There are tons of TV shows, YouTube channels and articles that make it seem like the fix-and-flip model of real estate investing is really simple and straightforward. However, it’s not as easy as it looks and there is more than meets the eye. There are tons of mistakes that new investors make that could easily be avoided with a little bit of education and coaching on the front end.
If you’re thinking about getting into fix and flip real estate investing, we encourage you to do some research and learn from people who have been doing it for a while. There’s no sense in reinventing the wheel when there are tons of resources available to you to help and keep you on the right track from the very beginning. In this article, we are going to break down some of the key mistakes that new investors make and how to avoid them.
This type of investing involves an investing purchasing a property not to keep or use, but to turn around and sell for a profit as quickly as possible. Most fix and flip scenarios involve some level of cosmetic enhancements, renovations or improvements that are done to the home prior to putting it back on the market to sell. It’s a really great way to turn quick profits if you do it well.
According to ATTOM Data solutions, 6.2% of all home sales in the United States in 2019 were house flips completed by fix and flip investors. That’s approximately 250,000 homes and an average of $62,000 gross profit on each. The key here is “gross” profit. Notice it didn’t say “net”.
What’s important to understand about flipping houses is that once you close on the property, the quicker you can turn it around, the better. For this reason, flippers are often attracted to foreclosures, short sales and other such situations that allow for a quick turnaround. But you also have to be really careful to balance the attractiveness of a quick turnaround with the amount of money and work it could take to get it ready to put back on the market.
Let’s dive into some of the mistakes that new investors make and how to avoid them. The more you know on the front end, the better off you’ll be!
This is a lesson that is often learned the hard way amongst new investors. Just because you can get a house for a really cheap price doesn’t mean it’s worth it. There could be very good reasons why it’s priced so low and taking it on is not always a wise decision.
Doing your homework on the neighborhood, the housing market and current conditions can save you thousands in the long run. It takes a little bit more effort in the beginning, but can be a total game changer. There are lots of resources, websites, mobile apps, etc. to help you make sound decisions during the buying process, so be sure to look into those, as well.
There is a rule called the “70% Rule” that we highly recommend you consider when researching your properties. It simply states that you shouldn’t purchase the home for more than 70% of what it will be worth AFTER the renovations or the AVR (after repair value). In order to adhere to this rule, you have to know what the house will actually be worth and approximately how much it will cost you to do the renovations that need to be done.
Ideally, you want to be able to purchase the homes in cash to avoid paying any financing fees, interest, etc. However, most investors who are just getting started don’t have access to that kind of cash right out of the gate. Making smart decisions in your financing will be a major game changer for you in the end.
There are tons of vendors out there offering “no money down” and “low money down” options, but they are often touted by fly-by-night companies, rather than legitimate lenders. Don’t get caught in that trap because you are much more likely to lose money in the end, rather than making any. Additionally, if you are financing not only the property but also the acquisition of the property, you will be paying interest on that money, too. Remember that every dollar counts.
Research all of your lending options and ask lots of questions in the process. You want to find a lender you can trust who can provide a mortgage product that works for you. Look for low interest rates, low closing costs and minimal fees.
Then you need to consider how long it’s going to take you to turn the property around and get it back on the market and sold. Since you’ll be paying the mortgage while you’re renovating it, you need to consider those costs in your calculations. Again, every dollar counts.
If you finance your investment property, you’ll be paying a mortgage payment and interest for every month that you own the property. This means that time is money – literally. Making good use of the time and being efficient with renovation plans is critical.
We recommend a few different techniques in this scenario.
Many new investors are still working a full-time job because they have not yet built their investment portfolio to the point that they can quit their 9-to-5. If this is you, try to be realistic about how much time you can dedicate to the work that needs to be done. Do you have a spouse at home? Kids? School? All of these things can contribute to distractions that will keep you from being able to complete the work in a timely manner. It’s not a bad thing, but rather just something to think about.
