When the real estate market is good, many entrepreneurially minded people think about getting into the business of flipping houses. But how do you start? How do you know which properties are a good choice? What should you do to the house? Want tips on dealing with contractors? Learn how you analyze home values? How do you deal with the transaction? In my many years of real estate I have flipped, analyzed and consulted in the business of flipping houses. Here I am offering some knowledge into the finer points of becoming a flipper, whether you’re going to flip one house or 100, these principles can help you wade through the question marks.
You’ll need to figure out your financing, yes, how to purchase the properties. There are creative ways, like finding people who need to sell a property and who will do an owner carry back financing for no money down but you will still need to come up with money for repairs. There is the opportunity in this situation (if the house is really well priced) to wholesale it, meaning flip it to other flippers for a small profit without having to put any money out. Many people may find that farming out neighborhoods (using mailers or door knocking) to find these wholesale deals can be a good strategy. If you are going to purchase properties out right – off of wholesale lists or through your own network – you can finance them using hard money lenders who will charge anywhere from 8 to 14% interest and sometimes charge origination fees or points. You obviously will want to shop around for the best rates and deals. Remember that origination fees and points are direct cash fees on top of the interest. Be sure to calculate your interest properly since your financing costs will be one of your larger expenses. Financing costs have to be handled very carefully and diligently because having a deal that goes on too long can turn a good deal into a bad one when high interest rates can add up over several months. Example: if a lender is going to give you a 70% loan to value (LTV), some lenders will do that on what the finished value is on the after repair value (ARV). So if you’re buying a property for $100,000 that will be worth $150,000 when you’re finished and the lender lends 70% on that finished value or $105,000. That means you still have to come up with the $45,000 in cash plus money for repairs. In your financing expense calculation, you definitely want to make sure you give yourself a good window of time to get the home remodeled and sold.
Good flippers who do their jobs quickly and price their homes perfectly can expect to turn homes around in as little as 60 days but you should plan on a minimum of 90 days. Follow a strategy such that if your home doesn’t sell quickly you will probably need to lower the price rapidly, so as not to incur high financing costs or stigmatize the house as one that hasn’t sold because there is something wrong with it. It is hard to be in the flipping business without some cash on hand and everybody has a different threshold for money they have access to. Possibly, you can get an investor will participate for a percentage of profits or an interest rate of return in exchange for funding the down payment. Sometimes you can find an investor with deep pockets who will lend all of the money. If you can find investors like that you are definitely in the game from the financing side. It is very important to do a good job and make sure that the investor is taken care of, otherwise you more than likely won’t have that investor for very long.
Analyze the market/choose a property
Understanding how to analyze the market will better help you choose the right property or category of properties on which to focus. Obviously if you’re just starting out, it will be easier from a financing standpoint and a remodeling standpoint, to handle lower priced properties. When analyzing real estate there are some basic inherent factors that will directly affect value such as: general area, curb appeal (and not just of the subject property but other properties on that street), lot orientation, functionality of the floor plan, general condition and finishes of a particular property such as flooring, cabinetry, counter tops, bathrooms, etc. When you look for properties in a particular price range or area, you will compare a prospective wholesale property against the high end of that specific retail market (comparables or comps). Generally speaking, the high-end of the retail market is what has sold for the highest price per square foot on the multiple listing service (MLS) within the last six months for for that particular type of property when you compare everything apples to apples. Be very diligent about not kidding yourself when it comes to a true apples to apples comparison. For example, larger homes will sell for a lower price per square foot than a smaller one in the same neighborhood. In sunny climates such as Phoenix, often times northern and eastern facing backyards are more sought after then southern and western facing backyards because of sun exposure. Open, highly functional floor plans sell better. Modern finishes are obviously bringing the top dollar. Usable, finished, well designed backyards will push properties to the higher retail value also, etc. So then you need to be able to do the math. If you find a property for $100,000 and you think it will be worth $150,000, you have to know how much you need to put in to the property to make it with $150,000. You have to calculate all your expenses. One of the largest expenses is the backside closing costs including sales commissions. If you are a realtor you can cut your sales commissions exposure in half but you have to calculate all these expenses and subtract them from the retail price. A general rule of thumb would be NOT to buy a wholesale deal that is more than 70% of the after repair value (ARV or retail value). But depending on how much work the property needs or doesn’t need, how vibrant the market is and what your expected profit is, that percentage could vary slightly but usually not much more than 5% eithe
Determine value add/repairs needed
First, determine how you will position the home in the overall pricing scheme of the market based on your wholesale purchase price and the potential retail value. Are you going for an average price per square foot with average finishes or trying to hit the high end with better finishes? Your analysis of the marketplace should help you determine where the most demand is and the most velocity in the market place to ensure a quick sale. Supply what the market needs. Do not try to force square pegs into round holes because you will always pay the price for talking yourself into your own bad ideas. Do not kid yourself, use apples to apples comparisons when pricing or it will come back to haunt you when buyers start looking. When you have figured out where your retail price point will be, you have to get the house in THAT condition based on the comparative market competition. Look on the MLS for recent solds (closed properties) in that particular neighborhood and even on that street. Do not look too far outside of your specific neighborhood as different neighborhoods can change in value quite quickly and drastically.
