Flipping homes has quickly become one of the most popular forms of short-term investment in the country. Maybe it’s all the reality shows on HGTV, the increase in opportunities since the recession, the possibility of making a tidy profit within months or a combination of all three. Either way, last year the number of house flippers hit a 10-year high .
The technical industry definition of a house flip is when a home is bought and sold within the first 12 months of ownership. Of course, that can happen without the intention of flipping. Here’s another way to define what house flipping is - when a home is bought with the express purpose of selling it within a year to make a profit, usually after improvements are made.
In other words, it’s an investment property that you never intend on living in or renting. The goal is to purchase a home below value then turn a profit by selling it at the true market value a short time later.
However, you should know there are a few things that house flipping is and isn’t:
It isn’t for the faint of heart - Despite what you see on TV, flipping is a large gamble and you have to play your hand right to realize a profit.
It ain’t easy - Flipping a house takes a lot of time, energy, effort, and money.
It’s best left to those who have experience owning and renovating - A true novice can try house flipping, but it’s a lot easier if you’ve already owned and renovated a home.
It’s a high-cost, short-term investment - There are hundreds of thousands of dollars involved with a house flipping investment and things move very quickly.
Keep reading to get a better feel for what it’s like to flip homes and whether it’s an investment you want to try.
House Flipping: Is it a Good Investment?
House flipping is a short-term investment that more and more people are making. On average, house flips brought in $65,500-$69,500 in gross profit during the first half of 2018. Of course, that’s the average not a guarantee for all house flips. Another thing to consider is that the profit margin for house flipping has shrunk slightly since there are less distressed homes up for grabs.
Even though the profits are getting a little tighter, in Q2 2018 flippers made a 44.3% gross return. Any investor will tell you that’s a very good number, but it doesn’t fully answer the question, is house flipping a good investment ?
Before cashing out your 401K and tapping into your life savings there are a few things to consider:
Are you in a good flipping location?
Remember the number one rule of real estate - location, location, location. Prime house flipping markets will have a selection of distressed homes for sale and buyer demand. If you’re in a seller’s market with low monthly inventory that’s a good sign.
What’s the potential gross profit margin?
Gross profit return only gauges what a home was bought and sold for. To get an accurate measure of profitability you need to calculate the gross profit margin: Sale price - acquisition cost - rehab/reno costs = gross profit margin. Most flippers shoot for a 30% gross profit margin.
Do you need to leverage funding for a flip?
Using a loan to fund a flip (for either the purchase or to cover the cost of renovations) is going to eat into your profit. You’ll have to factor in closing costs and interest rates as part of the acquisition expenses when estimating the gross profit margin.
As you can see, the answer to whether house flipping is a good investment doesn’t have a straightforward answer. You’ve got to do a lot of analysis for each individual house flip to determine profitability.
Flipping With and Without a Real Estate License
Do you need a real estate license to flip homes ? No, but it sure does make things a whole lot easier. And it can help your bottom line because part of the commission stays in your pocket.
If you’re a first-time flipper you probably don’t have a license yet, but it’s good to have someone on your side that does have one. The top reasons to have a real estate agent if you don’t have a license are:
- They can help you find homes to flip.
- Valuations are readily available.
- You can leverage their professional connections.
- Homes sold by real estate agents sell for 6% more than FSBOs.
- It provides added legal protections.
- Their services are free when you purchase a home.
Ultimately, many investors that decide to flip on a regular basis find that getting a real estate license makes the process more simple. That way you can access all of the information to do research and sales analysis on your own.
Funding a House Flip
How much money do you need to flip a house ? That all depends on how you purchase the house and how much work it needs. The costs vary for every home, but there are three expenses virtually every house flipper will pay:
- Acquisition Costs - This is the amount you pay to purchase the property, and it’s the first big factor in determining profitability.
- Taxes - Whether you make $1 or $100,000 on a house flip, Uncle Sam will collect short-term capital gain taxes. You may also owe state capital gains taxes depending on where you live (not where you flip). Property taxes will also have to be paid no matter what.
- Make-Ready Expenses - The cost of getting the house flip ready for market is the biggest budgeting variable. Typically, it’s a collection of dozens of expenses, some of which may be completely unexpected.
There are a number of other expenses involved with house flipping, which is why detailed budgeting before a purchase is a must.
You Can Get Funding for a House Flip, But Cash is King.
Today, around 40% of house flippers use some sort of funding for their investment. That number has been slowly increasing over the years, but cash is still king. When you have cash on hand for the purchase and renovations you can get a purchase handled quickly and for less money. You also don’t have to worry about credit score when you’re flipping with cash.
