I would guess that real estate reality TV shows have done more harm to more investors over the last several years than any of us can comprehend. The thrill and excitement of watching a couple of regular guys buy and fix a property for $100,000 and (maybe) sell it for $125,000! “Wow – Can you believe these guys just made $25,000 profit by fixing up a house?!” (I always find it interesting how these shows never actually show the house being sold … they typically end showing scenes of an open house and an estimated sale price and profit figure.)
There’s no denying that the idea of flipping houses has become a mainstream phenomenon in recent years. However, what you never actually see in a reality show is the breakdown of all of the costs associated with flipping a house and the true net number at the end of the day. When you see a “profit margin” of $25,000 flash across the screen at the end of the show, the average viewer typically has no understanding of what costs that were absorbed out of that 25K.
Chances are, if you’re a BiggerPockets member, you already understand that the investor had purchase costs, financing costs, holding costs and selling costs. At the end of the day, what appeared to be a $25,000 profit may in fact be much less.
Herein lies the question just about every experienced real estate investor has had to ask him or herself when analyzing a property. “Am I better off simply wholesaling this property or should I take a chance on fixing it up and selling it?”
I still wrestle with this question on a daily basis. However, I know some extremely successful investors who have ultimately decided they are better off wholesaling EVERYTHING rather than taking on additional risk by fixing and selling on the retail market.
How to Estimate Rehab Costs!
Estimating rehab costs accurately can make or break your real estate business, and it takes years of experience for even the best rehabbers to master the art. However, you can expose yourself to less risk and get more accurate with your projections by learning how the pros think when estimating construction costs.
A Closer Look at the Costs
In the example above, let’s suppose the gross margin based on SALES PRICE – (PURCHASE PRICE + REPAIRS) was $25,000. At initial glance, this may seem like a good deal. However, perhaps the additional costs that are not discussed on the show added up as follows:
Purchase Closing Costs: $1000
Hard Money Origination Fees: $3,000
Hard Money Interest (3 months): $4,500
Real Estate Selling Commissions: $7500
Closing Cost Contribution: $2500
Additional Inspection Repairs: $1500
= TOTAL ADDITIONAL COSTS OF $21,000
So taking into consideration all of the costs that weren’t disclosed on the show, the actual profit number may have only been $4,000?! I realize this may be a little bit of an exaggeration, but not necessarily. Many new investors simply don’t calculate all of the buying, selling and holding costs associated with a transaction.
Analyzing the Risks
And while you can typically zero in on your approximate purchase costs and selling costs, the biggest unknown is your holding costs. What if it takes nine months to sell your the property and your interest expense is through the roof? What if you own the property during the coldest months of the year and your utility bills are way higher than expected. What if the house gets vandalized or you have a busted water pipe while the house is sitting vacant?
Investors that have flipped enough houses know that all of these risks are very real. I’ve had many properties over the years that appeared to be slam dunks, but ultimately ended up losing money or just breaking even.
Over time, many investors decide that the hassle and risks associated with buying, fixing and flipping just aren’t worth it … and in many cases they are probably right. Even in the example above, let’s say you can shave some of those costs and pull off an estimated net profit of $10,000. If I could wholesale that same property and make $7,500 without ever buying it and taking on the risks of flipping, you can bet I’d wholesale that house all day long.
Don’t get me wrong, I’m not advocating that all house flippers become wholesalers. I absolutely believe there is great money to be made in flipping houses. However, the more houses you flip, the more attractive wholesaling becomes when you can make quick money without the hassle and risks associated with flipping.
I’d like to hear from you guys – anybody make the change from flipping to wholesaling? Or are there a lot of you like me who still make the decision on individual properties whether to wholesale or flip?