5 questions you should ask yourself before you start renovating houses for profit
Back in 2011, house flipping seemed to be a perfect opportunity for a person with a good taste for remodeling to make some extra money. The market was flooded with houses left vacant from the high rate of foreclosures triggered by the housing bubble that burst a few years before that.
You could buy a home from a bank, make some repairs, replace the kitchen cabinets and appliances, install hardwood floors, splash on a fresh coat of paint and then sell it at a really high price. This old post-recession practice of buying a house for under market value, doing some rehab and selling it for a profit a month or two later is way less likely nowadays. This type of investing in real estate, seen as an easy moneymaking way in the U.S, has practically become a national trend in between many people who had some time for a second job or business and those who thought that having some available cash and a designer taste is enough to start making money by flipping homes. But this trend was actually a business popularized to really high levels in most cases and driven by popular TV shows that take a home from purchase to renovation to resale in an hour or less, make a lot of people believe this could be an easy way to make money, but unfortunately, the reality is way more different and complexed that the 1-hour show showing probably a 10-20% of the entire process of house flipping. This business is often glamorized by those shows and mostly by companies trying to sell house flipping training programs and later on by the banks who were selling you the capital to start the business.
The television and real estate investing gurus make flipping houses look easy when there is so much more involved than what they show you. Especially those on YouTube who present themselves as super successful investors who decide just like that to start teaching on YouTube and show to the ordinary Americans how easy it is to start the House flipping, but unfortunately those people were the ones that had the least knowing how to do it. When you go through 10-15 episodes of House flipping shows on HGTV, it’s easy to come to some crazy conclusions. Conclusions like, “House flipping looks easy! Looks Fun, Why not. I should try it!”
The first question in front of the beginner investor is:
1. How are you going to finance your project?
If you are one of those who already have the 100-300K ready to invest in the business, then your path to the successful house flipper is a little shorter than the rest of it. But if you are one of those that has an “X” amount of cash reserves not enough for all cash start then you will definitely need financing. Here is the first tip from me that you really have to think about before you start looking for financing. A specific business is very profitable only if a small group of people is able to step in it That was the case with House Flipping 10 years ago.
- No iBuyers were on the market in those years
- The financing for distressed properties was very difficult if not impossible.
- No millions of “educational and motivational movies/shows online” where ordinary people could acquire the necessary information to start doing it.
- Not that many people had 100-300K or more in the bank to start doing it and if they had it they had no idea what are the steps towards the success in House Flipping.
Because of those reasons above only the handful of people who had the knowledge and the savvy investors who had some cash to invest in it, saw the opportunity and manage to grow easily a Real Estate portfolio worth millions nowadays. Another factor was the availability of many distressed and foreclosure homes. Those are the people who were really lucky to build the house flipping business 10 years back and those are the people for whom house flipping is still a very profitable business nowadays.
Here is the breakdown of the current situations with the financing for house flipping in 2020. The market is flooded with lenders for this type of business and loans are called ‘bridge loans“, Lending Home, Patch of Land and many more including the local lenders in every state.
A bridge loan is a short-term loan used until a person or company secures permanent financing or removes an existing obligation. It allows the user to meet current obligations by providing immediate cash flow.
If you have the thought to use conventional financing you will never be able to make through successfully because your offers won’t be able to compete with all-cash offers. So you’ll definitely need a bridge loan as an alternative to cash. If you’re wondering what the requirements are, the answer is NONE
You can literally obtain a loan from any of those lenders up to 1 million with financing available up to 85% of the value of the house without the need to show any type of income or if you even have any income at all, a credit score above 600 it’s a perfect score if you decide to borrow money from friends families or anywhere else they don’t care where the money coming from. You don’t have to even show any significant amount of money in your account too just the ability to pay your interest-only payment for a few months ahead.
Those banks are not concerned even if you don’t have enough money to actually rehab the property.
Literally the right term here is the banks are begging you to start flipping houses or at least give yourself a try a few times.
Which is the sweetest spot for them because the beginning is where you will pay the highest interest rate and points in order to obtain the loan. And the interest rates for beginners are 11%-13% even if the advertised interest rates are as low as 5-6% but in the beginning, you are far away from that, plus 2 points origination fee upfront and few other fees before closing.
So roughly if you obtain a loan for around 300 000$ your monthly INTEREST-only payment will be 3000$-3500$ per month.
