Considering a House Flip With 15k Profit? Don’t Do It

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Not that $15,000 isn’t a bad profit, it’s just that you are unlikely to make that amount and could even lose money. The reason is all of the unexpected costs.

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I Thought It Was Purchase Price Less Repairs Equals Profit…

The house flipping television shows love to show super simplistic formulas for how much profit is going to be made that completely ignore costs that are typical for fix and flips. If they were to cover all of the costs normally involved, the font would probably end up being as small as the small print legal statements made on some commercials. They’ve got to keep it simple so that it is not confusing. It’s not really confusing so let’s take a look at what could happen if you choose to do a house flip with only $15k profit potential.

The Temptation To Do a Deal

I want to start by considering why people are tempted to do deals that show $15,000 profit on paper. The typical formula used for calculating what the most you should pay for a house to flip is 70% of the after repaired value (what it will sell for) minus the cost to repair the house.

If a house will sell for $100,000 fixed up and will take $20,000 to fix it up, you should not pay more than $50,000 for the house. To the uninitiated, this may appear to leave $30,000 in profit. That would be awesome but is almost never the case. There are other costs that are involved and the 30% in room covers your profit as well as those other costs.

If we’re underestimating these ‘other’ costs, we might be tempted to do a deal that shows the potential for $15,000 in profit. For the above example, that would mean buying the house for $65,000 instead of $50,000. We should still make $15,000 in profit, right? Wrong.

Fix and Flip Costs That Could Eat Your Lunch

  • Closing Costs When Buying
  • Oddly enough, people don’t tend to concern themselves too much with the cost of actually buying the house. If you are getting a loan (especially if you are getting a hard money loan), you could be paying thousands in points. Title policy, escrow fees, document preparation, courier fees, etc. can all add up to a good chunk of your intended profit.

  • Change Orders
  • You will find things that you have to fix that you didn’t plan on. Just count on it. Most rehabbers will come up with a repair estimate for a house and then add 20% or even double the entire repair amount. This is because repair costs can spiral out of control if you are not in complete control.

    Sometimes we are tempted to keep certain things and relace other things in a house. It’s amazing how outdated or filthy things look after you paint the house and you left some things alone. This can lead to changing out a lot of items that you intended to keep.

    I’m not even talking about over-remodeling a house, just doing what is necessary to make the house desireable to potential buyers.

  • Holding Costs

    Holding costs will usually include loan payments,property taxes,insurance,utilities,HOA dues and any other cost associated with owning the house while you get it fixed up and sold.

    It may not seem like these costs would really eat much into our profit, but let’s take a look at an example.

    Say we are fixing up and selling the house in our initial example. We’ve bought it for $65,000 and need to put in $20,000 in repairs with hopes of making $15,000. Let’s assume we got a loan for the purchase and repairs ($85,000). It was a hard money loan that allows interest-only payments at 14% interest. The monthly interest payments would be $991.67. Woah. That’s a lot, especially when you consider that it could easily take you 6 months to fix it and sell it. If that happened, it would cost you $5,950.02. Add vacant house insurance on that and you could be paying another $1,000. Property taxes where I live and invest are roughly 3% and so for a house valued close to $100,000 would be about $3,000 for the year. So even if you fixed and sold within 6 months, you would be looking at a $1,500 property tax bill.

    I’m sure you get the idea. It’s a wonder people don’t contemplate these costs more before jumping into an investment. With just the ones mentioned, we’re looking at about $8,500. That’s over half of your expected profit!

  • Realtor Commissions
  • Realtor commissions are typically 6% of the sales price. For our example flip, this would be $6,000 (normally $3,000 to the buyer’s agent and $3,000 to the seller’s agent).

    Of course you could sell it yourself For Sale By Owner or get licensed and list it yourself to save half the commission, but that might be more than you are willing to do realistically.

  • Buyer Closing Cost Assistance
  • Most of the fix and flip houses we sell are sold to buyers that are getting a FHA loan. The buyers are allowed to get assistance from the seller for some of their closing costs and usually need it. The Federal Housing Administration limits this assistance to the lesser of 6% of the sales price or allowable closing costs.

    You could end up selling to a cash buyer or someone qualified for a conventional loan that won’t request closing cost assistance, but you are more likely to get a buyer that needs the assistance.

    For our example house this could be upwards of $6,000! Not exactly chump change.

