OK, let’s get back to basics.
If you are just getting into flipping houses for profit, there’s much to learn, no doubt.
So I may have bad news for you: you can’t learn how to do it a single weekend course, you can’t learn how to do it by reading one article on a blog (although there are tons of great articles from great writers right here on Bigger Pockets) and you can’t do it by watching one episode of House Flipping reality TV. Contrary to what the gurus would have you believe, house flipping is not easy and simple.
But there is a way to do it and the best way to learn how to flip houses is by doing it on your own, making mistakes along the way, while having safeguards in place to make sure that you minimize your downside risk.
Is it as easy as people say? No way. But there are ways you can shorten your learning curve, avoid the major pitfalls, and still come out with a nice profit. And of course, the more you do it, just like anything in life, the better you get at it. Experience, after all, is the greatest teacher.
The Different Definitions of House Flipping
So before we get into the “how to’s”, let’s clarify the definition of house flipping first.
When people refer to “flipping houses”, many are referring to the process of buying deeply distressed properties at auction, from foreclosure or bank short sales at a deep discount, then quickly “flipping” (selling) that property to a homeowner without much in the way of renovations. Although this kind of house flipping is popular and potentially lucrative, this not the kind of house flipping we are referring to here.
That kind of “flipping” relies on quick sales and even quicker profits. Unfortunately at the same time, this kind of “flipping” has given the real estate investing industry a bit of a black eye in the process. Not only is that kind of flipping oftentimes irresponsible (reason #1 not to do it), but there is also less profit in it than traditional buy, renovate and flip style of house flipping.
When you buy a distressed property, make no real improvements, then quickly “flip it” to a buyer, you really don’t add a whole lot of value to the end-user. But when you buy a distressed property, beautifully renovate and then sell it, you are adding real value. And with that real value, comes even greater profit potential. That is the kind of house flipping that not only provides excellent living spaces for families and individuals, but also helps to continue to strengthen the emerging housing recovery.
Additionally, house flipping is also oftentimes referred to and sometimes confused with wholesaling. Wholesaling real estate is often called “flipping” because a wholesaler “flips” a contract to a real estate investor who then does whatever they want to do with the property. I use wholesalers quite a lot and find them to be tremendously helpful resources for many of my house flips.
Neither of these kinds of house flipping are what my definition entails, but we’ll get into that in just a moment.
Flipping Houses For Profit: Not As Simple As They Say
Learning any kind of real estate investing, whether it’s flipping houses or buying homes to buy and hold, is not simple. It’s capital-intensive and is a lot of hard work. In traditional renovation-style house flipping, you need cash to buy the house, cash to make the improvements and then hopefully to get it all back (and then some) to make it all worthwhile to you.
I am not going to kid you, all these factors make house flipping a risky investment and not for everyone. It’s fast paced, fraught with potential risks, but when you do it right, the profit margins are very sweet indeed.
So whether you are just starting out flipping houses or are thinking about getting into it, whether on a part-time or a full-time basis, there are some beginner’s steps that will help to shorten your learning curve and get you flipping houses profitably in a short period of time.
House Flipping Steps for Beginners
Step #1: Assess Your Cash Situation
When first learning all about flipping houses for profit; you need to take stock of your own financial resources. You need to know how much money you have to invest on your own, or whether you’ll need to find investors. Finding investors is an art unto itself, but knowing how much cash you have to invest before you begin is the logical first step. If you have money to invest in real estate, this is certainly a bonus. However if you don’t, there are a myriad of ways to flip houses with no money of your own using banks, private money lenders and other means.
One great way to get started flipping houses if you don’t have the money to do it all on your own is to find a joint venture partner or partners who have money to invest. Splitting your first house flip profits with other partners is a great way to start, while building some momentum and getting your first house flip under your belt. Sure, you’ll have to split profits, but it’s far better to get 50% of something than 100% of nothing.
Step #2: Start Building Your House Flipping Team
As soon as you finalize your cash situation, the next step is to start building your house flipping team. This team will help you to find, fix and sell the property – and the collective wisdom and expertise will surely help you reach your house flip goals that much faster. No matter your level of experience, you simply will not be able to do everything on your own, so enlisting your own mastermind group will not only help you be more productive, but will help you work through the inevitable problems and challenges that you’ll face.
