So – You Think You Want to Flip?

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I never cease to be amazed that so many new investors gravitate to fix and flipping single family housing as their strategy of choice.  Don’t get me wrong, I understand why this is – allure of quick money is strong indeed; and it looks so easy on TV.  My experience, however, has been that flipping houses is perhaps the single most difficult and most risky activity under the umbrella of real estate investing, and I unequivocally believe that even though everyone gets lucky once in a while, only the Pros whose businesses are streamlined, automated, and well-funded are able to be consistently profitable with flipping.

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Flipping is Risky Business – Really?

While there can be no guarantees in any type of real estate investing, in my view the activity of flipping is more of a gamble than just about anything else that we do as real estate investors.  I say this because the two primary risk-mitigating factors in any investment, TIME and MULTIPLE EXIT OPTIONS, are not on your side when flipping.  The only exit strategy is to sell the property, and it has to be accomplished on a strict time-frame before holding costs eat you alive.  But more than that, even having been as prepared and prudent as can be and having executed flawlessly, you still can’t control the market!  A small problem, wouldn’t you say…

The events of the past several years reminded us that markets can change very quickly indeed.  Many people started a flip on a house with an ARV (After Repair Value) of $320,000, but by the time the house was ready to go on the market 2 months down the road, it was only worth $270,000.

Think it can’t happen again?  Think retail mortgage funding can never again drop off the face of the Earth and take with it real estate values, leaving investors upside down and unable to sell or refinance?  This is exactly what happened and it can very well happen again!  A lot of investors, and not just the beginners but especially beginners, got into flips with the wrongful presumption that the markets will continue to go up forever.  Furthermore, most of them bought and financed their projects in a ways not conducive to being able to rent the property for enough to carry it in case they couldn’t sell.  The eventuality that followed were tons of foreclosed upon flips.  How many of you know someone who found him or herself in this precarious position?

Here is a million dollar adviceWith the exception of a few very high-end markets, be sure to execute your flip at a price-point that will allow you to hold on to it by renting the house should you encounter difficulties selling.  This creates a secondary exit option, which dramatically reduces risk in flipping!!!

Mistakes, Mistakes, and more Mistakes

But, let’s say that the markets cooperate – after all a crash such as what we had a few years back constitutes an extreme circumstance in the markets which doesn’t happen often.  I promise you that even with the market at large off the table as a risk, which it never really is, there are so many more places to mess up when performing a flip.  The following are few of the things that you must get right in order to make money on a fix and flip:

  1. You must isolate the right location for your flip.
  2. You must buy the “right kind” of house for your flip.
  3. You must estimate the After Repair Value (ARV) correctly.
  4. You must estimate the repairs correctly.
  5. You must estimate your holding time and costs correctly.
  6. You must buy the flip for the right price.
  7. You must finance your flip the right way – boy, must you ever do that!
  8. Good lock on this one – You must not to run into any major complications with the scope of remodel and/or contractors, which will cost you money and time.
  9. You must find a qualified credit-worthy buyer.
  10. Your flip must appraise for enough to accommodate financing for the buyer – this is HUGE in 2013!
  11. OK – I am out of breath, but you get the point…

These are a few of the things that you must get right, and each one of them is a complete process in and of itself.  Messing up a single step in the process will spell disaster.  And I repeat, even if you do get everything right, you still have no control of the conditions in the marketplace, which can change within 45 days!  All of this makes flipping houses the most difficult activity in all of real estate investing in my opinion.

Granted – there are no guarantees in anything within the world of investing, and getting ahead requires taking a calculated risk.  But flipping is in a league of its’ own, which is why in my opinion if you are going to do it – become a Pro.

Do you flip!? Do you agree or disagree? Leave your comments below and let’s talk about it!

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About Author

Ben Leybovich

Ben Leybovich has been investing in multifamily residential real estate since 2006. His area of expertise is creative finance. Ben works extensively with private as well as institutional financing. Ben is a licensed Realtor with YOCUM Realty in Lima, Ohio. He is also the author of Cash Flow Freedom University and creator of a cash flow analysis software CFFU Cash Flow Analyzer.

25 Comments

  1. noah campbell on

    very helpful post. i am going to do my first flip in about 3-4 months that i will be funding with my own money. my question is does using my own money reduce the risk at all because i will be able to hold the property n rent it out if market goes down..