    You don’t have to give the assistance, but if your buyer needs it and you were having trouble getting a buyer, you might be better offer doing it.

  • Lender-Required Repairs
  • Just because you fixed up the house and got a buyer on the hook, doesn’t mean your costs in the deal have ceased. Many times lenders will require certain repairs be made because they have guidelines on what it is they feel is necessary for what is being used as the collateral for the loan (the house). For FHA these required repairs tend to be related to health and safety issues, structural issues and safety and security of the house.

    You might be required to bring certain things up to current code and this could really cost you a small fortune. If you want your buyer to be able to get the loan, you might have to come out of pocket for these repairs.

  • Price Reductions
  • You might need to reduce your price, which will certainly affect the amount you make as profit from the deal. This is not only because of over-estimating the after repaired value and not finding a buyer willing to pay it but can happen if the house doesn’t appraise for that amount if you do find a buyer.

    So if the house is sitting on the market for months, you obviously need to lower the price (unless there is something else that potential buyers are saying is a major problem with the house). Remember, you only estimated making $15,000 and you’ve calculated that you’ve already lost most of that with your holding and repair costs. Dropping the price now is going to be super painful.

    Sometimes it’s necessary though to stop the bleeding.

Takeaway

I’ve lost money on a rehab before and it wasn’t pleasant. That kind of experience can teach you a lot but you really don’t need to learn it that way. Just be mindful of all of the costs that can eat up your profit and make sure you stick to the formulas used to buy these houses and maybe even make them more conservative. I try to shoot for 65% of ARV minus repairs most times. It’s not a bad idea to do the same. Of course, you also need to know how the market is where you intend to invest. If houses are sitting on the market for a year, you probably should be even more conservative than 65% of ARV.

If you’ve been considering a flip that shows the potential for $15,000 in profit but does not take into consideration most of these costs, I don’t recommend doing it. Not unless your plan is to see how much money you can lose on a deal.

I’m sure some of you have had other costs that have not been mentioned here and I’d love to hear what they are. You can share yours in the comments below. Please do. Thanks.

About Author

Danny Johnson (G+) is a real estate investor in San Antonio, TX. Visit his blog: Flipping Junkie - A House Flipping Blog to follow along with him as he shows, in detail, the marketing he is doing, the leads being generated, the lead and deal analysis, the rehabs and really, just about everything. He also provides real estate investor websites at LeadPropeller.com.

31 Comments

  1. Rita Phillips on

    Great article regarding the basics that can eat up profits. I generally work these concerns into my estimates. But after 20 years of flipping homes (with only one loss when the market started to tank I’m proud to say), here’s the one that finally got me last year in a 1971 built home. A septic tank.

    And the bad part is I just “knew” it was there, and didn’t go with my gut. The listing from the sale said it was sewer connection (who ever believes that?), and in four calls to the city to check they insisted that the home was connected to sewer. They’d even been billing the previously owner for services for years. But there were obvious signs to the contrary that I ignored.

    So as our major remodel progressed, the cracked tank was discovered. Due to the age of the home, the city wouldn’t let us replace the tank; requirements are now that you update and connect to sewer. How is that possible? The lines ran right down the street in front of the home. It turns out that the subdivision is half sewer, half septic. Cool; no problem you say? But wait…it gets worse.

    The home was near a mountain preserve with great views and easy access to hiking/biking trails, etc. Very sweet for resale, we thought. Except when you have to dig to put a line in to connect to the sewer in front of the home. The damn front yard was solid rock.

    Three weeks later and nearly 10K in permits/delays, additional subcontractor fees beyond his original estimate (all fair of course), misc. labor to repair landscaping, not to mention our personal costs for the extra time spent on the project, the expected profit certainly suffered.

    Lessons learned? 1) GO WITH YOUR GUT! 2) Don’t always believe what the city tells you. Okay, you seasoned flippers; that’s your laugh for the day. 3) Let it go. I doubt anyone would have seen this one coming. Flip on, my friends!

    • Thanks for sharing, Rita.

      I for one was not laughing. I was cringing. That’s painful to have costs like that pop up, especially when your gut was telling you something.

      Great read though and an even better lesson. Thank you.

    • I feel for you Rita!
      I’m getting bitten by a septic right now on a resale.
      Here in MA the laws on them are pretty rigorous and you have to get a ~17 page “Ttile V” report on a spectic before you can sell a place.
      I bought the place with a passed report from a couple months earlier (They are good for 2 years so wouldn’t even need a new one on resale!) so I thought I was all set.

