Making short-term profits by buying, fixing, and selling homes is referred to as “flipping”. There are a number of books, lecturer series and TV shows devoted to the process. Potential investors are enticed by the prospect of quickly making a big profit, with minimum risk and money. The truth is that it’s not easy; novices face additional challenges and risks.
The most critical challenge is purchasing a home at a price substantially lower than its updated and repaired value. The difference between the purchase price and the improved value has to cover five critical things. First, the cost of repairing and updating the home; second is compensation for your time; a reserve of unexpected expenses is third; fourth is the selling expenses and commissions; and finally, the most important, your profit. This necessary price differential can be substantial if the home is in poor condition and/or has structural issues.
Most homes in poor condition are considerably over-priced. Sellers typically price them at the repaired/updated market value minus the cost of improvements; there is no allowance for the four other critical things that need to be covered. Let’s take the example of a home listed at $340,000 that would be worth $400,000 when upgraded at a cost of $60,000. The closing expenses will be about $28,000; a good reserve amount might be $5,000, your time may be worth $5,000, and you would like a profit of $30,000; these additional amounts total $68,000. Your agent would need to negotiate a price of $272,000 to make this home a good candidate for flipping.
There are two major reasons that it’s very unlikely you’ll be able to get the price anywhere near the necessary point. You will be competing with owner-occupant buyers who don’t have to cover a profit, reserve or closing expenses; they can pay considerably more than you. Your other competitors for the home will be seasoned investors; they have their own work crews to do the repairs at a considerably lower cost, may be able to sell with reduced real estate commissions, and have the experience to accurately estimate the repairs and eliminate the need for a reserve allocation.
The other challenge for the novice investor is financing. Many homes that are good candidates for flipping have major structural issues and are not eligible for standard financing; you will need a 35-40% down; most seasoned investors have cash, which will be more appealing to the seller, putting you at an additional disadvantage.
Novice investors are better suited for long term investments. You can take advantage of the rental income over a period of time and make a profit selling after the property has appreciated in value. Flipping homes is better suited for seasoned investors who buy and sell on an ongoing basis; they can afford to occasionally make a mistake.
Steve Setka is an exclusive buyer’s agent with Keller Williams Realty in Durango and a licensed mortgage originator. He can be reached at 903-7782 or Steve@DurangoRE.net.