This Cheat Sheet brings you up to speed in a hurry on house flipping basics and helps you clear the most common hurdles.
Finding houses to flip
The first step in the house-flipping process is the most crucial — finding a property with profit potential:
- Look for dontwanners in your neighborhood — vacant, unkempt homes the owners “don’t want.”
- Search on Auction.com.
- Read local foreclosure notices, available through your county’s sheriff’s office or register of deeds.
- Contact banks to find out about real estate owned (REO) properties.
- Network with probate, bankruptcy, and divorce attorneys.
- Search www.HudHomeStore.gov.
- Team up with a Realtor.
Making a profit when you buy a house to flip
When you invest in real estate, you make your profit when you buy a property, and you realize that profit when you sell it. The goal is to find a property you know you can sell for significantly more than it costs you to buy it, fix it up, and sell it. Here’s how you achieve that goal:
- Estimate the market value of the property after it’s all fixed up. Estimates are typically based on the market value of comparable properties in the same area that have sold recently, the asking prices of comparable homes currently listed in the area, and the direction the market is headed — whether property values are increasing or decreasing and how fast.
- Subtract your total estimated costs, which will probably include
- Purchase price
- Cost of repairs and renovations
- Any back taxes due on the property
- Holding costs (property taxes, utilities, insurance, interest payments, homeowner association fees, and so on for the time you expect it will take to buy, fix, and sell the house)
- Any agent commissions and closing costs when selling the house
- Decide whether your projected profit is worth it to you. Is it worth the time, effort, and risk?
Generally, when you’re first getting started, aim to earn at least a 20 percent profit after subtracting all costs. A 20 percent projected profit gives you a good buffer to protect against unexpected costs.
Financing your flips
Where do you find the money to finance your flips? Here are a few sources to consider:
- Your own savings
- Home equity loan or line of credit (on your current home)
- Bank loan (you’ll need cash for a down payment)
- Personal loans (from friends or family members)
- Government loan (if you’re buying from a government program)
- Hard money loans (from investors)
Whenever possible, use other people’s money (OPM) and put up the investment property as collateral to secure the loan. This approach gives you more leverage to invest in properties you otherwise couldn’t afford, and it helps to shield your assets (such as the home you live in and your retirement savings) from loss.
After you purchase a property, you may be able to finance the repairs and renovations by refinancing to pull the equity out of the property.
Start with a relatively easy project
When you’re just getting started, it’s best to pick an easy property to flip — a great house that’s cosmetically challenged. Then, make the following improvements (also referred to as white-boxing):
- Fix or replace whatever’s broken
- Clean everything thoroughly
- Repaint the interior walls, all white
- Install new wall-to-wall carpeting where it makes sense to carpet
- Replace all light switch and outlet covers
- Replace all register covers if they look worn
- Spruce up the landscaping
The idea is to freshen up the house to give it a nice, clean, manicured appearance. You want the house to be in “move-in condition” and up to market standards.
Don’t waste money over-improving a property — a common mistake. Invest only enough money to bring the property up to market standards. Investing $100,000 in a property where homes sell for $150,000 won’t make that property worth any more than $150,000. Homebuyers who are in the market for a half-million-dollar home will shop in areas where homes are selling for a half million dollars or more.
How to read a property listing with flipping in mind
A property listing typically contains a ton of details, all of which can be very helpful in your search for a flippable house. Some of these details, however, are more useful than others. Focus your search on the following golden nuggets:
- List price: Limit your search to listings of only those homes in your price range. Examine the list price and compare it to that of other comparable houses in the same area. An inordinately low price can signal a buying opportunity, or it can raise a red flag, making you (and others) wonder, “What’s wrong with this one?” As a house flipper, these are the properties you’re looking for.
- List date or time on the market: How long has the home been on the market? You typically find your best opportunities in homes that have recently been listed (in the past couple of days) or in homes that have been on the market for a couple of months. A home that’s not selling may be overpriced for the current market.
In many cases, the longer the seller holds out, the harder the home is to sell, and the more desperate the seller becomes. This cycle can signal a buying opportunity now or in the near future. Your agent can tell you the average time a home is on the market in any given neighborhood so you can properly gauge what’s considered “a long time.”
- Remarks: Near the bottom of every multiple listing service (MLS) listing is a Remarks or Property Description section that offers additional bits of information. Look for key terms, such as “sold as is,” “handyman’s special,” “in need of a little TLC,” or “needs work.” These phrases translate to “You’ll get the house for less because the current owner doesn’t want to clean, paint, or re-carpet.”
Agents may also be able to download the seller’s residential disclosure, which contains additional details on what works and what doesn’t, whether the property has ever had biological contaminates (such as mold), how old the roof is, and so forth.
10 common house-flipping blunders
Many eager, ill-informed investors become overenthusiastic about the big picture and lose sight of the critical details that can make or break a deal. They pay too much for a property, underestimate the cost of repairs and renovations, fail to inspect a property or research the title, or enter into contracts they don’t fully understand.
