All too often people watch a television show or read an article about house flipping
and get excited about the possibility of making “easy money.” The concept of house flipping is fairly simple - you buy a cheap, fixer-upper home, remodel it
and sell it at a much higher price than you purchased it at. While there are many people who do in fact make a profit following this formula, it’s important to remember that house flipping does not come without risks. Unfortunately, there is no guarantee that flipping a house will be a profitable endeavor, or that it can be done quickly or painlessly.
Here are some important things to consider if you are thinking about getting into house flipping:
1.) Purchase price or down payment. The primary assumption when flipping a house is that you can buy a home cheap enough that it can easily be sold for a profit. If you have ample savings to pay for the purchase of a fixer-upper, great. But if not, you’ll need to secure financing, which can be a bit tricky. While a traditional mortgage loan might work if you’re looking to use the home as your primary residence for a couple of years while you renovate it, it’s likely not the best option if you’re looking to quickly “flip” a second property. Mortgages from banks and credit unions typically take at least 30 days to close, and their terms are generally more favorable for borrowers looking to hold onto a property for several years. Because of this, time-sensitive house flippers generally turn to private lenders or hard money loans to finance the purchase of their properties. Regardless of which type of financing you secure, keep in mind that in most cases you’ll need to contribute a down payment up front.
2.) Renovation costs. In order to turn a profit, you’ll likely need to make extensive repairs or upgrades to the property, which will require additional funds. Unless you have the cash on hand to pay for renovations, you‘ll likely need to finance those costs. In addition to the hard money loans and private lending options discussed above, house flippers might also consider taking out a home equity loan or line of credit against their primary residence in order to fund the cost of renovating a fixer-upper. Other financing options include personal loans or borrowing from a 401(k).
3.) Holding costs. Between the time that you purchase the property and sell it, there are several costs that you’ll be responsible for. These are typically referred to as “holding” costs, as they are the costs you’ll incur while “holding” onto the property. These include your mortgage or loan payments, property taxes, utility payments, and insurance. The longer it takes you to renovate and sell the property, the more you’ll rack up in holding costs, which will have a direct impact on your overall profit.
4.) Selling costs. Once the property is fully renovated and ready to turn a profit, you’ll need to consider the costs involved with selling it. These can include home staging and landscaping costs, as well as realtor commissions and closing costs.
5.) Capital gains tax. It’s also important to keep in mind that any profit you make from selling your house flip could be subject to the capital gains tax depending on how long the project takes to complete. It might be worth meeting with a tax professional or accountant prior to beginning a house flipping project to ensure you understand all the potential tax implications involved.
Like any investment, there is a risk of losing money with a house flip. It’s impossible to predict exactly how your house flipping project will go, so you should be aware of things that could potentially take a bite out of your profits. These include:
• Unforeseen expenses. Unfortunately, many factors could put your house flipping project over budget. Materials could end up costing more than you estimated, or you could uncover structural or safety issues you hadn’t budgeted for.
• Delays. Keep in mind that your costs grow every day that you hold onto the property. Because of this, any snag in your timeline will ultimately decrease your profit. Building permits could be denied or delayed, materials could be backordered, or repair work could take longer than expected.
• Overestimating resale value. When you start a house flip, you’ll likely have a dollar amount in mind of what you want (or need) the home to sell for. But, if you overestimate that sales price, your house flip could prove barely profitable – or unprofitable altogether. Keep in mind that the market value of the home after renovations are complete will be based on more than just the amount of money that went into fixing it. Home values are influenced by a number of factors including the prices of similar homes in the area, the overall economy, and current interest rates. Just because you have a magic number in mind, doesn’t mean you’ll easily find a buyer willing to pay that price.
• Overestimating your skills. Do you have the time and personal abilities to see the house flipping process through to completion? One of the biggest risks involved with flipping a house is biting off more than you can chew. If you go into a house flip thinking that you can complete the required renovations on your own, your potential profit will be severely diminished if you end up having to outsource much of the work.
If you are still interested in house flipping after evaluating the costs and risks involved, you should begin to map out a plan for moving forward. This should be done before you commit any funds to the project. Here are some steps to take:
• Secure funding. Determine where the capital will come from to fund your house flip. If you don’t have the cash available to cover the costs involved, reach out to lenders to see what kind of financing you may qualify for. As discussed above, you should keep in mind that a traditional mortgage loan may not be the right fit for a house flipping project.
• Build a team. When hiring contractors, ensure they are experienced, reliable and can complete the project within the timeframe you need. Be sure you have a clear idea of who will handle what, and that you are all on the same page regarding deadlines, estimates, and goals.
• Plan for the worst. Ensure your plan includes a sufficient cash reserve for worst-case scenarios and emergency needs. For a first-time house flipper, this might involve pulling funds from your personal emergency fund until you can build up a dedicated reserve from your profits.
The reason most people get into house flipping is to make money and enhance their personal financial situation. Many people do it as a side hustle while still holding a full-time job, and for others, the goal might be to turn house flipping into a full-time gig. Unfortunately, not all house flipping projects are successful. A house flip could fail despite your best planning and efforts. Because of this, it’s extremely important to do your homework before moving forward with such a venture. Take time to evaluate what a failure would mean to your personal financial status and future. On the other hand, with the right resources, planning, and skills, house flipping could prove to be a profitable and rewarding investment.