Flippin' Homes (part 1)

In this series we dive into the process of buying a property, improving it, and selling it for more money, or as it's commonly referred to, Flipping.

This is probably something you've heard of and are vaguely familiar with in concept, but you might be in the dark as to how to do it or if you can do it, and so it's probably terrifying to you.  Of course maybe you have done some flipping yourself, or are at least pretty knowledgeable about the whole process, and maybe this will provide some insight.

When we talk about flipping homes, we mean either the fast flip or the slow flip. The fast flip is more popular and there are reality shows about doing it.  With the fast flip, the idea is to find the cheapest house that has the most potential, buy it, fix it up, and sell it at the biggest profit in the shortest amount of time possible.  Slow flipping is completely different.  The slow flip is when you find a house you want to live in that needs some updating or repairs and is therefore cheaper than comparable homes in the area.  You move in, fix it up over the course of living there for maybe 15 years, and sell it at a profit.  Of course you don't have to live there 15  years or even 10 or even 3 years, but the point is that you make it your primary residence while you fix it up relatively slowly.  The slow flip is something most homeowners should be doing.  It's sorta like sweat equity.

In this post, we will mostly be going over the fast flip.  The fast flip, or just flip from here on out, is pretty possible and you can make a fat chunk of change in a fairly short amount of time. 

I always like to simplify things and paint a clear picture, so let's break down the main players in a typical flip.  Here they are in no particular order, along with the purpose each serves: 

Realtor : Does the real estate part

Money guy : Has the money

Construction Workers : Do the construction work

That should clear things up! 

These players are all indispensable.  You need a Realtor to find the homes, run comps, negotiate the deal, find out as much as you can about the house and the sellers, and be able to list it and market it quickly and effectively once it's all fixed up. 

The money guy needs to have enough liquid assets to purchase the home without taking out a loan.  Now you COULD buy the home on a mortgage with good credit, but then the close takes longer, there are more closing fees, and you will pay interest to the bank.  

The construction workers need to be fast, cheap, and very good.  The foreman, or boss of this crew, needs to know everything about construction and have lots of experience remodeling.  He is the one who decides if the whole thing will work in the first place.  He also needs to know how long it will take and he needs to have plenty of guys who are willing to work fast and do an appropriate job.  Sometimes if the home you are flipping isn't going to be able to sell for THAT much, then you may find yourself cutting corners.  So if you buy a house for $90,000 that will sell for only $125,000, you don't have a lot of budget and corners will be inevitably cut.  But if you stand to profit a lot and the homes in the area are of high quality, you will spend more time making sure it is perfect.

It helps if each player knows at least a little about the other roles too.  For instance, I am a Realtor, but I also have a design and construction background, and I have remodeled a few of my own homes.  So I can tell pretty well if a flip will work or not without wasting too much time.  The foreman also knows a little about comps and what it takes to sell a house etc.  And if the money guy is experienced with flipping, he'll know about buying and selling real estate and also about the time and money it takes to remodel a house.  

If you are interested in flipping, you must know a little bit about the costs.  Let's say you obtain a property for $300,000 and sell it for $425,000 in a total of four months.  Sounds pretty awesome, but out of that $125,000 difference, how much do you actually get to keep?

Well, upon buying the property, there will be some closing costs, but not much.    If you get the home inspected, appraised, or warranted, your costs will be higher.  Sometimes experienced flippers will not do any of these things, since they will be tearing the house apart anyway and are buying with cash. Now when you SELL the home, your closing costs will be much higher, perhaps $35,000 if it sells for $425,000.  Most of this cost is in the form of Realtor commissions.  And if you have a good crew and can get things done efficiently and get materials at wholesale or close to it, you might spend around $40,000 in construction costs.  So we are left with around $49,000 in profit.  Not bad for a four month project.