Check out these ten common house-flipping blunders to help you avoid costly mistakes and maximize your profits from the start.
Falling for a scam
Money attracts entrepreneurs, but it also attracts thieves. When you flip a house, you stand to earn tens of thousands of dollars on a single transaction. But being successful requires determination, diligence, and hard work ― don’t let anyone convince you otherwise. Don’t be a sucker. Be on guard for the following threats:
- Get-rich-quick schemes, cash-back-at-closing schemes, no-money-down deals, and anything else that sounds too good to be true
- Partnerships, especially those that require you to take on all the risk, supply most of the money, or do most of the work
- Anyone who offers to “take care of everything for you”
Speculating on the housing market
Like the stock market, the housing market has its ups and downs. In a hot market, investors often become infected with irrational exuberance — the belief that current appreciation rates are an accurate representation of future rates. They overpay for properties, expecting them to appreciate, and when the market flattens or takes a dive, they’re stuck with a property they need to sell at a price no buyer is willing to pay.
Don’t bank on double-digit increases in housing values, and be prepared with a Plan B, such as holding a property and leasing it out to tenants until the market recovers.
Waffling on an obviously good deal
Some investors experience paralysis by analysis: They overanalyze a great deal and can even talk themselves out of it, or else they waffle until another investor shows interest — and then it’s often too late.
When you see a good deal, act quickly. You don’t necessarily need to buy the property right away, but by making an offer on the property, you can tie it up for several days so that you can research the title and inspect the property.
Backing yourself into a contractual corner
Rarely do people hand you contracts to sign that protect your rights or interests. Instead, they hand you contracts that protect their rights and interests. Before you sign a contract or purchase agreement, read it carefully and make sure that it has a weasel clause — a legal back door through which you can make a graceful exit.
Failing to inspect the property before closing on it
Don’t rely on the seller’s claims and disclosures. The real estate community has a saying: “Buyers are liars, and sellers are worse, and sellers by owner eat their young.” Have the house inspected.
A city inspection is best because it provides you with an inspection team consisting of a professional plumber, an electrician, a heating and air-conditioning specialist, and a builder (for structural features). In some areas, however, city inspections are unavailable or are performed only on new construction; if that’s the case, have a trusted contractor inspect the property with you.
If you’re buying a house at a foreclosure sale, obtaining a thorough home inspection before handing over the cash may not be an option, but you should inspect the home yourself as thoroughly as possible. Drive by the house, inspect the outside, and do what you can to get inside to take a look around. The less you know about a property, the higher you should set your margin to cover unexpected costs.
Complete a final walk-through a half-hour before closing to make sure the house is still in the same condition as when you last saw it and that whatever you’re expecting to be included in the sale is still on the property. I’ve walked through homes before closing to discover that the seller took all the appliances when those items were supposed to remain in the house. Work to resolve any issues before you close — you have no recourse after that.
Assuming that the title is clear
Anyone can sell a property. Even people who don’t own a property can sell it. Some con artists wait until the owner takes an extended vacation. They move into the house, pose as the owner, print out a fake title, and sell it to an eager but clueless buyer. Sometimes, they sell the house to several buyers!
Another possibility is that a homeowner may try to sell you a house without telling you that the property has multiple liens against it. Unless you research the title and have the title company perform a title search, you can’t be sure the title is clear or even valid or that the person selling the house legally owns it. And, if you’re not 100 percent certain, don’t buy the property.
Underestimating the cost of repairs and renovations
Beginning investors often experience sticker shock when they hire contractors to perform repairs and renovations. Just make sure you have your sticker shock before you buy a property, not after you own it — when it’s too late to do anything about it.
For necessary repairs and renovations, you should have an accurate estimate of all costs before you buy a property. You can jot down notes while you’re inspecting it and then consult repair and renovation services to obtain estimates.
Doing shoddy work to save money
Sellers have all sorts of tactics to cover defects in a home. They may carpet over a floor that has extensive water or termite damage, pump out a septic tank that’s gone bad so that the toilets keep flushing for a couple more months, or install wood paneling in the basement to hide defects in the foundation.
As an investor who wants to remain in business, you should treat these tactics as taboo. Don’t sell your soul for a few thousand dollars.
Over-improving a property
Transforming a bungalow into the Taj Mahal may be a noble vision, but it ultimately lands you in the poorhouse. Know the housing market in your area, and routinely visit open houses to remain abreast of current trends and market demands. Gauge repairs and renovations to meet or slightly exceed what’s currently selling in your area. Your renovated home should be more appealing than comparable homes in the area, but not excessively more appealing.
Forgetting to pay the taxes
In the flurry of flipping, taxes are easy to overlook, especially property taxes. Forgetting to pay your taxes, however, can further complicate your flipping operation, and back taxes and penalties can take a big chunk of your future profits.
Set aside a certain percentage of your profit from each flip in a separate account, and pay your taxes out of that account. This separate account reduces the temptation to spend the money owed to the government. If you fall behind on taxes, catching up can be tough.