      Well I took the report at face value (as did everyone else) until we had an excepted offer and the buyer’s agent was at the townhall looking at some other stuff and saw something “funny”.
      Turns out there was a failed report from 2005, plans for a new system then, no record it ever went in, then the passed report I had.

      I’m sure you guessed it. No new system went in!
      Thank god that when the Board of Health went out to look at it with the inspectors that gave the current report they came to the conclusion that the whole system did not have to be replaced. Still had to do a new tank and fix some poorly designed plumbing.
      Here a new septic can easily run $30K or more if there aren’t any issues.
      Even just the relatively minor repairs I did will end up costing about $10K when taking into account the additional holding costs too.

      Those repairs along with a price drop, taking an offer a few grand under that new price, some FHA required repairs, and a slightly longer holding time before the spetic delay would all add up to disaster if I didn’t account for all the little costs and have a big buffer on it to start.
      At a $15K profit without factoring in a lot of things I would have lost a lot of money. As it is I will still make more than that since I bought it right.

        • Hey No problem!
          It is therapeutic to talk about. πŸ™‚

          I find that there is always SOMETHING that comes up on a flip. It goes to the point of the article about needing to account for everything you do know about so all the buffer is profit or unexpected things.

  2. Another great article!
    I love the flipping shows that assume a house is in perfect condition sight unseen by the investors. Then they go through and takes off profit for all the repairs needed. They also fail to account for all the other costs. There margins are so thin it is ridiculous.

    • Hey Mark.

      They’ve got to create drama though don’t they. It is ridiculous. I’m always left wondering how much they are making from the show because they cannot possibly be making much from the houses a lot of the time.

  3. Jason Grote

    Danny,
    These “extra” costs are the ones hard to get into the seller’s head, but if they are not in the investor’s head, he is in trouble! We have a running joke in our family that when I say a particular house will cost us $50k(which is supposed to include all of the costs you mentioned above), my wife says, “Ok, so $55-60k”. Thanks for the great posts, Danny. You are a true flipper!

    • Rita Phillips on

      Jason – HA…sounds like our house. Except I’m the one adding in the extra costs, not husband. We always say that’s a great team…one optimist, one conservative to keep everything nicely in line. πŸ™‚

    • Same here. But, it’s usually her showing me the numbers after the deal is done. I think she likes to see my jaw drop when I find out how much I ended up going over budget. It’s best to just say it was the wrong budget. πŸ™‚

  4. Sometimes a 15k profit can be awesome. We focus more on the return on our investment as opposed to a set number. If a 15k profit is a 15-20% ROI, then that is an awesome return.

  5. Great explination. And you’re right, if the profit is $15,000 but you have already accounted for those costs, it’s not a bad deal. It’s just when you ignore the additional costs that you get into trouble. I have to explain these to FSBO sellers all the time. They are shocked at what it costs just to sell a home and how little money they are likely to walk away with!

    • Deborah,

      It sure is a great way to inform sellers that the difference in what you are offering and what they think it is worth is not all profit for us. Most know there are many costs usually involved, but the amounts and what they add up to can be quite shocking.

      • Tracey Holtzclaw on

        We bought a rental and believed it to be on public water due to the MLS listing that disclosed that. Once we closed and our contractor couldn’t find the water meter we realized our water came from the neighbor’s well that originally owned all the property. She would not entertain us buying water from her so 10,000.00 we had a brand new well that was “600” feet deep to find water. We found out later this contractor was notorious for always having to drill “600” feet to find water. We even tried to go back to the list agent and seller (a bank that had us sign disclosures out the wazoo), that got us no where. Great lesson learned by all and there are great success stories in our business that make up for bonehead moves like this one.

    • Rita Phillips on

      Ryan – Nope; we never even thought of it. Being it was a very old problem, and that we had just bought the home for a few months for a flip, would that have been possible? No limitations regarding existing conditions? Sure would be good to know! Thx much.

  6. Easy read article. One of the most over looked cost item is TIME. Many people do the repair themselves. They do not factor time spent on the job. How much is your time worth? How did the project finish? How many trips to the store… Thanks for the GOOD advice.