Again, apples to apples AND don’t kid yourself. You may determine that to get top retail dollar, you’ll need to do a full gut out remodel including modern flooring, cabinetry, granite/quartz counter tops, stylish bathrooms, new paint inside and out, new windows, all new plumbing and electrical fixtures, possibly a new roof, new water heater, and HVAC, for example. A different property may be suited for just some paint, touchups, minor repairs and some new fixtures to get an average price per square foot and a decent, quick profit. Taking a quick profit where you can is always a good idea. Sometimes thinking too big and investing too much can come back to bite you, especially before you get experienced at controlling all your costs and understanding the market really well.
Once you have determined the repairs and finishes you want to accomplish you will need to get your contractors going. To flip real estate, which falls under the state of Developer Clause, meaning you are selling for profit potential and HAVE NOT occupied the property for a period of one year, you may have to be or hire a General Contractor, depending on your state’s law. In any case, you must hire all licensed contractors. If you hire a General Contractor (GC), he or she is basically the master license over all the other subcontractors. Typically, a general contractor will give you one bid to complete all the work of the subcontractors plus their fee. In other words all the contract work plus the general contracting fee is the sum of all the parts plus the GC fee. The GC has the master license and will manage and quality control the work for one price. That being said, do not be naive and think that you will not have to manage the general contractor. You will have to be over his shoulder making sure that work is done satisfactorily and in a timely manner so that you do not get left with substandard work or a time schedule that runs way too long.
The bidding process should involve scopes of work or descriptions of work for every trade, in detail, so that each subcontractor of a particular trade is giving you a price for the same work description and you can make apples to apples comparisons of the bids. For example, with tile work you want to include the type of tile, all of the areas, are there toe kicks installed? How you want patterns to lineup to bathtubs and cabinets and so on and so forth. Detailed scopes of work will take a lot of the confusion and guesswork out of comparing bids. Also, when you select a subcontractor for that trade you will basically have your contract and guidelines to go by that you have both already agreed upon. Many problems and conflicts arise with owners and contractors where the details of the craftsmanship are not outlined in the initial contract and you end up with substandard work or an argument. Know what you want and how it should be done and have it in writing!
Choosing a realtor/setting your price
Choosing a realtor and setting your price.: If you or somebody on your team is not a licensed realtor, then you will need to hire one. When choosing a realtor you should look for somebody with experience in the local market who also has handled the types of houses and clients you will be dealing with. There are lots of realtors out there these days but many people make the mistake of simply hiring somebody because they know them or they got a referral. Do your homework on who you are hiring. You especially want a realtor who will be responsive to your calls and the calls of clients, be on the ball, know the negotiation and contract process and be able to get deals done quickly and cleanly. You don’t want any problems arising because you hired a non-present, ill-informed or sloppy realtor. Setting your sales price is critical. Many people think – set the price a little high and you can always negotiate down so as not to miss out on any profit. This is a very common error made in residential real estate. There are plenty of statistics to show that if you overprice a home initially you very well may end up making less on that home due to market stagnation and stigmatization of the property. The best strategy is to know exactly what the retail price should be and price it right on the money. In many cases if you have a nice property that is well priced you can create a bidding war and even get a little bit more than your asking price! This is the situation you want to be in rather than chasing the market down and leaving your property on the market too long where people might start to think, ‘what is wrong with this property??’. There are additional links below that speak specifically on how to price your property, how to choose a realtor, how to deal with multiple offers and how to handle the inspection period.
