Financial Literacy for Everyone

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April 7, 2017

Flipping a house can seem like a walk in the park when it's wrapped into a few montages during a half-hour TV segment. Find a run-down property. Buy it. Take out a few walls, paint, replace carpets, upgrade the kitchen and voilà – you could make tens of thousands of dollars in just a short time. Reality is seldom so straightforward. Flipping a home can be risky, and there's no guarantee you'll profit.

Flipping Houses — It's Not Like TV

Finding and buying the right house at the right price point can be difficult. The shows often start with the submission of a winning offer on a home. You may not realize that it takes a lot of work to determine what a potentially good flip looks like and find a property to match.

Experienced flippers have learned how to estimate costs and work backward. A rule of thumb in the industry is to take 70 percent of the potential selling price (what's known as the after-repair value, or ARV), subtract the renovation costs and use that as the maximum buying price.

You'll need a lot of background information, including comparable selling prices of similar homes, to figure out the right numbers. The ability to be honest with yourself while estimating the cost of parts and labor is also important.

For example, if you estimate that you could sell your renovated home for $200,000, you'd start at $140,000 (70 percent of a $200,000). If you calculate that the renovation costs will be $40,000, you'll arrive at the maximum buying price of $100,000. The 30 percent margin that remains if everything goes according to plan isn't entirely profit; you may still have expenses like closing costs or reimbursing your investors.

You need a lot of working capital. While paying cash for a home can expedite the sale and increase profits, it might not be an option for beginner flippers. However, traditional lenders don't necessarily offer financing for flips, especially if you're trying to fix up a dilapidated home. Even when they do, you might not be able to borrow enough to cover all your expenses.

Instead, some flippers turn to hard-money lenders, private individuals or companies that issue short-term loans backed by real assets (such as the home you're buying). With either traditional or hard-money lenders, expect the financing costs to be higher than what you'd pay for a mortgage if you're buying a home to live in.

Keeping an eye on your total budget is essential. If you borrow enough money to make the purchase but don't have cash on hand to pay for the renovations and unexpected contingencies, you'll be stuck before you even start.

In addition to the purchase price, you'll need money for renovations, upgrades, inspections and permits. Also, consider the cost of ownership between the purchase and sale. Carrying costs, including utilities, financing, insurance and property maintenance, can add up each month.

You want to move fast. One thing you pick up from TV is that time is of the essence. In competitive markets, you'll need to move quickly to evaluate a home and put in an offer before someone else buys it.

Successful flippers may have a real estate license or work with a real estate agent to get access to the multiple listing service (MLS), a directory of homes that are for sale. Others look for homes that are for sale by owner (FSBO) or use direct mail campaigns to reach out to prospective sellers.

Once you buy the home, there's another race against time to complete the work and make a sale. Working with a trusted contractor and real estate attorney could expedite the project. Once you've developed a strong working relationship, you may even want to invite others to join your team and contribute their work in exchange for a cut of the profits.

Bottom line: Flipping homes can be profitable, particularly for those who have professional real estate experience, but don't expect it to be easy money. Months of hard work can go into a flip without any guarantee of success.

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This article is intended to provide general information and should not be considered health, legal, tax or financial advice. It's always a good idea to consult a tax or financial advisor for specific information on how certain laws apply to your situation and about your individual financial situation.

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