Thinking of flipping a home? Here are a few of the most common pitfalls to consider before buying your first shell home and flipping it into a remodeled home:
• Know the process inside and out before starting: The truth is that flipping homes takes time and includes myriad processes from start to finish. From demolition and permitting to remodel and staging, home flippers should be educated on the processes they will be undergoing.
One of the biggest pitfalls in flipping homes is the lack of understanding the permitting process before starting. Simply buying the shell of a house and beginning work is not possible in most jurisdictions. For any project that will be altering the layout of a home, permitting will be required. This includes renovations such as adding or removing a bedroom, installing a powder room, building an addition onto the home and many other common home flipping projects.
The permitting process isn’t one that a home flipper should casually wander through as it can be costly and time intensive. Instead, an inexperienced home flipper should align themselves with a good licensed general contractor who knows this process inside and out.
• Budget, budget, budget (and budget some more): There are two certainties in flipping homes — the first is that there will be unexpected costs associated with the project. While it should go without saying, a clear budget with clear expectations is required in flipping a home. Thus, any home flippers should include in their budget a buffer for unexpected costs (for most, a 10 percent buffer in expected repair costs).
Moreover, be sure to take into account the costs of selling the home later in the process. These items may include real estate commissions, staging fees and closing costs associated with selling the property. As a rule of thumb, it is always better to slightly overestimate the cost of a project than underestimate the cost.
• Set realistic timelines: The second certainty in flipping homes is that there will be delays somewhere in the process no matter how prepared you may be. With so many processes occurring at all times, it is very important to create a realistic and thorough timeline for your project.
Flippers may want to finish a project by a certain date, but factors outside of their control may delay this timeline. For example, regulatory agency inspections may delay progress if not completed after their first attempt. Moreover, it is important to schedule contractors at specific times during the flipping process. Some services will need to be scheduled earlier in the process (such as demolition) before scheduling services for work behind the walls (such as electric and HVAC).
In total, your timeline and budget together will set the greatest expectation for your flipped home’s journey.
• Don’t forget the 70 percent rule: One general formula used in home flipping is the 70 percent rule. This guideline uses the after-repair value (ARV) of a home along with the estimated repair cost (ERC) to determine a fair price for the pre-flipped home. This guideline, which BiggerPockets details here, can be summarized in the following formula: ARV times 70 percent minus ERC. The total is an estimate of how much to spend on a shell property to ensure a profitable flip.
For example, let’s say you are offered a distressed home that requires $50,000 of work to make it into a marketable flipped home. ARV properties in this area are at market around $700,000. So the most an investor should be prepared to pay for the shell of the property would be $700,000 times 70 percent minus $50,000. This equates to $440,000. Thus, the most an investor should consider paying for the shell property should be around $440,000. Of course, this formula does not work in every market, but is a good guide generally speaking.
• Schedule your subcontractors carefully (measure twice, cut once): Unless you own a large home construction company, you will undoubtedly enlist the help of several subcontractors (hired contracted help for a service).
These subcontractors will normally lay out the entire scope of their hired work before performing the job to set expectations. Thus, it is imperative to detail the work of your subcontractors in advance as precisely as possible. Change orders and modifications to most services normally add a change fee at the cost of the developer. For example, electricians may add cost to install additional plugs in a room.
HVAC installers will need to know exactly where you want ducts installed and changes may incur cost. Additionally, scheduling these subcontractors when appropriate is also key. Once again, a clear timeline is necessary to set expectations for both you and your contracted services.
• Know the houses in the neighborhood: Taste and quality standards are important to understand before installing finishes and appliances into a home. Not all neighborhoods adhere to the same standards, and it is important to understand these standards before performing work in a home. For example, the taste in some neighborhoods may sway toward open floor plans while other neighborhoods favor traditional layouts.
Removing a bedroom may push away buyers with larger family profiles, while adding more square footage may steer away new families or single buyers. Moreover, the type and quality of finishes will be dictated in a similar way. For a middle-income neighborhood, it may not be wise to install the highest-end appliance in every room when most homes on the street only include a middle-range finish. As a rule of thumb, you don’t want your flip to be the most expensive on the block, but rather the highest quality.
• Find an expert in the neighborhood: Cutting costs on the resale side of a flip is a common pitfall that is easily avoided at low cost. Every house flip includes a team. From the developer to architects to general contractors, there will be many hands working on the project.
When reselling the home, it is important to work with a real estate professional who truly knows the market value of the home and who may specialize in selling flipped homes. Instead of relying on online estimates for the home’s value, finding a neighborhood real estate specialist will set real expectations about how fast a flipped home will sell and for what price.
• Don’t forget the carry costs of the home: Finally, don’t forget about costs that may appear minimal in the short-term, but add up in the long term. Carrying costs of a flipping project include property taxes, utilities, insurance, lender costs (if borrowing for a home renovation loan or home equity loan) and administrative fees may appear small at first, but these costs can add up month-to-month, especially in the event of a delay.
All in all, flipped properties will remain a staple of the Washington-area housing market, especially given the lack of single-family home inventory. Home flippers should be cautious when entering the market. Home flipping is a great strategy for investment, but should not be viewed as a get-rich-quick scheme where quality can be sacrificed.
Tim Savoy, a real estate agent with Coldwell Banker Residential Brokerage Capitol Hill, writes an occasional column about the Washington-area housing market. He can be reached at Timothy.Savoy@cbmove.com and on Twitter @SavoyRealEstate.