    • Thank you for reading and commenting Noah, and yes – having no pending balloon payment certainly affords safety. But remember, a flipping remodel is very different from a rental remodel; the finishing surfaces are different as well as the scope of remodel to a large extent.

      • noah campbell on

        thank u for responding. i was / am not aware of the differences in the remodel of a flip verse rental.. could u tell me a few of the differences it would be very helpful.. thank u

        • Noah,

          Here’s the basic thinking. When remodeling a unit for resale, your main consideration in making the choice of product you install is desirability. This is to say that if you live on the East Coast, you will likely have to put in hardwood, while in the South West you’ll have to use a lot of tile, and in the Mid West we like out carpet. Weather, humidity, and other factors influence trends in different parts of the country – you need to do research.

          However, non of this addresses the issue of “ease of upkeep”, which is obviously paramount in a rental. For instance, I never put ceramic tile in rentals, but would use not in a flip. There reason is that it chips and breaks and it is more costly to install and replace. While a home owner will take care not to damage, a tenant will not, so installing it in a rental is asking for trouble. Same logic applies to appliances, paint, and many, many other items in the remodel.

          Thus, if you’ve remodeled a house for resale but end up renting it, you may run into difficulties with managing physical structure due to the finishing surfaces you’ve used which could have been avoided. Even though renting is an “emergency” exit strategy out of a flip-gone-bad, it is not desirable.

          Flipping is 20 parts art, and 80 parts science. Be smart and well educated! Let me know if I can help further,

          Ben

  2. Ben-

    I think you nailed all of the key elements of a successful flip. I was hoping you could comment on #6-Getting the flip for the right price. I’ve bid on dozens of properties at trustee sale, but the final sale price always goes ends up higher than I could possibly see anyone making money on the deal. I’m even using my own money for the deals, so I don’t have to worry about interest expense. I know that some “professional” flippers enjoy economy of scale benefits, but even with that factored in the margins are still very low. Where do you think other buyers are realizing cost savings to make these deals work?

    • Ryan,

      You are asking the wrong question. Your mind is focusing on the symptom – your inability to get a good deal. But, what causes this symptom? Figure that out and you’ll be able to start treating the real problem…

      So, the municipality advertizes the sale and a bunch of investors show up…what part of not being able to get a good enough deal in this environment is surprising to you exactly? Basic laws of supply and demand – the more demand, the higher the price 🙂

      So what to do? The answer – You’ve got to find deals that nobody else knows about, which means that you’ve got to look very differently from the way everyone else looks for deals. But if you succeed; if you are the only person who knows about the deal, then there will not be anyone there to drive up the price.

      This means a multitude of things, which is a good topic for an article – note to self; but if foreclosures is your thing, then you’ve got to step in earlier on in the process. They need to call you!

      Personally, the short-sale and foreclosure business is akin to the “latest flavor of the month” to me. Every newbie out there buys a course on a late night infomercial and tries to get into the game, which drives fears competition.

      I stay away and let them bite each other’s heads off, while I focus on driving the deals to me. I don’t waste energy looking for deals, because if they can be easily found, then other investors will see them as well, at which point I won’t get a good deal. For this reason, I don’t typically buy off of the MLS and I never buy on the courthouse steps. In lieu of looking for deals, I focus on positioning myself to attract deals that nobody else knows about…think about this Ryan. On the other hand, what do I know – I am just a dumb landlord 🙂

      Thank you for your comment, and good luck!

      • Thanks Ben for the great advice. I know you are absolutely right in your assessment of why it is difficult to find “deals” through trustee sales or on the MLS. Those are the easiest and most clear cut methods of purchasing properties, so of course they will attract the most competition. Could you elaborate on some of the other tools you use to find deals?

        • Ryan,

          You are asking me for a list of “tools” to find deals. I must point out that this again is the wrong question to ask…

          I believe in systems; I believe in building pipe-lines in lieu of carrying buckets of water. The real question is not how or where to “look” for deals, but how to position yourself in the path of those deals so that the deals can find you!

          Here comes a 10 million dollar piece of advice – Pay attention. Who knows about deals before you do?

          Answer: Owners, Their Neighbors, Their Friends, Their Barbers, Their Bankers, Their CPA, Real Estate Brokers, Real Estate Agents – are you getting the point?