- Bridge loans can be arranged fast
- Bridge loans can be arranged on properties otherwise unmortgageable
- Bridge loans can be exited at any time with no (or low) penalties
- Bridge loans are very very expensive”
This is where you have to sit and think about those amounts above very carefully. This is where your biggest losses will be if something goes wrong and if you just starting or already flipped just a few homes many things can go wrong. A simple example of it is if the renovation takes longer than you expected and if the house remains on the market for longer than your expectations.
Let’s also don’t forget that from the moment of the accepted offer to the closing you may wait another 60 days.
So with all that being said, you can remain the owner of the property for 7-8 months maybe even more sometimes. Add and the property taxes to all that above plus insurance which is not cheap at all for a house under construction and at the end of your investment you can end up paying up to 40 000$ or higher in interest rates, property taxes, insurance, and your initial fees to obtain the loan.
2. How to find the right property
Choosing the right property is an extremely difficult task especially in the begging.
Location, location, location, we all know that Real Estate law and it’s an absolute truth.
During your search, you’ll try to follow that as well but in most cases, the experienced investors will outbid you for those properties on prime location and the time will come for you to settle with a property that maybe it is not on a perfect location. This is totally fine, those properties sell too. The mistakes you can make with those properties are:
Do NOT ever think that if you renovate that property really well, invest more for better kitchen cabinets and appliances you’ll be able to get a little better above market value price. This is a huge mistake. The renovation will never win over the location. In other words, your house will sell for exactly the same or close amount as the other houses in the neighborhood, it doesn’t matter what kind of amazing designer you are or how much you paid for custom cabinetry remodeling the kitchen.
Renovate accordingly to the neighborhood and never aim to be the most expensive house on the block.
90% of the cases will be a tough sell for the price you choose and longer market time. People will spend above market value for the house with bad renovation or not renovated at all but on a perfect location, but they will never spend above the market value for great renovation on a bad or not perfect location.
That mistake will cost you a lot of extra interest paid for the extra market time or you have to set the price lower than you calculated it in the beginning after your real estate agent tells you the truth about you overbuilding the house.
3. Inspection of the property before closing.
Here is the tricky part of the inspections.
- In a perfect world, you will send your inspector in the property before closing and he will tell you everything wrong with the house and you’ll be able to predict most of the renovation cost.
- In real life when the time has come for the inspection and you have to check that box on your offer you will realize the truth most likely with the help of your realtor.
Offers deciding not to perform inspection are always most likely to win the bid over the others who are planning to perform the inspection. And if you still don’t know, yes you will engage in a bidding war for every property you decide to place an offer on.
The investor who’s experienced enough will be able to evaluate the property by himself and he will wave that right on the offer with confidence but the beginner investors won’t be able to do so without taking a huge risk.
Those are the options for you;
- Should you increase the offer and keep the inspection in order to go ahead of the bidding war but you risking overpaying for the property and not making enough
- Keep the reasonable offer but wave the inspection.
Those are some of the toughest decisions you have to make in the beginning, overpay or risk buying without knowing all the issues the specific house may have. Most likely one day you’ll wave that inspection on a house that looks less risky because you will be exhausted from losing bids and that is the day where many things can go sideways. I’m not going to write about every single issue that you may bump into but I can only give you advice regarding some issues to stay away from if you feel like there is something wrong.
- If you suspect or it’s written on the disclosures stay away from electrical system problems but in most cases, banks will put only “property is for sale as is” not even allowed sometimes to perform inspection even if you want to.
- Septic or well issues, unexpected problems with that can set you back with a really huge amount of money.
- Last but not least a broken or cracked foundation slab, a problem that can really eat a huge amount out of your projected income from a specific house.
4. Time for planning, renovation and city permits.
Planning the renovation and setting your budget is a very important task that sits ahead of everything else before you start and needs to be executed perfectly before if you want to achieve success.
Are you getting the idea yet that flipping a home is a big exercise in math?
Well, if you haven’t started laying all the costs out and figuring out what you can spend where then this is the moment.
Kitchen cabinetry, tile, floor installation, plumbing services, electricians, masonry work are some of the services you have to look for a contractor and of course landscaping that can be really costly, very important part even if sometimes people putting it on the side as a small expense.
You have to narrow down the right suppliers for materials for all that. Next, choose the right contractor. A really frustrating part you have to go through and you have to decide in between 2 paths.