Of course the construction costs are going to be different for each flip.  Maybe it's only $10,000 or even less.  When this happens, we call it a "lipstick flip."  Just slap some lipstick on it (new flooring and a coat of paint, and maybe new doorknobs or something) and sell it for more. But maybe the house needs tons of work.  Walls torn down, bathrooms and kitchens completely redone, even landscaping and a new roof and furnace.  You will have to have a really sharp pencil to make sure you can turn a profit in these cases.  

Many times I will find a potential flip property but "the numbers just aren't there," meaning it would cost too much to bring the house up to a desirable condition and still turn a profit.  Also, you want to be "way ahead" in the numbers so that if things do end up costing more or taking more time or the house doesn't sell so fast, you won't sweat it as much.

Flipping is pretty exciting.  But as with most things that are exciting, you'll also have risk.  You might buy the property and find that it has more problems than you thought.  You might get it all fixed up and it just won't sell at the price you need it to.  These are the two main risk factors in flipping.  

As a realtor, it is my job to find the property and negotiate to buy it.  This includes running comps in the area to determine what the property should sell for in excellent condition.  I basically tell the money guy "Hey, this home is available for this amount and I believe it can be sold quickly enough for this amount.  Larry (The foreman) says it sounds good too.  What do you think?"

And the money guy says "Hmm.  Sounds interesting."

First, I meet Larry at the subject house.  He's brought along a clipboard and a tape measure and goes around the whole house taking notes about what needs to be done, while I also double check things and bring up items he may have missed .  This is why it's good to have people who you like to work with.  Larry trusts me and I trust him.  We are a total team in every sense of the word.  There's no room at all for ego at this crucial step.  When you have 30 minutes to see if a house is worth flipping, you must pay very thorough attention. 

So once we're done and there is absolutely nothing else to know about the house, we'll go back to the office and pour over the numbers.  May have to call a few suppliers...may have to call a few guys, to make sure we know all the costs.   If it's looking good, we'll shoot over to Money Guy's office and present the deal in its entirety.  I like to do a "net out" at this point to show Mr. Moneybags.  A net out is just a rough but fairly reliable estimate of the closing costs that Money Guy will have to pay when we sell the house.  

At this point, if we want to make an offer, I write it up within the hour.  Larry will also tell me the most we can possibly pay for the home to make it work.  They are asking $300k, but we offer $275k.  They counter at 285, we say 280 is our max.  So we eventually settle on 280, which is good, since Larry said we would have been ok at 290.

So we start this one out ten thousand dollars ahead right out of the gate.  Good deal.  Since it's a cash offer, we are able to close in 14 business days, or around three weeks.  During this time, Larry assembles his crew and starts scheduling construction.  

We close on the house and it is all ours to do with what we wish.  Demolition comes first.  You get three or four good demo guys in there and most of it will be done in a day.  That's the easy part.  The tough part is scheduling and getting guys in to do the work.  You'll be expecting the plumbing guy to be there Wednesday, and it turns out he is much busier than previously stated.  So he is a week behind and this screws up the schedule for the tile guy, since he can't lay tile until the plumbing is done.  So just having the crew is not always good enough, because these guys, especially if they are good, usually have other jobs they are working on.   

When speaking about construction costs, some of the big things to look for on a potential flip are roof and mechanical.  A new roof can be big bucks and so can a new air conditioner and furnace.  The water heater is relatively cheap. So finding a potential flip that has a newer roof, air conditioner or furnace is a great thing. 

It all depends on how skilled you are with knowing about all the parts of construction and how extensive your network of tradesmen is.  You might have a mechanical guy who can get a new air conditioner put in pretty cheap.  Maybe around $4,000, when a typical homeowner would shell out $10,000 for the same setup.  If that's the case, then you are way ahead. 

But if you are just a fairly handy weekend warrior, you might get in over your head with something that needs major work.  If you have worked in construction and have many friends who also do, you might be able to tackle the worst condition home.  You just have to work it into the numbers before you buy and know your capabilities.

