to receive.
Using other people’s money is much better than using your own. Mitigating your risk as an investor will make flipping houses much more stress free. However, these lenders are savvy. When the market is flat, obtaining a private loan for an investment property will be much more difficult.
How much money can be made by flipping a house?
Stick to the basic rule of bargains: If an offer sounds too good to be true, it probably is. That goes for that perfect, underpriced ranch as well as for that overly friendly contractor. Also, make sure to always have a home inspection done. Know what you’re getting into before getting into it. That said, it is not unheard of to make $100k on a flip although I think that to be the exception rather than the rule. I feel if you make an ROI of 20-30% you did well. I would not even look to do a project less than 15% ROI because the margin for error is just too slim.
What kind of moral line do you walk by paying bottom dollar to people who need to sell their house for a discounted price?
I myself don’t believe there is a moral line. Your sellers need to sell fast and at a discounted price for some reason, no matter what it is. You have provided them with a way to move on or avoid an undesirable outcome with their financial situation. You have done them a service, and I assure you, they will thank you for it.
Many, most, of these homes need major repairs or updating to add enough value in order to sell it at a competitive price on the open market. You, as the house flipper, take all the risk. If not done properly you will lose. You have helped the community by doing away with an eyesore and helped increase home values throughout the neighborhood. They, also, will thank you.
House flipping works if you buy right, stick to a very strict set of rules and a budget. Know why you are flipping and don’t buy into the glamorized ideas that television has made this profession out to be. Make certain you know the market and the trends in the location in which you chose to do your rehab. This will be one of the biggest factors in whether you make money and how much.
Think outside the box when seeking out your flip property. Many wholesalers are very knowledgeable and skilled at getting deeply discounted properties. They might be the best route to take to save yourself a lot of hard work and headaches. Establish meaningful relationships with non-conventional lenders in order to get cash on demand. Don’t worry too much about the interest rate. If you can make the payments and still make money then who cares.
Look at your expected ROI. Set a limit for yourself. Make this a hard variable. Never go below but leave the high end open. And remember, you are doing everyone a valuable service. The sellers and the community will thank you. And so will the new homeowners.
Enjoy and have fun, but keep in mind, this is a very serious business. You can, and most likely will, lose money. But learn from that time and don’t let it happen again. If you stick to it and learn as you go, you will be successful and financially independent shortly. I hope you enjoy flipping houses as much as I do.