I’ve flipped a lot of houses. My practice is to live in the home while I am flipping, to avoid capital gains taxes when I go to sell. I have learned a lot about construction techniques and house flipping in the last 20 years.
It seems that once you know how to do something and have been doing it for years, you sort of forget all the steps that go into it – the beginning processes. I went to a meet up recently and talked about rental properties and screening procedures with someone who is just getting started. That somehow sparked the memory of my first flip, which got me thinking about the whole flipping process.
We’ve all seen those “reality” shows on TV, where they showcase a house flipper who makes a ton of mistakes, yet somehow still manages to turn a profit. It makes for nice TV, but it certainly isn’t part of any reality I’ve ever experienced.
I see so many people introducing themselves in the Forums, asking about flipping or telling their story of how they completed their flip, only to make $200 or even lose money when they finally sold the property. Unless you’re losing $50,000, you have still received a pretty thorough flipping education for less than the price of a bus tour from a real estate guru. I know that isn’t going to make you feel better — it is absolutely soul-crushing to go through a rehab with its time, stress and money, only to discover you paid for the pleasure of experiencing all that.
So here is how I did it and how I will do it again, once I am able to find my next flip house.
Find the Right House
Congratulations on deciding on flipping houses. Now you just have to find one. This is actually one of the most difficult steps because not only do you have to find a house that needs revamping, you also have to find one that can be purchased at the right price. And that has repairs you (and your contractor) feel comfortable doing. I’ve been flipping houses for a long time, but still recently walked away from a home with weird mold issues.
If this is your first time rehabbing a house, it’s better to either partner with someone who has a lot of experience or start off with a home that doesn’t need a ton of work.
Be sure you know what you are getting yourself into. Have a thorough home inspection and be there with the home inspector so he can point things out. He won’t be able to find everything (you can’t see through drywall or flooring), but you can ask questions and start to get a feel for the general condition of the house before you buy it. Let the inspector know what you plan to do with the house. Investor inspections can be very different than owner inspections.
A great time to buy is in the late fall or winter — there isn’t as much buyer competition later in the year, and sellers who have their house on the market at the time may be resigned to selling it lower because they have to get it sold. Spring is the prime selling season, and if you can get it completed in time, you can capitalize on when the most buyers will be looking.
Long term flips are great for avoiding capital gains taxes, but they aren’t without risk. I purchased a house in late 2006 to live in and flip… remember what happened in 2008? The market completely changed during my flip, and my many hundreds of thousands of dollars in potential profit were swallowed up by the poor economy. There is a lot to be said for getting in and out quickly.
Understand How to Use the 70% Rule
If you have spent any amount of time on the Forums, you have seen the 70% Rule bandied about. And while some flippers swear by this rule, it is a rule of thumb more than a hard and fast rule. It basically states that you should pay no more than 70% of the ARV (After Repair Value) minus the cost of repairs. A $300,000 ARV * .7 = $210,000. With $50,000 in repairs, you should make an offer of $160,000.
This is all fine and good in a normal market, but our current atmosphere is skewed toward sellers, which means they don’t have to take your ultra-low offer. In fact, you will be competing with buyers who can pay a whole lot more than $160,000 because they aren’t trying to make a profit when they sell it in 6 months. They want to live in it and will offer much closer to that $300,000 than you can ever consider.
I have never followed the 70% rule, and I have still made money every single time. I’m not saying you need to throw that rule out the window, but take it with a grain of salt. The lower the price of the property, the closer you have to stick to that rule if you want to make money.
Don’t fall in love with a house and bid too much for it. There will be another house. Always. You make your money when you buy.
Properly Estimate Costs
Here is where things can go sideways really quickly. If you have never been inside a Home Depot, you probably don’t know how much materials cost. And if you don’t know how much the materials will cost, you are going to underestimate. When you make a math mistake in flipping, it never turns out to be in your favor. Murphy’s Law rules the world of flipping houses.
While you are looking for that perfect house flipping candidate, browse the aisles of Home Depot. Look at all the options in the flooring department and you will see that it varies considerably. I have seen tile for as little as $.78/sq ft. I have also seen tile cost as much as $60/sq ft. For a 10 x 10 floor, you are looking at $78 vs. $6,000. That’s a HUGE difference. And that is just one rather small aspect of the job. Imagine if you budgeted everything at the low end, and then chose everything from the high end? Your budget is blown, and your profits are gone. And we’ve only talked about flooring. Look at everything you think you will be making changes to. Cabinets have a huge variance in price from RTA (Ready To Assemble) to Off the Shelf to Custom. Bathroom vanities, mirrors, even paint has low, medium and high quality choices.
Are you building walls? Make sure to account for all the materials involved. A 2 x 4 stud only runs about $2.50, but you can’t build a wall with just one — they go in every 16″. Plus you need boards for the top and bottom. Nails, too. Are you putting a door or window in that wall? You’ll need a header. Those boards cost more.