If you’re in a really great place financially, this might be a good option for you, but for most fix and flip investors, particularly new ones, the real profits come from doing the work yourself. We call this sweat equity. If you’re able to purchase the home, do the majority of the work yourself and in a timely manner, your profits will increase exponentially. The cost of contracting the work to someone else might be so high that it eats up any profit you would have made.
There are many fix and flip investors who are contractors, builders, carpenters and other craftsmen for full-time work and do the investing as a part-time or seasonal gig on the side. These investors generally have the skills and knowledge to be able to complete the work quickly and efficiently, which allows them to turn better profits on their investments.
If you’re not handy with a tool box, you might want to consider whether or not the investment in the property and the contractors will be more than the profits earned after the resale. If the profits will be marginal at best, it might not be a great option for you. Instead, you could consider partnering with someone who is able to do the work, or opt for a different type of real estate investing.
If you ARE someone who is handy with a hammer and enjoys doing the construction yourself, it can be really easy to over-do it. When you’re passionate about home improvement and renovations, you can get carried away with all of the possibilities of the property. Try to restrict renovations to only the necessities.
This goes back to doing your research and knowing your market. Although it would be awesome to renovate the kitchen, all the bathrooms, knock down some walls, etc., is it really a smart decision? In some cases, the answer might be yes. But more often than not, the answer is likely no. If you purchase a house for $80,000 in a neighborhood where houses sell for about $120-130K, it doesn’t make sense to dump $50,000 into it. You’re not going to sell it at a price that is high enough to overcome your renovation costs.
Instead, think about what is absolutely necessary to make the home as attractive as possible to the current buyers who are purchasing homes in that area. Make those improvements as quickly and efficiently as possible and get the house back on the market. Also, don’t underestimate the power of a really good deep cleaning job, fresh paint and great landscaping. Curb appeal is more important than you think, so don’t forget about it.
There are many resources available in the market to help you figure out what your return on investment (ROI) is going to be on any given property, based on sales price, finance fees, renovation costs and resale. A good rule of thumb is to shoot for an ROI of 20-30%. This gives you some wiggle room in case something goes wrong. If there is a major issue during the renovation, you have more financial cushion before you end up losing money. The best rule is: don’t lose money!
Buying an investment property and doing the work to get it ready for resale can be a really exciting time. But many novice investors are too eager to get started and just jump at the first house they see, without doing their research or considering any of the other things we’ve talked about thus far. Although your knee-jerk reaction might be to dive in head-first, try to rationalize your decisions and be patient.
Do your research on the different areas of town in which you’re interested in purchasing an investment property. Then be patient and wait for the right deal. I’m not saying sit at home and wait for it to fall in your lap, but I AM saying that you need to weigh the pros and cons of each potential investment that you look at. If something seems off, or it’s not quite the right deal, let it go and wait for the right one.
This goes for contractors, as well. Hopefully, you are able to do the majority of the work yourself. If you find yourself needing to sub-contract some of the work, again, patience is a virtue. A good rule of thumb is to get three quotes from three different vendors before making a decision. Many new investors jump at the first bid and hire that contractor, not knowing whether or not it’s a good deal and whether or not that contractor is any good.
Fix and flip real estate investing is a great way to turn a quick profit for a savvy investor. If you have the skills to do the renovations yourself and the time to get them done quickly, this might be a perfect investing option for you. Just make sure you don’t make the mistakes we’ve discussed in this article.
The reason that most people invest in real estate is to make money. When you’re just getting started in the industry, you will make a lot more money if you pay attention to the deals, be patient and do your homework. If can be an incredibly lucrative side hustle or primary job if you do it well and avoid the major pitfalls that most new investors run into.
Charles Carillo is the founder and managing partner of Harborside Partners. He has invested in over $25 million worth of real estate, in several states, and has extensive knowledge in renovating and repositioning multifamily and commercial real estate. Charles holds a BS from the Connecticut State University.