Profit on Flips: Key Ingredients to Real Estate Investing Success
We’ve all seen at least one of those flipping shows on TV. You know the one that has the cute host that buys a run-down property, makes a really expensive mistake and still manages to make a six figure profit. I hate to be the one to break it to you but that rarely happens. Flipping a house usually takes longer, costs more money, and generates far less profit than seen on TV. Nevertheless, flipping houses is a great way to generate a return on your investment. Here’s how to profit on flips:
1. Correctly Value the Property to Flip
This can’t be stressed enough. You make your money when you buy the property. You must identify the as-repaired value of the property before you make your offer. The best way to determine the as-repaired value is with the use of sold comparable properties (comps). Ideally the comps that you use to determine value will be the same age, the square footage will be within 200 SF, the same number of bedrooms and bathrooms, and the lot size will be very close. Also, the comps should have sold within the last 90 days, be within a quarter of a mile and in the same neighborhood/school district as the property you are evaluating.
The only reliable source of market value is the actual sold price of comparable properties. Values from a real estate site estimate, the wholesaler’s spread sheet, the tax assessor’s appraised value or the list price of other houses on the market are not reliable sources of property value.
2. Have an Accurate Construction Estimate and Add a Contingency
Create or obtain a complete estimate of your construction costs, make sure that you include permits, labor, materials, and taxes if applicable. Also, make sure you have included clean-up costs in your estimate. For instance, roofers commonly include the hauling off of old shingles in their tear-off budget but the drywall crew almost never includes the disposal of sheet rock scraps and debris.
Also make sure you include an adequate contingency 5 to 10% if your budget is based on actual estimates from your crew and up to 20% if you are using a rule of thumb or calculator.
3. Don’t Forget Soft Costs
What are soft costs? Soft costs are all of the expenses associated with the purchase, holding and selling the property. These include all of the costs of financing, the closing costs to purchase the property, insurance, utility bills, security costs, interest and loan payments, property taxes, selling expenses and closing costs to sell the property. Make sure you estimate an adequate number of months of holding costs, remember to include the number of days it will take to market and sell the property as well as the time it will take to close the sale. It can take as long as 45 to 60 days from the time you sign the contract to sell the property and the closing of the sale. Other soft costs that are often overlooked are the appraisal, survey, staging and marketing expenses and a home-owner’s warranty for the new owner.
4. Profit on Flips
There is no reason to do all of this work without earning a profit.
Once you have determined the as-repaired value for the property, subtract your construction estimate with contingency, the soft costs and your desired profit. This number is the most you can pay for the property. At this point you will probably bargain with yourself. You will tell yourself that your construction budget is too high, your timeline too long or your ARV is too low. Don’t do it, I know you really want this house but if you start fudging your numbers now you will not make any money. It is only when you buy properties for the right price that you ensure that you will make a profit on flips in the end.
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