When you tell most people that you are a “real estate investor”, they probably reply something to the effect of “oh, you flip houses?”. Whether or not this assumption is true in your case, the fact remains that one of the most popular forms of real estate investment is house “flipping”. Flipping is a term used to describe the process of purchasing a property, putting some money, or some work into it, and quickly turning around and selling the house or the land for a premium. The term “flip” is used to describe the fast turnaround time of repairing and selling right away.
As we discussed above, “Flipping” is a term used to describe the process of purchasing a real estate investment with the goal of turning it around quickly and selling it for a profit. Typically, this process involves investing some money, and work into the property to help increase its value and the chance that it sells for a profit quickly. This style of investing is attractive for many reasons, these projects can be very enjoyable for those who are interested in the work of fixing up or making a property more aesthetically pleasing. The most common motivation for flipping a property is profit, and how quickly profits can add up. A seasoned investor with resources on hand can routinely clear tens of thousands or more per “deal” done. (A “deal” is a slang term for a property investment project). The name of the game in flipping is speed, and so profits can be realized very quickly. Like anything else, high potential reward can also mean a high potential loss if something goes wrong on your project. The purpose of this guide is to help clear some of those hurdles out of the way by highlighting key terminology, common pitfalls, and what to look for when getting into flipping.
So why flipping? Of all the different ways that investors can leverage real estate as an investment tool, why do investors select flipping over more common buy and rent or commercial property deals? The answer is simple, flipping is fast paced and offers a high potential of profits. Rather than owning a large portfolio of properties, each requiring a manager as well as a list of services and maintenance requirements, flipping allows investors to turn over their portfolio quickly and leave the ongoing maintenance to someone else. A flipper can purchase a home, fix it up for a month and immediately sell.
There are many advantageous aspects of this quick turnover flipping strategy, at the top of the list is low ongoing costs, as well as maintenance requirements, but flipping also allows investors to do many more deals in any period of time than other types of investing. Flippers also enjoy immediate lump sum profits. Where a landlord has ongoing payments and therefore small, steady profits over time, a flipper makes all his or her money all at once. They can purchase a property in the beginning of the summer for fifty thousand dollars and sell in august for seventy-five. When everything is said and done, our investor keeps whatever is left over after all closing and administrative costs. This results in tens of thousands, sometimes hundreds of thousands of dollars in profit being made all in one swing.
This allows an investor to quickly turn one hundred thousand dollars into much more money very quickly assuming everything goes well. Of course, that is not an assumption that investors can always make. As mentioned, any time there are potential high rewards, investors should expect an equal chance for financial loss. There are many factors that can quickly turn a great investment flip project into a drawn out and costly mistake.
One of the highest risks that a flip investor faces is the inability to sell a property for a profit after investing money in rehabilitating the property. Remember that each month an investor fails to sell, he or she is responsible for paying all costs of upkeeping and maintaining both the property, and the debt service on that property. Three months of interest, electricity, gas, other utilities, on top of any other cosmetic or structural work that an investor is paying for can really add up and chip away at any profit an investor may see. This market risk is one that should not be overlooked and can be very difficult to quantify and get down on paper.
For example, imagine an investor who purchases a townhome in a city that’s home to a large employer that brings many people to the community. A flipper identifies a property near the company’s headquarters, that will require just a few thousand dollars to fix up and get ready to sell. The investor, after looking into the numbers, identifies an opportunity to make around fifteen or twenty thousand dollars by selling the renovated property to an employee of this large firm.
The flip goes well, and after closing the needed work is done quickly and effectively, the property is in great shape and should sell quickly. Two weeks before the house is on the market, this large company announces layoffs at the local headquarters, and will be shifting its operations to other parts of the country. Nearly overnight, the value of this home has plummeted. With less and less employees in the area, demand for the home falls and what once was a property worth one hundred thousand dollars, an investor may have to settle for seventy. Instead of netting a cool fifteen thousand, our investor takes a multi-thousand-dollar bath for all the hard work they put into the project.
In this example, the investor did everything correctly and saw their investment derailed by something totally outside of their control. This market risk is built into flip investing and should give investors pause. It is critical to understand the economy and unique qualities of any area where a flip is being considered. While a buy, hold, and rent investor can stand to watch their properties value fluctuate over time, a flip investor is beholden to the local market as well as the timing that can come into play in relation to home prices in the area. For this reason, many flippers elect to invest close to home, or at least in an area where they understand local economic trends in real estate pricing.
