I absolutely love flipping homes.
I get a wonderful feeling of accomplishment from the before and after pictures and a nice check to deposit in the bank account. But the home-flipping TV shows don’t much resemble the reality of the business, and the real estate gurus are out in force once again selling books and courses telling you how easy and risk-free it is to flip homes.
Let’s talk about the reality.
I love breathing life into an old home but, truthfully, very few people get rich doing it. Most successful flippers end up graduating into something else, such as development, wholesaling or commercial properties. Or they do it as a supplement to other ventures. There are no home flippers on the Fortune 500 list.
Here’s why you need to be realistic about your home-flipping expectations:
It’s a high-cost business
Flipping a home is a costly endeavor. It involves the input of dozens of specialists, all of whom have to be paid. No one can do all of this alone. Even if you could, it probably wouldn’t be the best use of your time. Most of the time I feel like I’m really good at making other people money.
There are a lot of people between my final paycheck and me.
I have to pay my lenders and investors for the use of their money. No one uses all their own money for this stuff. If you have a million dollars in the bank, don’t bother with the headaches of flipping a home. Just lend the money to someone else and let them chase deals and struggle with contractors.
Even though I am a licensed real estate agent in Virginia, I still have a significant agent expense. I need to move the deals fast, so I have to pay the agent who brings me a buyer. I’ve tried cutting agents out, but it doesn’t work as well. It costs me more than I save.
I also have to pay lawyers, contractors, material suppliers, inspectors and appraisers. And the tax man gets me about three to five different times for the same deal.
On a deal I recently wrapped up in Montgomery County, Md., I paid more than $10,700 in just state and local transfer and recording charges. I also paid about $6,000 in property tax for the time I held the house and then I paid income tax on the profit and in some counties I have to pay a gross sales tax, even on real estate sales.
Here’s the government transfer tax and fees I paid on the Montgomery County deal. I paid the fees when I bought the house and when I sold it just a few months later.
|Government fees at purchase|
|Government recording charges||$290.00|
|State recordation tax||$1,931.00|
|Recordation tax on deed||$836.60|
|Government fees at sale|
|Government recording charges||$100.00|
|State recordation tax||$1,881.25|
|Recordation tax on deed||$1,287.50|
|Total government fees for project||$10,746.35|
There are a lot more costs I could go over, but the point is there are a lot of hands out when you’re doing a home flip. There have been plenty of deals in which I paid all the hands out and then looked at what I got to keep and thought: Is this worth it? If you don’t love this stuff, then the answer is probably, no, it’s not worth it.
A lot of professionals are involved in the business which makes for high costs. It also means a lot of your business is out of your direct control. You feel pretty helpless when a contractor messes up your project and walks away.
Low margins and high risk
Sure, I might make a $40,000 profit on a project, but that is a really low return if I had to spend $600,000 on it. Most retail businesses are shooting for a 40 to 50 percent gross margin. I’m shooting for a 10 to 15 percent margin.
Despite what the gurus tell you, this is very high-risk business, especially for those who are new. You have to rely on a lot of other people. The biggest risks are in valuing the property, determining the renovations and managing the construction. If you’re wrong about the value of the home and you pay too much for it, you’re doomed before you start. You’ll never be 100 percent sure what a property is worth. There’s always a chance you missed something in the valuation.
You never know what you’ll find in the home once you open it up. Everything is fixable, but it’s a matter of the cost. And, really, my biggest problem is the contractors. I never really know how they’re going to perform on any given project. If you flip homes long enough you will have a bad contractor experience.
Time-consuming and hard to delegate and scale
Another thing I always hear the real estate gurus talk about is passive income. Well, flipping homes is far from a passive business. You have to be involved from start to finish. In fact, at least half of the work of flipping a house is finding the house in the first place. In this market, it’s pretty rare to find a good flip deal on the multiple listing services (MLS), and even those take a lot of work to discover and verify. So you spend a lot of time working on flipping before you even have a home to work on. Many people never find that first deal, give up and walk away from the business with nothing to show for their time and money.
Once you find the deal, you have to line up funding, develop a scope of work and get contractors’ bids. Not only do you have to put together a scope of work, but if you’re good, then most projects will require several different scopes with various levels of renovations, and then you have to determine what the home will sell for at the different levels of renovation. Then you determine the option that maximizes profit and proceed accordingly.
For example, I just had a home that I knew I could resell completely as-is, I could do a standard renovation or I could add a second level. All the options were viable. I determined a scope of work for each option, got bids for each scope and totaled up the costs for each scenario, including the holding and financing costs. Adding a second level would cost me about $175,000 in direct renovation costs, plus it would take nine months to complete, which adds thousands to the holding and financing costs. It also comes with added opportunity costs and increases risk. I decided to put that home up on the market as it sat and sell it as a fixer-upper.
Every deal is different. They’re very hard to systemize. Therefore, it’s a difficult business to scale.
You have to know at least a little about a lot of different things to be able to manage the business. In my opinion, the most important knowledge required is real estate market specifics. You absolutely have to know how to value a home and what the buyers want, which includes popular designs and decor.
Construction is a valuable skill to have, but I see a lot of contractors get into trouble when they try to flip homes because they over- or under-improve. Still, it’s very tough to be successful in this business if you don’t have a good understanding of construction, which includes the dozens of specific trades required in building a home.
Besides those items, you also need to know real estate and business law, insurance, contracting, negotiations, project management and more. Honestly, if I knew how much I didn’t know before I flipped my first home, I probably never would have tried. Thank goodness for my ignorance.
No, there are no home flippers in the Fortune 500. There’s no better feeling than making $50,000 in four or five months on a successful flip project, but it also really hurts to work for months and make nothing or even lose money. If you are a professional with a good-paying career you enjoy and you have little to no real estate experience, then home flipping is not the place to start. I invested in real estate for about five years before I tried to flip my first home.
If you’re a well-compensated professional with good benefits, then you don’t need to be distracted by all the minutiae of a flip project. Even if you’re not all that well paid in your career, you still probably don’t want to jump right into a flip deal as your first attempt at real estate investing. I recommend buying a small rental property as your first real estate investment.
In my next piece, I’m going to explore what you might expect if you bought just one relatively cheap rental property per year for the next 20 years. I’m talking about properties that cost you $50,000 to $100,000 in markets with favorable landlord-tenant laws and good rent-to-purchase price ratios.
Justin Pierce is a real estate investor and real estate agent who regularly writes about his experiences buying, renovating and selling houses in the Washington area.