  7. Robert Steele on

    “You might need to reduce your price, which will certainly affect the amount you make as profit from the deal. This is not only because of over-estimating the after repaired value and not finding a buyer willing to pay it but can happen if the house doesn’t appraise for that amount if you do find a buyer.”

    Ahhh, the best laid plans of mice and men.

    I am looking at a rehab at the moment and the ARV is either $200K or $275K. It is a nutty neighborhood and impossible to comp. A couple of nicely updated houses sold for around $200K but some dated houses sold for $220K and then some other nicely updated houses sold for $275K. I cannot see any common thread or theme. They are all in the same neighborhood.

    I think the ARV for this neighborhood is based on whichever buyer happens to be in the market when that one property comes up for sale. Some buyers have bigger, er deeper pockets than others.

    So I have decided to play it safe and not go all out crazy updating on the rehab.

    • Rita Phillips on

      Robert – I feel for ya! I’m facing the same issue right now. There are so many variables, and more so when comp’s are nearly impossible. No matter how many times I flip, I can’t help but stress out just a bit about how much / where / will I get a good return? on improvements of a larger $$ value. Sounds like you’ve made a good decision. Good luck!

    • Sounds like a good plan, Robert.

      That can be very frustrating and we have some areas in town that are like that. I always try to make my calculations with the conservative numbers. Then, if it will sell for the higher dollar, awesome. If not, I’m still good.

      But figuring out how much to do to the rehab can also be a huge challenge. One thing we are careful of is either doing just a little or doing everything. I’ve never felt good about only doing certain repairs and then realizing the house still looks like it needs a lot (even if it doesn’t – the feeling is just there).

  8. House flipping tv shows are the worst! Even when the really bad, cringe-worthy stuff happens – like discovering asbestos when a wall is torn down – the rehabber is still able to find additional money elsewhere or reallocate funds effortlessly. The budget is always consolidated into a few simple lines that only require basic addition and subtraction. So thanks for keeping it real with this article, Danny!

  9. Good Article Danny. It is so important for new investors to stay clear when an agent says…Oh this one will be a great QUICK FLIP!. Yeah, no such thing! Those are the ones that can bite you bad. Like you said, do your own homework and leave plenty of room for error, because murphy’s law says…You’re gonna need it!

    • I’ve always loved that line about the easy flip. πŸ™‚

      When they say that, I don’t think they are considering the hassles involved in dealing with contractors, inspectors, appraisers, the city, neighbors, buyers, underwriters, etc., etc., etc.

  10. This article was just what the doctor ordered today. I’m mulling over the relocation of an older house to a nearby vacant lot. Running conservative numbers gives me a 24k profit 8 months out, taking into account everything you’ve mentioned. That is, except for additional time delays and some items the city may throw at me that will add more costs. I probably underestimated my truck trips to Home Depot as well πŸ™‚ Just doesn’t seem like enough wiggle room for me, since this would be my first true flip.

    If you feel confident that your numbers are good, and are willing to take on the risk involved with a certain project, what is your bottom line profit number, if not 15k?

    • I think you do have to have a minimum target but usually base my numbers on a percentage of ARV. You really need to expect to make 10-20% profit to make it worth the effort and to ensure that if there are issues that come up you have a buffer.

      I think having a $15K minimum goal is okay as long as it is AFTER factoring in all your known costs and at least a 20% contingency on your rehab numbers. I also think you have to be in a low to mid range market.
      It is fine going into a $80K resale looking to make (A well accounted for) $15K but you could be out of the game pretty fast if you are flipping a $500K house and anything goes wrong.

  11. Shaun ,

    I like your percentage of ARV approach better than a target number. That makes more sense to me than chasing a dollar amount. Your point about being in a low to mid range market makes sense as well. Hard to walk away from a profit, but I’m going to take a closer look at the amount and type of work involved to get there. I certainly don’t mind working hard for my money, but the type of work and energy expended on a project needs to fit with long term goals. Gotta keep my eye on that prize.
    Thanks for some more great nuggets to chew on.

    • Hey Page,

      Glad it was helpful.
      I would advise still having a dropdead floor on a dollar value for profit since if you get into lower end ones it could just get to low.
      In my $80K ARV example if you decide you are willing to work hard for the money and be okay with a 10% profit that would be $8K. That is WAY to low to do a flip. That can get eaten up with only minor setbacks.
      Even if you get it done that was a LOT of time, effort, risk and stress for a fairly small amount of money.

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