          The real question you have to answer is: WHY SHOULD THESE PEOPLE CALL YOU FIRST? Figure out how to get the phone to wring and you won’t need to look for deals ever again!

          Building a pipeline takes a lot longer and requires much more skill and commitment, but it lays a solid foundation under your business!

  3. Good article, Ben. I’ve flipped a few houses myself and I’ve found it to be a profitable business, but you are right that it is laden with risks, and new investors are frequently caught off guard by many of those risks. Thanks for making the warning label that should be on the front cover of every guru flipping course.

    • Thank you Mr. Burke,

      I’ve flipped enough to know that even though it can be profitable, I just don’t want to work that hard 🙂 Flipping is not only the most dicey technique in RE, it is also the most work-intensive in my opinion – just my opinion.

  4. Ben is correct on his synopsis of flipping. If your only exit strategy is to sell you are limiting yourself. Selling should be the goal however. No matter how good the initial purchase, no matter how good the cash flow and the ROI initially – holding is holding on to non performing buried cash. Cash is king. Ask anyone who has gone to auction and bought a house for pennies on the dollar!

    I just purchased a duplex for cash with a great cash flow from the REO stock of the mortgage company. I will easily realize a 30% cash on cash just renting. But why would I speak of this when speaking of flipping – because I bought my profit when I purchased and cured the economic defect of the property. The property didn’t have economic obsolescence or was it overpriced for the area in terms of rental from the previous owner. It didn’t have a bad location. It had bad management which let the property to foreclose. Thus in purchasing, I have purchased opportunity and equity far greater than any sweat of the brow though the property will need some TLC to bring it to market standards. Deferred maintenance is one thing I look for – but not major renovation or at least not in this climate. There are to many opportunities that don’t require 100% over cost in renovation – there are better uses for money.

    Yet, my star goal is to fix up the property, rent, and then market at or below comparable investment properties. I’d be selling to many who are reading this article who want a good cash flow but no clue as to the purchase and limited renovation. Thus, I’d be offering good value at a fair price with a fairly high cap rate – the definition of a flip for profit. Amount invested $50K – profit realized at worst case scenario – $30K. Actual value of property in the $100K range less expenses but I”d take the money and do it again for now is the time to buy and own or flip. Time horizon mid summer. The true definition of a flip. What if it doesn’t flip? I will be crying all the way to the bank with a net $1300/mo on a $50 K investment giving ample money for expenses (probably closer to $1500/mo). So 30% ROI year on year on initial investment to keep or 60% ROI Cash on Cash flip – that is the exit strategy options Ben wrote about.

    Bottom line – buy your profit going in. Getting out is the challenge regardless if it is in 6 months or 8 years and be willing to stay for the money not for the pride or stubbornness or loss potential. If you are bleeding red – you are dying. Motto – never bleed red. That is for the seller to my purchases. I am a solver of problems as I relieve him from his misery of a negative cash flow or non performing asset.

    • Ben,

      Thank you for your comment. I completely agree that we make money at the front door! However, I respectfully disagree on your premise a bit…

      Flipping, by definition, is a short-term investment – it is a trade. As such, in order to live another day, once you sell this one you will have to repeat the process all over again, which requires assuming all of the risks all over again. I don’t like this.

      I much prefer to hold onto an asset, which means that I never buy anything that I wouldn’t be totally happy retiring with. Furthermore, in my brand of RE investing, what I am after is financial independence, which is defined as “stable, recurring passive income in amount greater than the cost of my life.” In achieving this, I create a circumstance whereby I no longer need earned income – this is the goal for me! By deffinition, flipping income is not stable, and is not necessarily recurring either. You have to reinvent the wheel every time, and while this works for some, it doesn’t fit my goals.

      One other point; when I say that we make money at the front door, relative to a flip we accomplish this by buying low. That’s the only way to create a value spread. However, in a long-term hold, specifically multi-unit, there are many other terms that unlock value. I am working on an article for BP relative to this concept, so please keep an eye out.

      Bottom line, you have a decision to make. You can flip the duplex and collect CAP gains, which will likely be taxed rather heavily by the way unless you 1031, or you can pull most of the equity out via a tax-free refi and use the profit for the next deal. This is a triky call on a duplex since the CF will be quite low after the debt service, but on a 6-unit or larger you could very easily realize significant CF even after the refi. This is why now days I play in the multi-family space only…

      Thanks very much for your comment Ben.