Applying the 70% rule
I have seen the 70% rule calculated before fix up/repairs and after. You need to know the difference. However it is calculated, you need to know how to run your numbers. Another consideration is which way do you work the numbers, from your acquisition price up, or the retail price down? well, it will vary. What if someone offers to sell you a wholesale deal at a certain price? or what if you know what retail values are and want to make a wholesale offer? Either way, the key is knowing what houses sell for in specific conditions of repair or finishes. After close inspection of sold comps on the MLS, you should recognize the retail values (ARV) for homes with varying degrees of finishes. For example; granite counter tops vs tile tops vs laminate tops, ceramic tile floors vs stone or wood, new windows vs old, etc. In any case make sure you are going off of comps very similar to what you intend to have in your finished house!
70% rule with repair/fix-up expenses included in the 30%. Lets say you determine the after repair value (ARV or retail value) will be $200,000.00 (PP), repairs = $20,000.00 (R) (including property taxes, insurance and utilities), what should be your purchase price? Let’s say you’re getting a 70% (of ARV) hard money loan (LA) at 10% interest (I) and 1 point origination fee (P). You estimate the entire process will take three months from purchase to sale. So… 200,000 PP – 20,000 R – 4,900F calculation for financing costs: (200,000 PP x 70% = 140,000 LA x 10% I = 14,000/12 months = 1166.66 per month x 3 months = 3,500) + (140,000 LA x 1% P = 1,400) = 4,900 in total financing costs. Then, 180,000 (PP-R) – 4,900 = 175,100 – back end closing costs @ 7% (3% buyer broker + 3% listing broker = 1% title fees) = (200,000 PP x 7%) = 14,000; so, 175,100 – 14,000 = 161,100. So if you applied the 70% rule where you pay 70% of ARV, you would have bought the house for $140,000 and taken in $161,100 after expenses which equals $21,100 (NP) in net profit! So to calculate your cash on cash rate of return, you would have put in 60k loan down payment + 20k in fix up money (all financing costs already subtracted from revenue) = 80k cash investment (C). So, 80,000 C / 21,100 NP = 26.37% cash on cash return (ROI) and to get an annualized rate of return (AROI), multiply by the amount you would THEORETICALLY make if you reused that money for the entire year or four times (3 month deal, 4 times = one year, right) = 26.37 x 4 = 105.48%AROI!
Now, that’s pretty good. I have seen the 70% rule where you buy at 70% minus the expenses. So in this case you would have bought for around $120,000. Ok, obviously that is a great deal, even better than the one I illustrated. The problem is, it is very hard to even find deals like my example, so to find them as the latter example, especially on a regular basis, good luck! If you can do it, you’re doing well. No one can tell you what you should make but be careful! Just try playing with a few of the numbers and you’ll see how easily these deals can go bad. I gave you all the inputs, so try hypothesizing that the deal takes longer to sell and you have to string it out for five months and drop the price $10k. So less, revenue, a bit less commission paid, but more interest
These are the basics of House Flipping 101. Now you have at least enough information to make you dangerous, hopefully to the competition and not yourself! The best way to go forward now is to take this knowledge and go flip some homes!
Disclaimer! There are inherent risks in flipping homes or any real estate investment. Matthew Makovic or any of his affiliates, partners, employers, etc., assume no responsibility for actions, errors and or omissions in anyone utilizing the above advice. Market fluctuations and independent investor practices will affect respective outcomes in regard to profit/loss. Proceed at your own risk. Contact Matthew directly for consultation.