Your team at the very least should be composed of real estate brokers, contractors, architects, insurance specialists, accountants and money lenders. All these professionals can help you shorten your learning curve and get you making money flipping houses faster than you would have been able to do on your own.
Step #3: Find A Good House to Flip
Finding a suitable property to flip is certainly a challenge. This is especially true if you have decided to look in a specific geographic area you’ve both fully researched and is situated in an area which interests you. Ideally, you should be able to buy the house for a low price, eyeball it to be able to rehab it quickly and relatively cheaply, so you can sell it at a higher price…and obviously make a profit. Knowing all these aspects in order to make the profit, you’ll need to rely heavily on your house flip team from Step #2 above.
A good real estate agent can assist you in finding houses to flip. You may want to focus on properties that may not need expensive repairs or you can focus on properties that need more extensive repairs, but the repairs will substantially increase the equity. Both real estate agents and real estate wholesalers can help you in finding both kinds of properties.
Step #4: Do the House Flipping Math
When doing your initial house flipping analysis, you can do a little “napkin math” to estimate if the house is a winner. The first thing you need to do is determine the potential selling price of the house when it’s all fixed up – this is what’s known as After Repair Value (or ARV). Then simply subtract the purchase price, repairs and all your monthly carrying costs. What you have left over is your profit.
If all this initial math point to profitability, then you may have an excellent house flip on your hands and you should consider purchasing it.
Step #5: Manage the Rehab Tightly
Once you do purchase the house, don’t just solely rely on your contractor to handle and supervise all the repairs. Make sure you manage this process tightly if you are doing the management on your own, but better yet, hire a professional contractor to oversee all the rehabilitation, especially if the rehab is extensive. Make sure you personally supervise the repairs to ensure that they are being carried out properly and on budget.
In the end, your profit largely depends on what you pay for the house initially, but making sure that the repair costs stay within your budget is equally if not more important. Likewise, overextending yourself by doing more than your budget allows on the rehab or taking your eye off the ball and allowing your contractor to run free are two of the quickest ways to ensure that your make profits will go up in smoke.
Step #6: Work Fast, Make Profit
Time is of the essence when flipping houses for profit. It’s a race against the clock because the longer the rehab takes or the longer the house sits on the market once it’s done, the less profit you make. Soft costs such as financing payments, insurance payments, town taxes, utilities and any and all other carrying costs, all which have to be paid at regular intervals, add up to diminish your profits, the longer you own the house.
It’s simple, the shorter the time you hold onto your investors’ money, the better your profits will be. So make your improvements fast. Do the job well, but do it fast. Make sure your contractors do the job on budget and on time and hire good real estate agents who help you price the final product so it sells quickly. In all of our house flips, we estimate six months from purchase to sale, but factor in a few additional months of expenses to make sure we profit on each and every flip we do.
Conclusion
Contrary to what many people think, rapidly appreciating markets are not a necessary ingredient for house flipping success. As long as you stick to a disciplined set of rules, as big if not bigger profits can be made in slower markets as well. House flipping, because it is such a short-term style of real estate investing, is largely immune to extreme market fluctuations. And as a result, successful house flipping can be done under any kind of prevailing market conditions.
When you think about it, house flipping is one of the least risky types of real estate investing there is. When you buy right, do a good job on the rehab, stick to your budget and put an end product on the market that shows beautifully and is priced right, you will make a profit flipping houses.
If you’ve read this far please leave a comment below! What do you think about house flipping? Do you have any tips to tell the beginners? Leave a comment below and let me know!
{ 29 comments… read them below or add one }
Excellent! WOW! Amazing 6 steps. This is a winning recipe. I practiced several of those methods on my very first real estate investment and coincidently just added a post to my blog today describing my first Fix n Flip in 2003.
I especially thought this was a salient point: “Contrary to what many people think, rapidly appreciating markets are not a necessary ingredient for house flipping success. As long as you stick to a disciplined set of rules, as big if not bigger profits can be made in slower markets as well.”
This site is a wonderful read and I’ve added to my blog roll.
