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  • Writer's pictureJeffrey Lahasky

The Nuts and Bolts of Flipping Houses: Part 2


Now that you’ve read Part 1 and have a basic understanding of how the numbers work, picking your team, finding and picking properties, and details of making an offer, where do you go from here?


Condition of the House & What to Do with It:


Obviously, if a home is in perfect condition, there’s not much of an opportunity to renovate. Currently, we target the worst possible houses. If they’re about to collapse, all the better! However, that’s not where we started. Three bedroom, two bathroom homes that were in decent overall condition but were dated and had separate kitchen / living areas were where we started. Converting a 2-bedroom home to a 3-bedroom home, making the Master Bathroom an on-suite Master Bath, and converting the house to an open floor plan are huge value-adds. You want to install new flooring, paint the house, renovate the kitchen and bathrooms, install new light fixtures and plumbing fixtures throughout, remove the wall separating the kitchen from the living room in order to give the home an open floor plan, spruce up the exterior with paint and landscaping, verify the roof and foundation are in good shape, confirm your electrical and mechanical systems are in good working order, and voila! You’re ready to list for sale!


Once again, look at what’s selling in your area. Take note of unique characteristics that are helping homes to sell faster. The key is to appeal to the masses. Do a unique upgrade here or there for a “pop,” and to separate your house from the others, but at the same time, make sure your color schemes, kitchen styles, etc. will appeal to the masses. Today, white shaker cabinets and light grey walls with white trim are selling the fastest. When we started, cherry oak cabinets and tan walls were selling the fastest. Know what appeals to the masses and duplicate it with small touches of above-average, eye catching details.


At the end of the day, people love a move-in-ready home. If it’s up to date, the floor plan flows well, it’s aesthetically pleasing, priced fairly, and they don’t have to do anything but move in their furniture, the chancing of selling is very high!


How to Get the Construction Work Done:


More than likely, what work to do is up to you. You’ll need to determine the scope of work, what fixtures to purchase, what flooring to purchase, if you need stainless or black appliances, is it worth it to expand the size of the Master Suite, and a slew of other questions. However, you may or may not be an expert at construction. What you definitely need from day one is either someone to help you estimate repair costs or have a basic knowledge of costs yourself. You may not need to know everything, but you should have estimates such as painting is $2.00- $3.00 / SF, flooring removal and replacement is $5-7 / SF, a new kitchen is $7-9k, a new bathroom is $3,500 - $4,000, moving a wall may cost $1200, a lighting package may cost $1,800, etc. These numbers will alter based on your location and level of finishes, but it’s important for you to know them for your market. These simple numbers alone can give you a ballpark of where you stand after viewing a home, and you can determine if it’s worth evaluating further.


Some people do the renovations themselves, some contract the work out to sub-contractors themselves, and some simply hire a General Contractor (GC), and let them handle the construction. Generally, when you first start, you do a lot of the work yourself, or you at least oversee each individual trade yourself. The key is to do the work the right way while staying on budget. As you increase the quantity of projects you undertake at one time, it’s definitely beneficial to have a construction specialist as a partner. If you are not a construction specialist yourself (likely, a licensed GC), most people just hire a GC.


What we do is different from most. We’ve decided that the best way to scale the business is to partner with our contractors. In other words, we sign Joint Venture agreements with our contractors. We purchase the house in our LLC, finance the deal, and the construction partner obviously handles the construction. The difference is that the GC does not charge a markup on construction for profit. We are in the deal as partners, not as clients. When the house sells for a profit, we get a percentage of the profit and our GC gets a percentage of the profit. The downside to this scenario is that if the project does very well financially, we’ll likely give up a bigger chunk of our profits. The benefit, however, is that you have a partner who knows construction, who is on your side, and who understands that the better the house looks, the faster it is built, and the cheaper it is built, the more money they make. In this scenario, you can spend more of your time looking for future deals, as opposed to worrying about if the painter shows up to the house on time that day.


This may not work for everyone, but for us, it has been a win-win scenario that has been very lucrative for all parties involved and has yielded not only strong business partnerships but strong personal friendships as well.


Financing:


So where does the money come from? Realistically, this is up to you and depends on your current situation. The bottom line is that you have to get started, and you can’t get started without money. Obviously, it is possible to get a loan for 100% of your costs, but it is not very likely, and it is probably expensive.


One thing to take note of are additional lender fees outside of just the interest rate. Pay close attention to how many “Points” are associated with the loan. Points are basically a percentage of the overall loan that you’ll have to pay up front. One Point generally equals 1% of the total loan value. So, depending on how long you need the loan for, as well as other factors to consider, a $300k loan at 7% interest and 3 Points, may be a worse deal than a loan at 9% interest but only ½ a Point. Do the math for your particular deal, and figure out what’s best for you.


