House Flipping Pitfalls

House Flipping Pitfalls

By

Jeff Kehl

Ok, so let’s be honest with ourselves for a minute. You see those shows on tv where people buy a trashed-out foreclosed house, fix it up and sell it for a ‘$50,000 profit’ and think, ‘I could do that’. Why don’t you?

Wouldn’t a life of being horrified by past design decisions and life choices and correcting them with stainless steel and granite be preferable to what you’re doing now?

Let’s face it, the work you’re doing in that cubicle is not really affecting anyone in the long-run. If the TPS report does not have the correct value in box A do you really need to correct it?

Wouldn’t society be better off if you were out selecting just the right tile for the back splash?

I am not a professional flipper by any means. I am mostly a buy-and-hold investor but I am just now selling my 5th flip in the last couple years and I have a few words of wisdom or at least entertainment to impart.

Acquiring the property

First, most of those shows you see on tv are set in very expensive markets like L.A., San Francisco or Toronto. $50k profit on a $1 million bungalow is, actually not much when you consider the risk of buying a tiny little house for that much money.

In my area and in most of America you can buy… a whole house for $50,000.

So, let’s say you are flipping in a sane market like mine in a far-out suburb of Atlanta.

Expert flippers say you need to buy a house for 70% of the After Repaired Value –minus the cost of repairs. So as an example, if you find a house in a neighborhood of 3 br/ 2ba ranches houses that sell for approximately $100k you need to buy it for $70k. Oh and then let’s say it needs about $20k worth of work so you need to buy it for $50k.

Generally, people are not going to sell you their property for WAY below market value unless they are crazy, stupid or high.

But situations do exist where people will sell for that much below market. Usually there is some distress going on and they just need out of the house as quickly as possible. Foreclosure, death, divorce, incarceration, drug use, job loss, hoarding and health problems are all examples of situations in which people need to fire sale their house.

So, you can find houses for the right price but A) they are not easy to find and B) it makes for some depressing conversations.

I wonder why they don’t show that part on tv? Oh, your husband is in jail for armed robbery and you need to sell the house to raise bail? Your dear, departed mother had 68 cats here but now we can’t find them because of the trash in the house? Actually, I think they do have those shows but they’re on a different channel.

Fixing the Property

But whatever, let’s say you get a property for far below what it’s worth. Now you have to fix it up. If you have friends who are contractors this might work out. Otherwise you are likely to get over-charged/ripped off.

And it may or may not be the contractor’s fault. To successfully rehab a house, you need to be able to specify what needs to be fixed/changed.

The good contractors are generally busy either doing their own flips or working for customers that have already done a lot of flips.

But for arguments sake let’s say you find one. Exactly what are you going to tell them to fix/change? This is known as the statement of work.

Lots of people know what to put on that statement of work because they see it on tv right?

I toured a house the other day that an inexperienced flipper had done. It was a foreclosure I had looked at and I knew he got a good deal paying $30k for a house in a $70kish working-class neighborhood.

Well he had watched the shows because he had decided to change the layout of the house. He combined two small bedrooms into a large master suite and then added a bedroom off the kitchen where the laundry had been. Laundry? He put it in a closet where there was only room for a stackable.

He fixed this house up just like on tv, granite countertops, stainless appliances, expensive cabinets and hardwood floors where there wasn’t hardwood before.

I don’t know what he spent on the rehab but my guess is north of $80k and he now has the house listed for $160k, twice what the average house sells for in that area. Guess what… it’s not selling.

Bottom line, you improve the house only to what the neighborhood will bear. If he had spent $10-$20k on basic finishes and not changed the layout of the house he would have made a nice profit.

Selling the house

Speaking of a nice profit. It always cracks me up how they don’t show all the costs in flipping a house. That’s the reason you need to buy them so cheap because there are a lot of costs involved.

Here’s a few that most people don’t consider.

Real estate commissions and closing costs - This will mostly hit you when you sell but often there are some costs associated with the buy as well. I usually plan on $10k for a $100k house.

Financing costs – Usually you need to buy the house for cash and pay for the rehab costs with cash. You only get the money back when you sell. Unless you have a spare $100k laying around usually this means you borrow it and generally it’s a hard money type loan at high interest with points. 12% with 4 points is not unusual. Assuming it takes you 6 months to do the flip that’s about another $10k.

Carrying costs – During the time you own the house, you have the same costs as owning any house. taxes, insurance (which will be higher because the house is vacant), utilities, lawncare. On a typical flip here that could be a few thousand dollars.

Contingency – Generally something you’re not planning on will go wrong. With me it’s usually a hot water heater or furnace that stops working. But on my last flip it was a tree from a neighbor’s yard that fell on my roof just as I was about to list it for sale. It cost $6k to repair the damage and remove the tree and my insurance only ended up paying about $2k of that. Even worse was the extra month it took to get the work done.

Concessions – Of the five houses I have flipped, every single buyer has asked me to pay their closing costs which run several thousand dollars. And then there’s the inspections where they ask for things like a new front door, CO detectors to be installed or new light fixtures to be installed.

Conclusion

So, after going through all of that you may or may not have made a profit and you’ve done a heck of a lot of work. The other thing they don’t show on tv is that there are any number of little things you will probably end up doing like changing lightbulbs and sweeping the front porch. Yes, you can hire someone to do that but at the end of the day it your responsibility to get it done.

Really the question is not ‘Could you flip a house?’ but rather ‘Do you really want to flip a house?’ It’s much easier just to watch the tv show and you’re done in 30 minutes.