Can't make a profit flipping?

Question

That is what my SIL told me tonight.  Her brothers bought 4 houses to rehab and flip and couldn't sell any of them for a profit, so they kept them as rentals.  She said no one could afford to buy them for what they are worth.

Is that more of a function of the market as a whole (Tulsa, OK) or because their houses were in a low income part of town where probably >50% of households are renter occupied, and qualified homebuyers can look in more desirable areas?

My rehab plan is to buy at around $48-50 per sq foot in a newer part of town - 1990's construction, then depending on the quality of the house, ready to move in comps are asking $73-83/ft.  Does that give me enough room to make a profit assuming I do a lot of the minor work - new showers, paint, siding repair, fixtures, landscaping myself and hire out for AC/roof/carpet from discount outlets?

At a minimum it should cash flow $200-300/mo if I rented it.

Mark Ferguson · Answer

Bill Briscoe,
I didn't mean I never consider square footage for value, I mean I don't think of value in terms of $80/sqft or $100/sqft. I think of value as $100,000 or $120,000.  There are too many variables involved to say homes in this neighborhood are worth $80/sqft.  
When I am comping out a house I search 10 years older and newer, within 20% above ground sqft, and within same neighborhood if possible then go out to .5 miles and then 1 mile.

If I can't find enough comps with that method I may expand the age and square footage parameters and make adjustments accordingly.  If I have too many comps I narrow them down by condition, bed/bath count, basement, garage etc.  I make adjustments for all of that if they differ from the subject.

My team and I do about 1,000 Broker Price Opinions a year for banks and have our system down pretty good fro values.

Jon Holdman · Answer

When an appraiser compares one house to another, he or she will consider size and make an adjustment.  If houses in the area sell for about $80 a sq.ft., then, in the appraisals I've seen, they will adjust about $40 per sq.ft. for ground floor footage, $20 for second floor, and, maybe, $10 for basement.  So, a ranch without basement that's 200 sq.ft. different would get an adjustment of $8,000, not $16,000.

This gets really tricky if the styles are different, so appraisers will try very hard to find houses that are the same style.

If you have a hard finding comps, the house is not a good candidate for a fix and flip.  You want an area where there is good retail sales activity with plenty of houses for comps.  That way you can have some confidence of what an appraiser will pick.  If you have a hard time finding solid comps, an appraiser will too and its a real crap shoot as to what value they will come up with.

Some of what you list would require permits here.  Water heaters, in particular.  Cities here are clamping down when houses are sold.  The rehabber I mentioned has permits for some work, but not everything.  The inspectors notice other work and started poking around.  In the end, we had to dig up part of the basement and open up walls to expose work that was done decades ago.  You might say "it was like that when I got here."  But start touching stuff, and its your problem.  Especially if you're a rehabber.  You're going to be held to a higher standard than a homeowner.

You can get in trouble in any neighborhood.  You must spend time looking at other houses in the area.  Figure out the standard of the neighhborhood and fix to that standard.  Going beyond that will net you very little additional value.

If the neighborhood you're considering is all rentals, then your target buyer is a landlord, not an OO.  That's a different buyer that an OO, and you have to do things differently.  Its really easy to over improve in that case.

David Beard · Answer

You nailed the problem in that they tried to flip to owner occs in the wrong part of town. They didn't do their homework.  There were probably no comps in that area for fixed up retail properties.

There might well be a market selling these as turnkey rentals to investors, which is popular in Midwest and heartland cities with good rent yields.  Thats the lesser known fix and flip strategy, but can permit good volume if you market them effectively, especially to out of town folks from expensive regions of the country.

Bill Briscoe · Answer

Mark,
How do you not work with sq ft?  I understand that all else equal, a bigger house will have a lower $/sq ft than a smaller one, but if you are looking a good comps - +/- 200 sq ft, same beds/baths/garage, age+/- 5 years, and condition and neighborhood don't you have to plug in sq ft somewhere in the appraisal formula - especially for mass-produced suburban SFHs?  All realtors use it for CMAs...

Bill Briscoe · Answer

I guess my question about the brothers comes down to: is it easier to "over-improve" relative to your neighborhood in a low % OO area than a high OO area?

In OK, prices are and always have been so low that its credit and stability that generally determines whether someone owns or rents long term, not income.  Renting generally costs more per month than owning, so if you have good credit and therefore can buy, why would you buy something nice in a run-down neighborhood?

Bill Briscoe · Answer

Jon,
I'm only doing the repairs that I've done before on other houses: pouring a small patio, installing new light fixures, replacing a toilet or a bathtub insert or a new sink, paint, siding repair, drywall repair, or even a water heater - none of that requires a permit in OK.  I'll have a pro do the roof, AC, and carpet but those don't require permits either.

I'm aiming to buy newer (20-30 years) homes and I'm not changing anything structurally or adding sq footage or replacing wiring mains - and I'll have the wiring/plumbing inspected to make sure.

Mark Ferguson · Answer

Houses are worth what the market will pay for them, not what the seller thinks they are worth.  Many beginner flippers get into trouble by over estimating value after they rehab a home.  They think can add special features or touches that will make the home worth more than what other homes are selling for.  We always assume the worst case scenarios to see if we still will make a profit not the best.

I would work with actual values not $/sqft.  There are a lot of factors like garages, lots, etc. that will change value aside form sqft.

Jon Holdman · Answer

Highly unlikely.  Don't mean to beat up your SIL and her brothers, but what I read into this is they based their pricing on what they needed to make a profit and priced them above the market.  I can absolutely guarantee that if they put them on the MLS for $1000 each, they would have buyers within 24 hours.  For both rentals and resales, landlords and sellers sometimes get into their heads their mortgage payment (for rentals) or the money they have invested (for sales) is somehow relevant to what they can get.

The rule of thumb for fix and flips is that if purchase plus rehab is 70% of the selling price (ARV), you can turn the deal in six months, and  you're using hard money to fund the deal, you can make a profit of 15% of ARV at the very best.  Since its very common for deals to take longer, cost more to rehab and sell for less than you think, 10% is a more realistic number.  I have no idea if those numbers like up with that rule of thumb.

You have to be careful DIY'ing rehabs.  Permits are required for electrical, plumbing and maybe other trades, and maybe for remodelling in general.  Shortcutting this process might work.  But it might bite you.  Ask the rehabber I funded who got caught without permits.  Ended up giving me and my partner the house, with a loss of about $30K on his part.

Also don't get too hung up on $/sq.ft.  That's not how an appraiser will determine value.  10% bigger than comps doesn't mean 10% higher value.  Vice versa if you're smaller.