Your LTV or Loan-to-Value is an important phrase to know here as well. This represents the amount of the ARV (After-Repair-Value) discussed above that a lender is willing to lend you. So, if your ARV is $300k, and the lender has a 70% LTV requirement, this means that the lender will not lend you more than $210k. Or, the lender may have a LTC or Loan-to-Cost ratio of 70%, which means that even though the ARV is $300k, if you’re in the deal for $240k, they will not loan you more than 70% of $240k, which is obviously $168k.


In general, the riskier the deal and/or the less experience you have, the more expensive the money will be to borrow. Conversely, the lower the LTV you need, the cheaper the money will be to borrow. You’ll be in the best position if you can at least put up a portion of the funds yourself. People want to work with people who have “skin in the game.” If you can’t do that, you need to partner with someone who brings value to the table, whether it be construction knowledge, a background in real estate investments, and / or the ability to obtain loans from a bank. Nine times out of ten, bank loans are the cheapest. If you can’t get a bank loan, or if you can get a bank loan for part of the money, you’ll need a Private Loan or Hard Money lender to fund the remainder. The money may be more expensive, but they can provide you with the cash you need to get in the game!


At the end of the day, it’s OK to make much less money at the beginning in order to build credibility and knowledge. However, we recommend doing it by giving up equity as opposed to guaranteeing extremely high interest rates or guaranteed profits. If you guarantee a lender a certain amount of money, and your project doesn’t make as much as you expected, the lender could walk away with a pretty pay-day, while you’re left with a loss!


Risk vs. Reward:


There are many different business strategies to be found. If you talk to 10 different real estate experts, you may find 10 different strategies. In our opinion, the key is to balance risk and reward. The house that needs only carpet and paint and yields a $15k profit in the most desirable neighborhood in town, may be a better bet than the falling-down house in the rough area of town that could yield $30k. If your expenses are higher than you thought, or you can’t sell the house because of the crime in the area, you could be looking at a $30k loss instead of a $30k gain.


When you look at our advice for financing, the JV partnerships we do with our construction partners, and the types and price points of the houses we usually Flip, you can see that we air on the side of caution. At the end of the day, you can’t lose money you didn’t invest. While you have to get started if you want to make money, I’ve never lost a dollar I didn’t risk! Keep this in mind, and remember, it’s better to make less money, be less greedy, and sleep better at night, than the opposite.


Additionally, always protect yourself from loss as best you can. Obtain flood insurance when possible, and always obtain Builder’s Risk Insurance on every project. This is insurance which covers the house during construction. Personally, I’d rather spend $1,000 on a policy I didn’t need than lose $250k if the house burns to the ground! A bonus tidbit of information is to make sure your policy has demolition coverage whenever you are moving any walls. Builder’s Risk Insurance policies are notorious for excluding demolition, and if you go to move a wall and the roof collapses, well, let’s just say you’re Sh*t out of luck!.


Lastly, create an LLC before purchasing a single property. All properties should be purchased and owned by an incorporated entity in order to protect yourself personally. I don’t think your husband or wife will be very happy if you get sued and have to give up the house you live in because you skimped $250 on creating an LLC. It’s always better to be safe than sorry!


Closing:


As you can see, this business is not rocket-science. With that being said, it is certainly not risk free either. Problems do arise, and they probably arise more often than not. We’ve had a house where a murder has taken place just doors away, and we couldn’t sell the house. We’ve had a house where we built a gorgeous circle driveway which everyone loved, only to find out that the City would not approve it, and they made us tear it up and remove it. We’ve had a property where the flood zone changed and our bank forced new insurance on us for $12,000 when our original policy was only $1,200! We’ve had a house where the cabinet company closed their doors, loaded their inventory on an 18-wheeler, and took our cabinets, along with our $7,000 payment, with them to California where they were never-to-be seen again!


If you think this business is all peaches and cream, and you’re going to sit back and make a fortune, you’ve got another thing coming! But, if you’re willing to put in the hard work, surround yourself with the right people, operate in a conservative manner, and be smart with your decisions, there’s a real chance of making money flipping houses.


Be smart, be calculated, and don’t get greedy. And remember, you don’t have to be a full-time house flipper to get involved either. You may have financial capital and want to lend money to a company that does investments themselves. You may want to be a Wholesaler yourself and find the deals for the investment company. Or, you may be a contractor who wants to do JV partnerships with the investment company. Either way, if you want to make money in this business or in any other, you’ve got to find a way to get started. Inside the gutted wall of the first house I ever Flipped, I found a sign that still hangs in my home office to this day. The sign reads: “THERE ARE THREE KINDS OF PEOPLE: Those Who Make Things Happen, Those Who Watch Things Happen, And Those Who Wonder What Happened.” I know darn-well what kind of person I want to be! Do you???




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