If you are using a contractor, they should know these things, and if they don’t, this is a good way to weed them out. They should account for all the materials they will need when they write up your bid, so make sure you know what you want them to do before you make your budget.
Be cautious of hourly contractors. It may seem great on the surface, but those arrangements can backfire. I paid an hour contractor way too much money for a shoddy job once. Now I get bids for the entire job.
Account for Time
Here is another place you can lose huge. If you think it’s only going to take you the two months the contractor quoted you to flip that house, think again. I have never had a contractor give me a time quote that was accurate. Since I live in my flips to avoid capital gains taxes, I have to be there for two years. An extra month on the timeline is annoying, but it isn’t a huge deal. My mortgage costs are the same if I am working on the house or if it’s finished.
But if you’re flipping a house with a budget of 3 months of holding costs and the flip turns into 6 months of holding costs, that can blow through a large chunk of your profits.
One way to avoid this is to find a quality contractor. Good luck. Ask at your local REIA meet ups for recommendations, or check out the new BiggerPockets Local Real Estate Networking & Recommendations Forum, which is divided into all 50 states, then sub-divided into the largest cities in each state. You should be able to find a sub-forum close to you.
Finding a quality contractor doesn’t guarantee they won’t run into problems and extend the timeline; some things are unavoidable. But a quality contractor is more likely to keep you in the loop.
Build some extra time into your budget. If you don’t need it, that’s just more money in your pocket. But trust me, you’ll need it.
Stick to Your Budget
It isn’t wrong to want the top-quality finishes in your house, but if the neighborhood doesn’t support it, you will be over-building your property and you won’t make the money back. The whole reason you are flipping a house is to make some money, right?
Once you have a handle on what needs to be rehabbed, ask your real estate agent to take you through some of the other houses in the neighborhood to get a feel for what is being offered. Most likely these houses will have sold by the time yours comes on the market, but you can start to see what is expected in the area. You don’t want to budget for laminate countertops when everyone else is offering granite. By the same token, you don’t want to put in granite if laminate will do just fine.
Now that you know what needs to be repaired, and what the competition is offering, you can make your budget. At the very least, you want to upgrade your home to be on par with the area, but to make your home stand out – and sell as quick as possible – you want to go just above the norm.
If you are new to rehabbing, missed items will kill your budget. Lucky for you, J. Scott took his experience and wrote a book called The Book on Estimating Rehab Costs. This book details more than 150 of the most common home improvements and helps you determine what contractors to use for what projects, as well as advice on how to tackle those big problems like mold and termites. (Bonus, if you buy The Book on Flipping Houses, you get The Book on Estimating Rehab Costs for free.)
When your budget is done, double check that you have accounted for all repairs and upgrades, then add 10% for overruns.
Quality Shines Through
Whether you are doing all the work yourself, hiring it all out, or creating a hybrid of the two, you want to make sure the work being performed is high quality. “Good enough” isn’t really good enough. You are performing work in order to build your business. Your reputation is everything.
If you are outsourcing the work, get recommendations from people you know, rather than finding someone and asking them for references. Better yet, visit the property where the work was performed to see if it looks great. Best possible scenario, visit the current job site to see his work firsthand. If it doesn’t look good, find another contractor.
Don’t be Afraid to Fire Bad Workers
My first time hiring a job out, I let the contractor finish the job, rather than stopping all work and finding someone else. That cost me $32,000 when I had to hire someone else to come in and fix the problem, plus replace the windows and doors that were installed incorrectly. Learn from my mistake. If they aren’t doing a good job, meet with them and explain what you want them to be doing. If they still do a bad job, let them go. Don’t throw good money after bad.
Make it Shine
Once you have completed the work on the property, you aren’t quite done. Your next task is to make it stand out. Your property should be sparkling clean before you put it on the market, including windows, baseboards and everything else. If you replaced the cabinets, make sure they are vacuumed out. Open the windows and let the paint smell evaporate. If your market has slowed down a bit, stage the house — especially those odd spaces that don’t have an apparent purpose — to give your buyers an idea of what they can do with the home.
Take Excellent Pictures
According to a Realtor.org report, 43% of today’s buyers start their search online and 92% of them use the internet at some point in their search. While nothing can take the place of being in the home, if your pictures don’t look amazing online, buyers will click off your house and move on to the next one. Take pictures at different times of day and night. Some of my best images were taken at night.
Price it Right
If you stayed on budget, you should be able to price it right at or slightly below market value. Your most valuable time on the market is the first two weeks it’s listed. After those weeks are up, your listing starts to become stale. It is tempting to price it high, with the idea that you have room to negotiate. But this can actually work against you, costing you market time and end up with a lower selling price.
Another strategy is to price it ultra low and let a bidding war determine the price. I think this is a dishonest tactic. You should list it for a price you would be willing to accept.
Start Looking for Your Next House
Once you’ve finished this flip, it’s time to do it all over again. Start back at square one, looking for a house. Lather, rinse, repeat.
Have you successfully (or even unsuccessfully) flipped a house? What did you learn from your experience?
Be sure to leave a comment below.