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With the new year upon us, I think it’s time we shed some light on Flipping Houses! After all, isn’t that what everyone’s interested in? TV shows, infomercials, Instagram pics, and many more avenues are focusing on flipping houses these days. The number of people who tell me, “I want to flip a house” is astounding! They ask me: So what does it entail? How do the numbers work? How do I know what property to purchase? Where do I get the money? Well, I’m going to take a few minutes here today to give some brief insight into those questions and more! Let’s get started:
Knowing the Numbers:
If you’re going to Flip houses, Step 1 is obviously knowing how the numbers work! Most people think to start with the purchase price of the house they want to Flip. They buy it, fix it, then based on how much money they have in it, they determine how much they want to sell it for. Well, I’ve got news for you: If you do this, you will surely go broke….and fast!
What you need to do is work backwards. Let me repeat that. What you need to do is work backwards! If you don’t get anything else out of this article, remember this one statement: Know how much the house will sell for once renovated, and work backwards from there. This is the most important aspect of being successful. If you do not accurately know how much the house will sell for once completed, you will surely fail.
Here’s how it works:
A = ARV or After-Repair Value
B = Overhead & Profit
C = Construction Cost of Renovation
D = Price you can pay for the house at purchase.
So, your formula is: A (-) B (-) C (=) D
Example: You want to buy a house that your realtor says has an ARV of $300k. You estimate your Overhead to equal $34k, and you want to make a profit of $30k on the house, so B = $64,000. You then receive a proposal from a contractor to renovate the house for $72k.
$300,000 (-) $64,000 (-) $72,000 (=) $164,000.
So, $164,000 is the amount you can pay for the house. Do NOT, under any circumstance, pay more than $164,000 for the house.
Key Notes:
1.) Make sure not to miss any soft costs. Some things to consider include interest on money, closing costs both during purchase and sale, realtor fees, taxes, insurance, permits and construction plans when necessary.
2.) Include a contingency amount of 5-10% in your budget. There are ALWAYS unforeseen circumstances and things that pop up when you don’t expect them. Haven’t you watched the TV shows?!
3.) ALWAYS start with the ARV.
Surround Yourself with a Great Team:
Now that you have a basic understanding of the math formula for the houses, where do you go from here? Well, if you’re going to be in this business, you need a great team. If you think you know everything about everything, you’re wrong, and I have no problem telling you that. Even if you don’t think you know everything, but you want to save the money of paying an expert, you’re most likely wrong in that scenario as well! You need a realtor, a title agent, an accountant, (most likely) a contractor, and a slew of other people who can help you through the process. A realtor may cost you 3% of a sale, but how much money will you lose if you think the house will sell for $300k and it’s only worth $260k?! Let’s not be penny-wise and pound-foolish here. At the end of the day, knowledge is power, and you want to surround yourself with the most knowledgeable people possible. Even if you know absolutely nothing, but you have the most knowledgeable people around you, you have a decent shot at being successful.
Picking a Property to Flip:
A lot of people want to Flip the fancy house they see on the TV shows. The truth of the matter is, for starters, the “sweet spot” in the market place is probably where you should start. Take a look at the area where you want to Flip a house. What is the median home in that area? How many SF? How many bedrooms? What types of finishes? What price point?
Even today, when we Flip a house, our bread-and-butter is the median property in any zip code. In one zip code, it may be a $200k house, and in another zip code, it may be a $600k house. Either way, it’s most likely a 3 bedroom, 2 bathroom home, somewhere around 1500 – 2000 SF, and it has a yard. It’s got off-street parking, average to slightly above-average finishes and amenities, and we try to price it somewhere near the median priced home for the area once we renovate it. The key is to find properties that are in average or below average condition. Houses that need work are obviously where you will have an opportunity to profit.
The key to picking the right home is doing your homework. If you try to Flip a 2400 SF home and list it at $375k in a neighborhood where the surrounding homes are 1700 SF and $265k, you will likely have problems even if your home is beautiful and the Price per SF is the exact same. Before you buy, research what properties have sold in the highest quantities over the previous 180 days. What zip codes, what size, what price point, what amenities? Also look at days on market and see what’s selling the fastest. In general, starter homes and one level up from starter homes have the highest demand. Target the “sweet spot” and your success level will go up exponentially!
Finding Properties:
There are many strategies for finding properties, but really, you just need to get the word out. Tell every person you know that you buy houses. Have realtors look for properties on your behalf. Set searches that send you all the houses on the MLS that are in Fair or Poor condition. Look at FSBO or For Sale By Owner properties. Get foreclosure lists. Talk to banks about the REO or Real Estate Owned properties. Look on social media. Look in the newspaper (yes, people still use these). Put out signs. Build relationships with Wholesalers. A Wholesaler is a person who finds the houses in need of repairs and then transfers the right to purchase to an investor for a fee. They search the City for succession records, drive neighborhoods for blighted properties, have relationships with attorneys, etc. You want to be the first investor these guys and girls think of when they have a deal to pass on. Realistically, if you can’t find properties that fit your criteria, you can never Flip a house!
Making the Offer:
Now that you have a team in place, you know what you’re looking for, and you’ve found a house, how do you make the offer? Well, we’ll talk about financing later, but if you’re able to make cash offers, you are in a MUCH stronger position than most. You can do this with a line of credit from the bank or a private money loan. Cash offers with little-to-no contingencies are very desirable to sellers, especially banks. If you can put in a cash offer with a 10 day or less due diligence period (when possible no due-diligence period is ideal, as long as you feel safe with the offer), a good size deposit, and you can close quickly, you become much more desirable to the seller. If you can not give an all-cash offer, make sure your offer is accompanied by an approval letter from your lender, as well as a photocopy of your earnest money check. We’ve seen many instances where we were not the highest priced offer, but our terms were so much better than our competition that our offer was the one that was accepted.
Foreclosures or REO (these are bank owned) properties are obviously good targets. An important note to dealing with bank owned properties is that the decision maker is often-times out of state and has never seen the house themselves. They are relying on market data and a realtor to tell them what the value is. They often times do not know the deficiencies of this particular house. When you make the offer, it can be beneficial to include photos of problems with the house. Show the water damage, show the mold, show the bathroom faucet detached, show the soffit falling off, etc. Put a strong emphasis on safety issues such as roofing and electrical problems, as well as items that will continue to get worse the longer the house sits on the market.
Then, provide an all-cash offer with a fast close and a zero – to - seven day inspection period. If you have to have an inspection period, accompany the offer with a note that says “We’re taking all of the above into account already. Our price reflects the mold, soffit deficiencies (etc.). We’re only doing the inspection to check for unforeseen items that can’t be seen with the naked eye. Barring an unexpected discovery, our price will stand as is, and we will close quickly.” I recommend putting a cover letter on the offer. Include a “bad” picture of the house on the cover letter along with a note that says something along the lines of, “All Cash Offer, Close in 14 Days!!” When the decision maker sees this info, they are more likely to accept the offer than just receiving a number on a piece of paper.
Additionally, regardless of whether the seller is an entity or an individual, you often times will not get your offer accepted on the first try. Make a note on your calendar, and re-submit your offer every 30 - 60 days. Who knows what’s happened with the seller during the previous 30 days. Maybe the bank’s balance sheet has taken a hit and the decision-maker’s boss told them to unload properties ASAP. Maybe the homeowner has run into financial trouble and needs money now. Regardless, if you want the property, re-submit monthly until they tell you to leave them the hell alone!
*Want to know what to do with the house once you buy it, how to get the construction done, financing details and more? Stay tuned for Part 2 coming soon.*
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