One of the other disadvantages of this strategy is the capital that is required to flip. An investor looking to flip will need to have cash on hand, or an ability to secure financing frequently throughout the year. While they plan to have all their cash back sooner rather than later, putting in multiple offers requires an investor to have an ability to drum up funding at a moment’s notice.
When it comes to selecting flip properties, there are many schools of thought. It’s best for new investors to spend time reading and educating themselves on investing and the different strategies involved with investing in certain property types. An investor who understands small single-family properties in one area will have a very different process for screening potential deals than an investor who specializes in commercial buildings. Very simply, an investor should be on the lookout for properties available in up and coming areas, understanding the local market.
In the example above the investor was seeking to invest in property near a large employer in the area. In this scenario, an investor will want to understand what do employees of this firm do for fun? Where do they shop? Are they family-oriented buyers or are they young professionals? Understanding who and how you plan to target your investment will allow you to narrow down potential properties. Families will be looking for larger homes with good schools and access to recreational events. Young professionals might like smaller more urban properties walking distance from local entertainment or nightlife.
When selecting property types, or locations, this is where investors get to have some autonomy. What do you enjoy? What are you good at? Do you enjoy skiing? Maybe condos near mountains in the northeast is your target? As someone who understands the culture of skiing, you will be in a much better position to understand what buyers will be looking for when it comes to buying a ski condo. So, find what works for you, it will make investing more fun and enjoyable, and will help you in sifting through all the available deals in your area.
When it comes to searching for homes, many online sites such as Zillow will provide you with a comprehensive database of properties available in a specific area. This will give you a starting point for your research and will give you a general idea of local pricing, competition, and what buyers in an area are looking for. Keep in mind that while these tools do come with lots of information available, the information is not always completely accurate and so it is best to use these sites as a research tool in tandem with many other methods of evaluating your deal. Go see the property in person and bring a friend in real estate or who is a home inspector.
Look for structural damage, look for water, and keep an eye on the age of certain features on the home. Hot water heaters, roofs, plumbing, and mostly any other component in your property have a shelf life. Be careful not to buy into a property that will need to be completely updated to get ready to sell. A tip for investors looking to own in certain parts of the country, buy in the spring. When snow is melting and everything is wet, you’ll get a better idea of how the property responds to water and other natural elements. Make sure you understand how the utilities on the property work. Is the heating electric? Gas? Do you have baseboard heat? Maybe the home has central air?
All these factors should align with your ideal buyer and should match up with what that type of buyer is looking for. Once you have a solid idea of the tangible aspects of the property and have discussed them with a professional, you can begin to look at financial modeling. This step of the process is more complex and probably could have an entire guide dedicated to it. There are many free resources available online offering templates for excel worksheets designed to evaluate potential deals based on the numbers.
At this stage, you will compile all your research into the location, market, timing, features of the home, and psychology of local buyers and start to assign numerical values to these things. You will never be able to perfectly map out how cash flow will work within a real estate deal, but you can get surprisingly close. You should have an idea of cost of the property, and the kinds of work, if any, that needs to be done. Get quotes from local builders and add those into your financial model. In creating the best possible chances for success, it is important to build in unforeseen costs. Plan for the sale to take 20% longer than you anticipate. Plan for a drop-in market value, the more fail safes you build into your numbers, the more likely your chance of either experiencing a positive outcome or identifying a possible landmine before you buy.
Once you have looked at both the tangible and intangible aspects of your potential deal, bring it to a professional. Many real estate professionals would be more than happy to help you identify anything you may have overlooked, and you’ll need to find a real estate agent anyways to complete a successful sale. Contact a mortgage underwriter and get an idea of how you will be financing the property. Once you have your research, the backing of a few professionals, and with a little luck, you should be on your way to a successful flip.
While this is an exiting step for many investors, it is important to restate the risks associated with the flip strategy. You absolutely could potentially lose thousands of dollars, when a deal goes south, you as the investor are squarely responsible and you can lose out. There are few guarantees in investing and real estate is no exception. Exiting and high reward strategies have an equal ability to lose out. Being cautious and doing your due diligence is key to shielding yourself from these losses.
Potential for loss aside, most investors who do their homework should find a decently straight forward path to profits. As you become more comfortable with your specific process and become more adept at identifying “good” deals, you should see a commensurate rise in the profitability of your projects. This is the goal of flip investors, work on your own schedule, on something your passionate about, and make a lot while doing it! If that all sounds good to you, then you may be a flipper! Just make sure to do your research before diving in. To learn more about investing in real estate, and to get into more detailed guides, click here to subscribe to our weekly newsletter.