Hey Curtis and welcome to BiggerPockets. Take some time to go through the blog — we’ve got well over 3,000 articles to peruse and many are just as helpful as this one. If you haven’t had the opportunity to also visit our social network, we’ve got a vast community of almost 110,000 members and close to 500,000 forum posts at http://www.biggerpockets.com — jump in and start getting involved; you’ll find no better place to connect and learn than here!
Thanks Curtis. Good to see a fellow house flipper using these strategies. Welcome to BP and the wealth of information you can get from other investors here is endless.
Look forward to hearing more from you. Where you flipping these days?
Thanks for your comments
Great post today Mike! I really like these “ultimate” guides that give a good overview of what the heck we are talking about
Excellent article!
Thanks Brandon!
Great article, Michael!
I’m so glad you emphasized how “it’s not easy.” Many investors start with the idea, “I’m just gonna flip a few properties for some quick cash.” Don’t we all wish! We’ve purchased a number of properties from “wannabes” who watched the flip-it shows and quickly got in over their heads.
Step #4, Do the house flipping math. I also encourage people to figure their ARV, then count on selling at 80-85% of that, as very few houses are selling yet at full retail. And, unless you have a lot of hold properties or something else to give you plenty of write-offs, don’t forget you’ll be paying short-term capital gains on the profits (long-term if you own it 366 days or longer).
Thanks for the great article. Investors who follow your lead will profit flipping properties!
Thanks Karen. I agree with you. I was talking to a potential client earlier this week and one of those national guys sales person told him he could flip 3-4 houses a month and make over a million dollars his first year. It just fires me up to hear this !#**&#@(>> & the false and unrealistic numbers they will tell new people in this business to make a coaching client sale. It is bad for the entire industry. I asked for his # because I want to sign up. LOL
Thanks for keeping it real!
HI Karen, what are your thoughts on the tax issue being discussed here, is it capital gains or ordinary income? Remember, I learned the hard way that if your income exceeds 150 k, then you cannot take any deductions. I have asked my accountant several times how we should be buying these homes to take advantage of the deductions. He says just to file schedule 9 I think, s are not operating like a business, which I think would be best. But, he is adamant the current filing method is the best. As with anything, ever one has a different opinion. So, I thought I would ask you.
Randy: Sorry, I missed your question until now!
Your flipping profits are taxed at ordinary income rate.
And, you’re correct, you cannot claim deductions when you make over $150,000 unless you qualify for full-time real estate professional status (real estate professional status requires the majority of your working time is in real estate – at least 51% of your working hours, a minimum 750 hours – so keep track of your time). And, not all CPAs are created equal so be sure you use one who is a real estate expert.
In addition to the 750 hours requirement, being a real estate professional also requires that >50% of your personal services must be in “real property trades or businesses.” This is difficult hurdle to meet unless you are a) a realtor, property manager or otherwise employed in the industry or b) a full time investor.
Keep in mind when tracking hours for a real estate professional designation that the metric is 750 hours *per activity*. One rental property is considered one activity. This makes the 750 hour threshhold also difficult to meet.
Investors are allowed to combine activities to reach the 750 hour threshhold, but understand that when doing so you will have made an irrevocable election to combine the activities forever. This means that if you sell a property at a loss, the loss will be suspended until you have disposed of the entire activity — e.g. sold ALL of the properties that were combined. If you then purchase a new property, and combine the hours with the remaining properties, you can enter a circle where you will never be able recognize the loss.
Since the only benefit of being a real estate professional is to remove the $25,000 rental loss cap, it seldom makes sense (unless your regular job is in the real estate industry) to be classified as one. Any rental losses over $25k will be suspended, but they will be used to a) absorb future rental income or b) offset any gain when the single property is sold.
Note that this applies only to rental income. Flip losses, which comes to the 1040 via sch C, will always be fully deductible and do not suspend.
Thanks Karen for your thorough explanations
This is an excellent article, I am getting into house flipping and needed this information I have already flip one but I partnered on the deal and learned a great deal of information. I am looking to do it on my own now and this article has gave me the confidence. Thanks for sharing.
Leonard
Excellent Leonard. You certainly learn more from doing. Ask any questions and I will try my best to answer for you and If I don’t have an answer you can bet someone from BP will. Where you flipping?
@ Karen Rittenhouse:
Flips are not capital gains. Flips go on Sch C and are considered ordinary income subject to both income and self employment tax. Total tax bite can be as high as ~45%.
