I love it when an agent or broker sends me a new potential flip opportunity. My face lights up, I feel the tingle of adrenaline coursing through me, and images of wealthy grandeur float through my mind. What am I gonna do with all that profit?! Usually the email has a number of exclamation points that signify the immediacy with which I need to act.
“The seller has to get rid of the house but needs an all-cash offer today!!!!” My anticipation heightens – I take another sip of my coffee to increase the frenzy of excitement!
I get down to the part of the email where the address is listed, quickly create a new tab in my browser where I can search for this wondrous deal on Redfin, and plug it in to get the quick lay of the land. Usually I have to double take and check again as to what the price of the home is. No way is the seller looking for over market value on this house! I thought they were distressed?! Did this agent do any due diligence or just simply fire it off to me looking for a quick buck? Maybe I’m missing something…
The reality is that most of the homes I look at aren’t worth flipping. Still, I go through the same process every time when I see an agent’s email. The excitement is half of the fun, but it needs to be tempered because most of the deals I see aren’t worth my time. It is particularly difficult to pass on marginal deals in a real estate market that is doing well, but it is important to realize that markets are cyclical and that this time is no different than the past.
Through a lot of trial (and many errors) I have developed six criteria that can take the buzz out of any over-hyped flip opportunity and yet still allow the good ones through. I don’t think my criteria are the only ones worth having; far from it. The point is that it is important to have some basis, process, or chill time to allow the fervor of a potential flip to cool before you make an economic investment decision. Here are mine.
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6 Criteria For Finding Profitable Houses to Flip
1. Comfortable Basement Sales Price
The natural thing to do when underwriting a flip is to look at the top comps. “Ohh, that one over there sold for $800,000, and the subject property is only five hundred square feet smaller so surely it will sell for… $795,000!” Trust me, I do this all the time, and I know that a little comp-sterbation can be fun. The problem is that you should want to be prepared for the worst case scenario. Is there a comp right next door to the $800,000 house that just sold for $550,000 and upon further review is actually pretty similar to the subject?
Yes, I know, your flip is going to be soooo much nicer than the one that sold for $550,000! “It isn’t even comparable,” you may tell me! Or maybe it is. Regardless, the $550,000 comp shows you what the comfortable basement sales price for your flip is. I’m not saying it is going to sell for $550,000, but if things go wrong you should feel confident that your house would sell for at least that much.
This is not necessarily a deal killer, particularly if you buy the subject house for $300,000 or something. However, you should structure your deal or need to get a resale of anything over $550,000 to make it work. Yes, there may be upside, but at worst you know the deal will make you money at the $550,000 number.
2. “Pop” Potential
Now that you have your comfortable basement number all set, let’s see if there is potential for big upside. (Note: there is a reason the comfortable basement sales price comes before this.)
That $800,000 comp is definitely a good one for your subject property. Even better would be to have a couple other ones in the $700,000 range. In talking with some of the more savvy real estate agents, they have clued me into how some of the high outlying sales prices have come about. Oftentimes it is in an area with a dearth of inventory, the home is listed well below market, and a buyer comes in and just overbids everyone else by hundreds of thousands of dollars. Yes, that is a comp, but it is also a unique buyer. This happens a lot in Silicon Valley where I do flips, and it makes underwriting hard.
This means that it is important to look at the story for the “Pop” potential flips. Was it listed at $775,000, went pending in two weeks, and then sold for $800,000? This is a meaningfully better comp in my opinion than a home listed initially for $600,000. Again, having a couple of homes sales in the $700,000 range would make your deal look really sweet, and possibly help raise your “comfortable basement sales price.”
3. Near Median Price Range for City or Area
Are you going to build the nicest, biggest home this neighborhood has ever seen?! If so, you stand a higher chance of losing money, at least in my opinion. How many people can afford the absolute nicest and most expensive home in the area? A few. What happens if they aren’t in the market for a new house, or simply don’t want to overspend? Your flip can sit.
I feel like a broken recorder, but this is not a huge issue when the market is going up like it is now. However, when things cool down, it could be problematic. The solution is to target properties that would resale for close to the median price range for a city or area. How many buyers are in that pool? A majority. It’s a probability play. The point is to aim for a market segment that has a large pool of buyers. If your house truly is the nicest, then maybe you make a little bump in a bidding war.
4. Clear Value Add Story
One of the first things I ask an agent when they send me a possible flip is, “What’s the story with the house?” The honest truth is that what I’m really looking for is a sign of distress. “The house was inherited, but no one lived there for a few years and there is a lot of damage to the roof. They are just trying to sell it quickly because they need the cash.” This would be a good story because it shows how you can add value to the situation, and why the home is selling for a discount.
Most important is that I like to see how I can add value to the property in order to make my money on the flip. It could be the ability to close quickly with cash, an intensive renovation, or an add-on/rebuild scenario. All of those options have barriers to entry that I’m able to cross and explains why I’m getting a good deal.
I’m wary of buying a house where it just seems like I’m stealing it for a good price. Don’t get me wrong; I’m certainly fine purchasing a home for a great price, but I’d like to be able to rationalize why I’m getting a good deal. With the proliferation of real estate technology, most people should have an idea of what their home is worth (maybe even an inflated idea). I feel more comfortable buying a home if I can explain to myself why I’m going to be able to profit.
5. Normal Layout
This is by far one of the most overlooked aspects of a home for potential flippers. Layout matters. I deal with a lot of homes that were built in the 1950’s and have some weird additions. The proverbial “lipstick on a pig” approach can end up being a loser. Even more disconcerting is that Winchester Mansion lookalikes don’t have an easy fix. A home with a leaky roof is bad, but at least there is a reasonable price to fix it. A home with a terrible layout is irreparable, unless of course you just knock down the whole home.
I understand the term “normal layout” is subjective and a bit ambiguous. The test I use when walking a house is to try and see if I can map out the floor plan in my mind. I can do so relatively easily, then I feel like the layout is fine. The other trick to use — for all of you gentlemen out there — is to bring along a female because they have a way better sense of these things than most men.
6. Nice Surrounding Houses
This is real estate 101, but it is so often forgotten about. Are you buying the best home on the block or the worst? The other homes nearby don’t need to be brand new rebuilds, but it makes a huge difference if they have a little pride of ownership. More importantly, you want to stay away from houses that are terrible looking or which have problem owners.
Walk around the neighborhood at several different times of day, and speak to people who are outside. It can be a little awkward, but be honest and tell them what you are up to. Most people are more than happy to share a little dirt on their neighborhoods.
What do you look for when you flip houses? What is your process? What are your criteria?
Share your tips and stories below!