- You can go with the cheapest one of course that will require a lot of attention on your end to spot all of the imperfections that kind of contractors will leave behind. In other words, you have to be on the field every single day with them. Be advised most of those type of contractors don’t have any insurance at all at that is a huge problem if some injury happened on the construction site.
- Go with a well-established construction company that will definitely cost more but you have the freedom not to be there every single minute during the renovation, the job will be done very well in most cases and you will have guarantees for the work that is been done on your property.
I’ll advise you to choose the 2nd one if you just starting the house flipping business.
I will not go through every issue that can come on your way because the list will be endless but I’ll give you an example of something that can be considered a small investment in the beginning and you can end up overspending thousands of dollars.
If you’re buying an older than 50-60 years old house in some cases you may buy even close to 90 or 100 years old especially if you’re on the East Cost in those old houses most of the time you won’t find any light fixtures on the ceilings only one switch on the wall that controls one outlet in the room. Your first thought will be to add the very popular recessed lights on the ceiling and may consider a budget of just a few thousand for it. Here is where you put yourself in a very unpleasant trap. Keeping the house with the existing lack of light fixtures on the ceilings and trying to sell it for the high price it’s not much of an option so most likely you’ll decide right away that recessed lights or any other type of lighting are a must in the particular house. You have to demolish a few walls and ceilings for it and try to attach the new wires to the existing wiring of the house in the junction boxes which is 50,60 and maybe even 90 years old and completely out of nowadays standards and building codes.
For a project like that, you MUST pull a permit from the city as same as for any other work you’ll perform in that house, and guess what, none of the other inspectors with some small exceptions will give you as much hard time as the electrical inspector.
If the work is not done well the house can catch a fire which will lead to the full destruction of the property which is the reason why the electrical inspection will be toughest to pass.
The problem won’t be the new light fixtures you will install but the existing obsolete wiring that you have to expose to connect the new ones. In most cases, the old wires will be in really bad shape and the electrical inspector may require you to rewire the entire house for safety reasons ones he evaluate it, in order for him to give you a pass on the electrical permit.
The expense for work like that for someone who is at the beginning of his adventure in the house flipping can be devastating. You have to completely remove a large portion of all walls in the house, ceilings, rewire every single outlet, switch and existing light fixture including replacing the main panel plus closing those walls, finishing it and painting it. All that work can easily eat your entire income from that property and even make you lose money from it.
5. Time to sell
After all setbacks you’ll probably hit during the renovation when the time comes to sell the property in most cases you may be already over budget and start thinking about how to cut costs for the sale of your property.
With all of the technologies nowadays you can try to save a 3% fee for the selling agent by trying selling it by yourself even if all agents will come and try to convince you how difficult that is. In such a competitive market today it is a task you have to learn especially if you’re a beginner and have to pay a lot of interest rates for the property you’re working on.
There are many companies out there that will put your listing on MLS for a flat fee of a few hundred dollars and you have to handle calls, open houses, and private showings. If you decide to use an agent it is definitely a plus to use a market specialist but the question is, are you able to afford it.
Home staging is effective because it emphasizes a property’s strengths and minimizes its weak points. It allows your home to be shown at its maximum potential. Presenting a well-cared for home and creating a property that gives a positive first impression.
Staging is an expense most people who just starting the house flipping never thought about it or at least underestimated or trying to avoid.
This is another extremely important part that most people think can skip. When you spend so much money to renovate a house and try saving from staging is not a smart idea especially for a pricier home. Staging is very important to bring more people in the house just by seeing the staged pictures and second, you can trigger people’s emotions when they see the beautifully staged house, they may decide to go slightly higher than market value than a house that is empty. Staging is definitely a big plus for selling the property faster. If you wondering what the cost of staging is. For a 3-4 bedroom house plus some furniture for the patio and if you have finished basement you can go north of 10k-12k easily.
Here are some of the biggest mistakes you can make in your house flipping adventure according to the industry specialists.
Overall the house flipping business is still profitable and it will remain profitable but it became way more complex and difficult than 10 years ago.
It requires way more precise calculation than before, careful study of the market and tight budgeting and most importantly it remains the all-cash business for those who can afford it or at least requires a lot of cash in combination with less financing to start it. Don’t mislead yourself with the availability of so many different types of financing out there and fake real estate gurus to prepare you for the real-life that your job will become easier with more opportunities. It is exactly the opposite. The availability of so many options creates a very high level of competition and extremely difficult to locate the right property and most importantly on the right price is the key to success nowadays.