They make it look so easy. Put on your makeup and yoga pants or freshly pressed jeans, strap on a tool belt, then grab a sledgehammer to remove a wall then drive to the bank with a big, fat check. Due to shows on HGTV which show house flippers polishing up diamonds in the rough and staging them to perfection while raking in the equivalent of a year’s salary in just a few weeks, couch surfers are allured by the opportunity of fast and easy money.
But is it so fast and easy?
You must pull aside the plastic curtain used to contain all the dust and chaos to see the real story. As we have seen in recent years, bubbles exist, and bubbles burst. To avoid getting caught up in the turmoil and unrealistic numbers or inflated profits, you have to be keenly aware of what it takes to be successful in flipping. Because, at the end of the day, real estate investing is a business and business is about numbers. Namely, the bottom line.
The Risks of Flipping
First off, flipping is risky, and you can stand to lose significant money if you make the wrong mistake. The puzzle of it all is how you can purchase a home, remodel it, and then sell it for a substantial profit? To do this, you have to get educated on what methods and tactics have been successful before, and factors you have to account for, such as:
- The current market
- Unexpected repairs
- Cost of labor
- The cost of financing
- Time from purchase to sale
- Prices to sell
- Capital gains/taxes
The Current Market
Your real estate profit is made when you purchase the property. The HGTV shows which depict house flippers running the numbers tell you nothing about what others are willing to pay for your polished-up gem. Know your market. Run comparables in the area, so you know how the market looks today. Comparables are bonafide. What things “used” to sell for or what they “will” sell for at some point in the future is irrelevant when you want to sell it today.
Have you ever noticed on those flipper shows how they would tear down a wall and find surprises like a crumbling foundation or water damage? Some flippers just get on the phone, approve the repair while showing a look or worry, and then fork out the money. In real life, those unexpected repairs can tank profits quickly. If you’re not a contractor or have little construction experience, hire someone who is to look at your properties (we’ve got an article on this!). Be sure to accompany them on inspections so you learn as much as you can about home building. That education is priceless.
Cost of Labor
Time is money, and fast money comes when you shorten the time. While you can do the project on your own, successful flippers don’t. They have a team and a system. So should you. And, figure the cost of the extra help into your purchase/sale costs up front.
The Cost of Financing
When you are financing your purchase, every day counts. So does the interest and costs of obtaining financing (ie…closing costs). Keep expenses down up-front. And, with rising interest rates, figure in how many mortgage payments you will make before the property is completed and sold. If the average time on market is 3-6 months, then you need a plan to either carry the loan for up to 6 months or price it below market with the goal of selling in less than three months.
Time From Purchase to Sale
There are carrying costs for holding an unoccupied home and mortgage. In addition to the interest on the loan and payment, there are taxes, insurance, and utility costs. The less time you hold the property, the fewer monthly payments you make, the better your bottom line profit.
Costs to Sell
FSBO, or For Sale By Owner, is one way to sell a home to save on realtor commission; however, if you don’t usually sell homes and know nothing about marketing, you could be at a disadvantage. An excellent way to think about this is that you probably wouldn’t drill your own teeth or perform surgery on yourself, you would hire an expert in those fields to do it for you, right? There are some options: List it FSBO, and agree to pay a broker that brings a buyer the standard commission for your area, or partner with a top realtor in your area to start marketing your house right away while you get on with the business of flipping. Either way, figure the costs into your purchase. Remember money likes speed, enlist the appropriate experts to assist you in your house-flipping business.
Capital Gains / Taxes
Even when you do everything else right, taxes can take away every bit of profit unless you set things up correctly in your real estate flipping business. Remember, this is a business, and like any business, a sharp CPA, financial planner, and business attorney can help you keep more of what you earn. Flipped properties are short-term gains, which means the profits may end up in a higher tax bracket. Failure to plan for future tax obligations can leave you struggling at the end of the year. Avoid all of that with careful planning, knowing your numbers, and accounting for them with each flip.