It is possible to invest in a house flip with no money of your own. However, interest rates and closing costs will lower your gross profit margin. Keep that in mind when you’re looking for a house to flip.
Market Matters: Is Your Market Good for House Flipping?
Is your market good for house flipping ? Like everything in real estate, house flipping is all about location, location, location. Some markets are flipping hotspots while others have cooled off. And just because there is a lot of flipping going on in a market that doesn’t mean it’s super profitable.
To figure out how good your market is for flipping, answer these five questions:
Are there opportunities to purchase distressed homes?
Distressed homes (those in foreclosure or bank-owned) are often sold well below market value. In some markets, there’s a healthy selection while others have almost no distressed homes for sale.
Is it a balanced, buyer’s or seller’s market?
In a seller’s market house flippers have the upper hand because demand exceeds supply.
Are labor costs reasonable?
The lower the labor costs are the higher the profit will be on a flip that needs work. Labor costs are rising, but location dictates how expensive it will be.
Is the area growing?
When there’s steady population and job growth demand for housing tends to be higher and home prices are appreciating.
Is there a lot of building in the works?
New home builders are direct competitors for house flippers. They too offer move-in ready homes, and a surge of new buildings can boost the inventory of a market. While new homes do tend to cost more and aren’t usually in the central areas of a city, they have appeal for many buyers.
A market with distressed homes (but not too many) in a seller’s market with low labor costs that’s growing without a lot of home building activity is a prime area for house flipping.
Home Renovations With the Best Return
When you flip houses renovations are almost always part of the deal. But which home renovations have the best return? Luckily Remodel Magazine publishes an annual report that answers the question. Real estate agents agree the following renovations tend to be the best investment:
- Replace the front door
- Replace the garage door
- Add a few coats of fresh paint
- Insulate the attic
- Use manufactured stone veneer
- Repair or replace the roof
- Do a minor kitchen remodel
Before you strap on a tool belt and start hiring contractors, there are a few things to keep in mind:
- Return for renovations varies by location. Some renovations are in higher demand in certain areas, which boosts the return.
- Mid-range renovations tend to have a higher return than upscale renos. In most neighborhoods, you won’t recoup the cost of going all out with high-end materials.
- Sweat equity really maximizes return. ... but only attempt renovations you can actually do.
- Return on renovations can be impacted by the surrounding homes. You’ll want to bring the home up to the level of the neighbors, which helps determine the renovations that will bring the best return.
- The right renovations can reduce time on the market. When your flip has the features buyers are looking for you better your chances of getting a quick offer and limiting the holding costs.
The most important thing is that you really understand your market. It will help you determine which renovations are worth the investment and which ones will just cut into your profit margin.
Common Rookie Flipper Mistakes You Don’t Have to Make
No flipper is going to be able to foresee every pitfall or make every perfect decision. It’s the reality and risk of being a house flipper. Here’s a quick hit list of common flipper mistakes that can eat into your gross profit.
- Over-improving the property. Don’t go overboard with the improvements or you’ll risk eating into your gross profit.
- Not knowing what local buyers want. Remember, you’re not flipping a house you’ll live in. It needs to be a home that appeals to an array of buyers.
- Forgoing the inspection. Saving a few hundred dollars isn’t worth not finding a surprise fix that costs thousands.
- Not running good comps before buying. You know to run comps to find a list price, but knowing the comps ahead of time can help you determine profitability and purchase price.
- Not analyzing sales activity in the area. It’s also important to know the average days on market, renter versus owner ratio and foreclosure rate for the area.
- Ignoring the backyard. Jazzing up the curb appeal is a given, but don’t forget to clean up the backyard if you want top dollar.
- Trying to do it all on your own. DIYing can save you money - or it can cost you a lot of money. Know your limitations and get help when you need it.
- Forgetting about the taxes. Taxes are one of those things that are inevitable in life, especially when you’re flipping houses.
- Ignoring zoning regulations and permits. Deciding to ignore the city regulations can be a very bad, costly decision.
- Not enlisting the help of a real estate agent. This is one expert that makes house flipping a whole lot easier.
There are plenty of other mistakes that can be made, which is why having an experienced real estate agent is highly beneficial when you’re new to house flipping. It won’t guarantee that you’ll make all the right moves, but a knowledgeable agent can help you avoid a lot of the rookie mistakes.
Worried about the cost of working with a real estate agent? Don’t be. Having a buyer’s agent won’t cost you a penny (the seller covers the commission), and homes sold by a real estate agent sell for more than FSBOs (see the Flipping With and Without a Real Estate License section).