Not necessarily Mark. It depends on whether your houses are classified as inventory or as capital assets, which in practice depends on how many flips you do per year.
A good strategy to minimize taxes could be to rehab, then rent for 1 year+, then sell it to the tenant. Your tax would be a long-term capital gain.
Bill:
How the property is classified is not a matter of choice, it is a matter of facts and circumstances. Flips are always “property held primarily for sale” (IRC 1221) taxed as ordinary income irrespective of holding period. The number you do is irrelevant. The only relevant criteria is ‘intent.’ Was the property held primarily for sale, or did you intend to buy and hold? Can you substantiate that intent?
If your intent was to flip, rental income is considered “incidental” to the flip business and will also be considered business income. This is true regardless of how long you “incidentally” rented the property you intended to flip — even if longer than a year. (Evidence: property was listed for sale, and was rented only after being listed for 6 months.)
If your intent was to hold and rent, but you end up selling the property, the transaction is still capital provided that you can substantiate that you intended to rent the property (Evidence: advertisements, credit checks, tenant showings, etc). Here is where the number of flips you do is important: if you regularly do flips, you may be considered a dealer and the burden of proving that a particular transaction was capital is increased.
Your strategy may work if you know that going in. But don’t be misled into thinking that you can advertise it for sale, put in a tenant to cover your cashflow, and still call it capital.
I have seen exactly one case where a guy got busted when IRS asked to see the realtor’s contract and noticed that it was dated before renovations were even complete. Obviously his intent was to flip it. That opened the door to three flips he had treated as capital that year… plus 5 more in the previous two years. They may be dumb but they’re not stupid.
Thanks Mark for your thorough explanations on taxation.
Great article. I am currently doing research on how to flip properties. Bigger Pockets is definitely a top resource for newbies like myself who are looking to invest in Real Estate. I’m located in Miami, Fl where real estate prices are a bit over priced. Rogue investors have really destroyed this market. The challenge for me will be finding properties.
good that you already are doing research and figuring that out. Don’t over pay. The math does not lie. move onto a different market if you have to.
Mike – as always , this is a terrific piece. Great breakdown. Thanks !
thanks Dale!
Mike, Great article for the newbie and also for the experienced because I need to be reminded of those things you stated. Alot of folks believe flipping houses is a matter of buying a course(which I have bought several) reading a few books and then take advantage of the best real estate market of your lifetime. All those ingredients in my opinion are essential there is just so so so much more to it. Somehow along the guru parade Real Estate Investing has been casted as separate from the risks of starting a new business, and just a simple way to make massive profits. Maybe so if your in it for a flip or two and get really lucky,but as for a career be prepared for the ride of your life…….. I love the Ride!
Thanks,Shane
Thanks Shane. So true. It is a business and no different. Thanks for your comments and enjoying the ride as well. Lets keep it going in the right direction!
Hello, as others have noted, a very good article. We have purchased 8 properties, since January 2011. Our goal was ten income properties. But, we have decided to stop at eight, and use the last two spots, dedicated to flipping homes. We like your definition of house flipping, because we really enjoy renovating the home with as many high end products and upgrades as the market will support, without over doing it. We really want someone to buy their home because they love it and it is not only pretty, but well built!! There is something special about seeing someone walk through the home and say “oh wow, this is beautiful.” We have printed your article so we can refresh our thoughts on staying with the basics. Thanks for the reminder.
Michael, Thanks for the advice. Do you factor in the higher income taxes if you sell within a year vs renting for a year and then selling under the lower capital gains tax?
Thanks
Hello Michael,
Everybody strategy is different & I do both. All depends on what you are doing and what your plan is.
Thanks for your comments.
I’m new to this page but I have flipped 7 houses in the last year in Jacksonville, FL. I can’t find a house here anymore does anyone know where a better market is in FL?
HI Charissa,
You check with your local real estate agent and see if she can refer you to another market area with a different agent. I don’t invest in Florida but maybe you can get on the forum page and ask there & I am sure the Florida investors on BP will chime in with what they know.
Great article. I suppose no one is buying foreclosures since u don’t get a warranty deed when the bank owns it? Or is there a way to get a general warranty deed from a bank foreclosure?