Usually opening up a kitchen to the living area is something that will be done.  Larry will have to make sure this is possible.  It could be that the wall separating the two rooms cannot be taken out without the house falling down.  So he has to be an expert in all things construction.  Things like new windows, doors, flooring, kitchens and baths are pretty straightforward.  He will know countertop guys, cabinet makers, plumbers, tile guys, carpenters, framers, sheetrockers, and electricians that will do things way cheaper than what typical homeowners pay.

So that's the construction part.  The concept is simple but there are a thousand things to consider.  Make sure you know exactly what you are getting into.

The profit part is simple.  In figuring this out, we take the end sales price minus the purchase price minus the construction cost minus the closing cost. $425,000-$280,000-$43,544.77-$34,000=$67,455.23.

It took 3 weeks to close the deal when we bought it.  It took 7 weeks to fix it up, and it took another 5 weeks to close when we sold it to the new buyer.   So that's about 15 weeks total.  

When flipping homes, the main things that get in your way are risk of the home not selling and unforseen construction costs and delays.  Generally if you've got the cash, you can just go buy any house.  If you've got the crew, you can fix it up.  And if you've got a Realtor, you  can buy and sell it.  These parts are pretty much in your control.  If you have a guaranteed buyer (which never happens) and you get a few inspections done when you buy it to make sure there are no surprises later, you would all but eliminate any risk.  

Well, the world is a risky place for sure, so let's talk about reducing risks.  One way to reduce the risk of unforeseen disasters is to get deeper into the inspections.  Foundations, termites, and radon inspections all go beyond the scope of what Larry is qualified to know anything about, so sometimes it's safe to pay for those inspections as insurance. 

Lest you think that you needn't worry about things like foundations, just remember that the people who BUY your masterpiece house may have the foundation inspected.  If it comes back bad, you are stuck with a huge problem.

But foundation problems are usually pretty rare.  Sometimes there will be an entire neighborhood or subdivision where foundation problems are common, but this is by now well-documented and you can almost see problems such as sinking, cracked walls or huge cracks in stem walls or slabs.  Sometimes you will feel like there is a slope to the interior floors, or several doors want to swing open or shut and won't stay halfway open.  

Knowing where to spend your precious time and money is key.  It's called management.  As a foreman, you're going to run into problems like the shower was supposed to be done yesterday and now it's going to take another week and a half.  And it was supposed to cost $2,250 and now it looks more like $3,500.  You can apply your energy and skills to keep the time and costs under control, or you can freak out and have mental breakdowns.  Usually it's a little of both.

Quality counts.  It takes a lot of patience to do things well.  The only thing worse than a tile job taking forever is tile that's crooked and uneven.  This goes for all trades.  

So, depending on the area of town in which you are working, you should plan on spending lots of time, or less time.  If the subject home is going to sell for $200,000, don't spend tons of extra time or effort thinking that it will sell for $400,000, because it can only sell as high as the surrounding homes.  The best situation is finding a home that gives you lots of budget to work with.  If you find a home for $150,000 that will sell for $200,000, and it needs $20,000 worth of work, that only leaves you with $14,000 profit after closing fees.  You may find yourself having to cut corners.  It may be just as possible to find a home for $750,000 that will sell for $1,000,000.  It needs $100,000 worth of work.  Now you have a lot left after closing.  You'll take your time and do it right. 

Another way to really bang it home is to work out a deal with your Realtor.  For instance if I am doing regular flips with a certain money guy, I will surely offer him a discount on my commission.  On the above million-dollar property, I might only charge him 1.5 percent instead of 3 percent.  I'm still making great commission because I earn it when we first buy it, and when we sell it.  So I will be doing very well, and saving the money guy big bucks with my discounted commission.  His profit goes up and he'll be much happier to work with me the next time.

Speaking of next time, that is when we will go over some of the finer points of this process.  See you then...

Post a Comment