The Downest and Dirtiest Guide to Real Estate Flipping
An old Marine Corps buddy of mine recently sent me a message. He said he’s retired from the Marine Corps now and he’s interested in real estate investing, specifically flipping. He asked me if I could give him the down and dirty on the business.
Flipping is a tough and risky business, don’t let anyone tell you any different. The first step is to find a great deal. Typically you need to buy a home at 50-60 cents on the dollar. In this business you make your money when you buy the home. If you buy right your profit is there and the renovation and resale process is only your effort to preserve your profit.
In most cases you can’t make your money in the renovation process. You can only preserve and secure the profit created by the negotiation of the purchase. The only time the renovation process is going to make you money is when you’re redeveloping the property.
I like to say that no contractor can save you from a bad purchase but a bad contractor can destroy a deal no matter how big the margin.
So the biggest trick and first hurdle to overcome in Flipping is knowing a deal when you see it, and that’s harder than you think. You have to know what a home is worth after some given amount of renovation. This is not an exact science. I have my real estate license because I don’t trust anyone else telling me what my homes are worth. Even the best realtor is probably going to push the numbers to the upper limit because they want to sell you the home. You’re the only one holding the bag at the end if the home won’t sell. Appraisers don’t even agree on what homes are worth. I once had the same home appraised by 2 different appraisers and they came in with a $75k difference between them. And this is on a home that sold for about $240,000 so $75k is huge.
I can’t explain to you how to do an appraisal because there are so many variables. People have written books on the subject. But, typically, if I’m buying a home I want to see everything that has sold in the last 6-8 months within about a half mile. From that you’ll start to get an idea. However, if the home is in a 1000 home subdivision then an appraiser probably is not going to use any comparable sales that are outside the subdivision even if that comp is right across the street. If the home is in a rural area then you might be able to go out a mile or more. I had an appraisal once where one of the comps was 20 miles away.
So, when you find a deal and you’re confident that you know what the home will be worth after renovations then you can work backwards from there. The general rule of thumb is that you can pay 70-75% of the ARV (After Repair Value)- the repairs.
SO: (ARV)0.75-Repair Costs=Purchase price.
Example Deal Breakdown:
Someone calls you with a home that you determine will be worth $300,000 after $50,000 in fix up.
$300,000 ARV
-25% Transactional costs & Profit (Buy costs, Sales Costs, Capital Expense, Realtors, Profit)
=$225,000
-$50,000 Repairs
=$175,000 Rough Purchase Price
This just gives you a ball park idea about your purchase price. It provides you a quick method for determining if a deal is even worth pursuing. If the seller says the home is worth $320,000 and it needs $50,000 so they’re willing to sell it for $280,000 then you know the deal is not worth spending the time to go through all the next steps.
Now that 25% transactional costs and profit is also just a rule of thumb. This is dependent on a lot of variables that will depend on your situation and location. Many people miss these costs. They always leave them out on those flip shows. Here’s some general numbers to go by when trying to estimate your transactional costs.
TRANSACTIONAL COSTS BREAK DOWN:
5-6% Realtor expense when you sell
1.5-2% Transaction costs when you buy (legal, title, title insurance, transfer taxes, Etc.)
1.5-2% Transaction costs when you sell (Legal, title, transfer tax, etc.)
7.5% Capital costs (Private lender rates are around 12% interest and 4 points, I always budget for 6 months) If you have the time and the ability you can get bank financing that will probably only cost you half of this. If you have cash then you can eliminate this expense but I always recommend that you budget in some cost of capital. What would you be earning on that money if it were not in a flip project?
0-3% Seller Concessions (Is the buyer going to want you to pay their closing costs? Look at the comps)
1% Holding costs (Taxes, Insurance, Utilities)
15% Profit
I highly recommend at least a 15% profit margin. Homes are sold on percentages and on average homes sell for about 92% of list price. So, if you only built in a 10% margin, and renovation costs run over budget as they normally do, and then your home sells for 8% less than what you’d anticipated, well, then you’re looking at a practice project or losing money. Flippers are under additional pressure to sell their homes fast. So, even if you think you can get more for a home, you often don’t have the luxury to wait for that right buyer.
Being flipper is like putting yourself in a pressure cooker. You’re squeezed between sellers wanting as much as they can get, contractors wanting as much as they can get and your buyer wanting to pay as little as possible. It’s a dance that requires a skilled choreographer.
Once you’ve got all of this pinned down you now have to figure out your renovation costs. Construction and material costs vary greatly by location. But, no matter where you go one thing remains constant; they’re more than you’d think. My area is a bit more expensive but the cheapest home I’ve ever renovated cost me over $40,000.
The second biggest mistake new flippers make is underestimating renovation costs. I always have people sending me deals that only need a “couple thousand of fix up.” You can’t carpet and paint a home for a couple thousand dollars unless you’re doing it yourself.
You’re probably going to pay a lot in renovations on your first few deals. Once you start making relationships with contractors and suppliers you’ll figure out ways to save money as you get more deals under your belt.
Here are a couple pieces I wrote for The Washington Post about how to renovate a kitchen and bathroom.
Estimating your construction costs is another topic on which books have been written. It’s not an easy task. The best way is to start networking with contractors. It’s best to find contractors that are already working with local flippers.
If you just open the yellow pages and look up contractors you’ll find that 70% of them are too expensive for a flip project. Of the 30% remaining probably 20% will unreliable or they’ll cut corners. That leaves you looking for that remaining 10% of contractors. Contractors are the weakest link in my business model.
Find that good contractor or two or three and start visiting properties. Have them give you estimates and after a few properties you’ll start to get a feel for renovation expenses.
No matter how you slice it, your first couple deals will be a learning experience and hopefully not too painful. If you buy right, properly estimate your costs and surround yourself with a good team you’ll do well in this business.
Flipping is a lot of risk and hard work. There are many Guru’s out there selling courses that say different. Don’t believe it. But it is a rewarding business both financially and personally if you do it correctly.
I know this all seems like a lot but It’s far less complicated than a lot of other businesses. Focus on finding good people, know your market and know your costs. Real estate investors do have a great many resources available to them. There are more books and videos on the subject than you could ever imagine. Use your network to find good resources and read heavily. You’ll be walking the walk and talking the talk in no time.
This is a project we currently have under renovation.