  5. Tracy Royce

    Good article, I’m glad someone is pointing out that Fix and Flipping is not the ONLY way to make money in real estate. It’s the most sexy, for sure, but one of the most difficult to accomplish successfully as an actual vocation, or even sometimes on a deal to deal basis.

    • Thank you Tracy,

      I guess I would only add that what is “sexy” is in the eye of the beholder. For some people hitting a homerun is sexy. For me, drilling them down the middle consistently is much sexier.

      Thank you for reading and commenting

  6. To your initial amazement of why so many new investors go to flipping is the Get Rich Quick mentality that so many people have.
    No other aspect of investing offers the possibility of finding a single deal, putting 3-6 months into it, then making what could be more than a years salary for a lot of people. Do 3-4 of those in a year and you can easily be in the 6 figure profit.

    Lots of newbies go to wholesaling too for the low barrier to entry and promise of a faster check, but you can’t make the same kind of money until you do serious volume.

    Then for buy and hold it is pretty impressive if you can go from nothing to 6 figures in income the first year. Also unless you can come up with creative financing methods (Which I know is your niche) there are serious capital barriers people have to deal with.

    I do agree that it is probably the most risky form of investing since there are more BIG things that can go wrong. Your steps for a good flip is a good list and many new investors will make serious mistakes on several of those and will crash and burn never to be heard from again.

    Most of the risk can be mitigated by being conservative and picky about the deal.
    Don’t overpay to “get in the game” and just be happy to make a small profit on your first deal to gain the experience. When you do that as a newbie you take away your cushion on the very deal you are most likely to need it.
    Some simple things you can do to cover your a$$et$.
    1) Base your numbers off of an ARV at the bottom of your value range.
    If you see the range as $160-185K and you feel you can probably list in in the $180s with the work you will do, base you numbers on something in the $160s so you can be covered.
    1a) There was one place that was a little dated but livable that sold for $150K in the above example. If you have to fire sale it for that make sure you are AT LEAST break even at that price.
    2) Over estimate you repairs. Use retail prices, especially on your first couple since you are likely to pay closer to that then someone with long term relationships with contractors. Also assume you need to fix everything that is the least bit questionable. Looking at REOs, vacant short sales or any other property with utilities turned off? Assume all new plumbing, electrical, and heating/ac systems. Are you an experienced roofer? If not plan on replacing that no matter what you think it looks like.
    3) Assume financing with hard money with terrible terms. Take something like 5pts and 18% for 6+ months. I personally have a default of 4pts and 15% (Which I have never paid that much) when looking at my expected profit. If you can’t win financing it then it isn’t a deal. Using your own cash, cheap credit lines (Like a HELOC or 0% credit card advances) or paying aunt Edna 5% on her life savings should only make a good deal better not to bring a dud to basic profitability.
    4) Put in a big factor for your soft costs. Lots of people forget about this all together so just having ANY factor for this will put you ahead of many. 6 months of taxes and 6 month estimate for your insurance and all utilities (Electric, Water/sewer, Oil and/or gas, etc). Make this 2nd guess pretty big to be safe and to cover you if you need things like landscaping in the summer or snow removal in the winter.

    Will you miss out on some possible deals being this conservative? Probably!
    Is it pretty unlikely that you will lose your shirt on a flip? Damn straight!
    I personally am okay missing out on some stuff that may have worked if I also keep myself from getting into a place I should have known was a loser.

    • Shaun,

      Thanks for your comment!

      There are parts of the country where a $50,000 to $100,000 or more profit is nothing out of the ordinary. If this is the case where you live and flip, then the risk/reward looks substantially different and perhaps makes more sense.

      Where I live, I need to retail for $70,000 to $110,000 in order for the flip to make sense at the back door. Unfortunately, at these price point a clean (after-tax) profit of $15,000 is really rather good – not good enough to be worth the type o work and stress and question marks attached to it.

      I understand that when working on 100k spread, you can do everything wrong and still be ok. But, narrow these spreads significantly to 15k and you’ve got yourself a fool time job; you crank out a house every 3 months, which is the soonest you can sell according t today’s seasoning standards; and you better be running 2 or 3 crews. In my market, you better be a pro if this is going to be a business.

      Thanks for your comment Shaun!

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