Buy a house.
Fix it fast.
Sell it quickly, recouping more than the total cost of the purchase, renovation and financing to make it happen.
That’s the house-flipping formula.
If you think you can handle that pressure, you might have what it takes to use fast-turn real estate investing to your financial advantage.
What is house flipping?
Unlike long-term real estate investing, in which investors buy and hold properties, house flipping is fast and furious. You’ll be competing against other bargain-hunters to find houses that fit the successful flipping formula: buy a house with “good bones” and in a good location for a low price; contain renovation costs; complete the renovation quickly; and get that house back on the market to outrun the cost of carrying short-term financing to pay for the entire exercise.
Advantages and disadvantages of flipping houses
“Flipping is a sprint,” said Tim Savage, clinical assistant professor at the NYU SPS Schack Institute of Real Estate. He has invested in a few properties himself, too, so he has more than just book knowledge.
Flipping houses is an adrenaline-driven process. Everything happens fast — or is supposed to — from the purchase to the renovation to the resale. You might read the prevailing real estate trends just right and sell in an escalating market, netting more money, faster, than you had expected. If you and your partners are itching to immerse in a big project that could pay off big, and have the financial and emotional resilience, you might have the personality for flipping.
With that speed comes self-imposed pressure. Everything has to go right to capture the maximum profit on a speedy timeline. But not everything will go right. Relationships will be stressed as your family and friends have to work around your project. Your lender will want regular updates on what you are doing with their money. And as quickly as you work, the real estate market still might turn against you, undermining your profit and effort.
Flipping houses, by the numbers
- Research market trends to understand how much time you likely have to complete the flip, start to finish.
- Identify and ready sources of funding.
- Define your parameters for profit:
- the amount you’re willing to spend for both purchasing and improving the property;
- target neighborhoods; potential business partners, from lenders to contractors;
- where you’ll source earnest money; purchase and construction loans, and resulting cash flow;
- your strategy: “serial flipping” of houses you live in or fast-and-furious flips of houses you do not occupy
- Pursue off-MLS sources of properties, cultivating relationships that can refer you to properties before they formally hit the market.
- Assess the profit formula (purchase price + renovation cost + about 30% = final asking price) when considering an offer.
- With prearranged funding, buy target properties.
- Obtain all permits and permissions before starting work.
- Complete work according to your schedule and strategy (see third step).
- Sell the house, repay lenders and calculate net profit.
Home, sweet home
The popular notion of house flipping usually focuses on an empty house. But a more common-sense way to build momentum is to be a serial flipper of houses you buy, occupy, renovate and sell, advised Scott Trench, CEO and president of BiggerPockets, a popular website and resource for individual real estate investors. As an owner-occupant, you can obtain financing with the most favorable terms, he pointed out, and that “gets the snowball going.” Various tax and lending breaks are available for owner-occupants, from the homestead property tax to capital gains tax exclusions, that are not available to investors in properties they do not live in.
“If you’re willing to do that two, three, four times, live in a construction zone, for the time to get the work done, you get an incredible tax benefit,” he said.
How to find houses to flip
Don’t bother trying to jump on properties newly listed on the multiple listing service (MLS), which is the huge database that realty agents use to post properties for sale. (Zillow, Trulia, Realtor.com and other big, national databases compile listings from regional multiple listing services, which are owned and operated by consortiums of realty brokerages.)
Find a way to specialize in a neighborhood or type of property, Trench recommended. If your baby boomer mom plays bridge, see if she will spread the word that you are on the lookout for as-is properties to buy. It’s easier, Trench said, to cultivate a reputation within a community or neighborhood than to try to pounce on available houses from across a region. Auctions and foreclosure notices are time-honored ways of capturing as-is houses, too.
To make a fast offer, you will need to be prepared. You’ll need an inspector who will come when you need them, and you’ll have to have money ready to seal the deal. Experts say that once a seller has made up their mind to sell, they are typically ready to go. Have earnest money ready to put down on the spot, and have purchase and project financing ready to flow.
Potential problems: Common mistakes in house flipping
One of the most common flipping flops that Savage sees is assuming that tackling a fast-track real estate project is just like owning your own house, just quicker and more intense.
Flipping deadlines are set by the amount of time you have to get work done to get the house on the market. Unless you are completely self-financing the project, you probably are carrying high interest rates for a short-term loan. The more quickly you sell the house and pay off the loan, the less money you lose to interest, and the more you keep.
But the timeline is your problem, said Savage. Others who must cooperate to accomplish your tight deadlines have their own problems. Contractors, building inspectors, materials suppliers and homebuyers will do their part of your project according to their own priorities. Glitches are guaranteed, said Savage, and that’s where flippers find themselves in trouble. Renovation headaches are bad enough when you’re working on your own house. But when you are racing against a deadline you inflicted on yourself, every speed bump could throw your project badly off course.
This pressure is compounded if you are not a master of at least a few necessary skills: project management, a building trade like plumbing or carpentry, accounting and selling real estate. The more skills you have to learn on your flip job site, the steeper the learning curve.
Is flipping houses a profitable venture?
Turning a profit on a house flip partly depends on factors you can control, such as the purchase price, the construction costs and your own effort, and partly on costs you cannot control, including market trends, the sale price and, again, construction costs.
Trench said that taking a little more time to work on a house you occupy by tackling projects over a couple of years instead of a couple of months, can save you money. You don’t have to pay premium prices for tradespeople and materials because you can schedule each stage of the renovation on a normal timeline, he said. And you can watch the market to sell at what you think is the best moment, instead of being forced to sell on a set schedule to repay your lender.
House flipping pros and cons
Pros
House flipping can be a fast way to capitalize on a steadily rising market. Watch two factors in the monthly reports issued by the residential real estate group for your area: days on market and asking versus sale price. If houses are steadily selling quickly — within 35 or so days — there is strong momentum in the market, and your well-priced, well-improved house has a good chance of selling as quickly as you need it to. If houses are reliably selling at rising prices that are close to the asking prices, you can likely turn that trend to your advantage, if you price your house accurately.
Cons
Savage and Trench said the biggest danger in flipping is overestimating your skills and underestimating the number of complications that can arise. The tighter the timeline, the higher the stakes for each missed deadline and late delivery. When complications converge, your project might be delayed for weeks while you reschedule deliveries, work and inspection. Meanwhile, interest payments accumulate, and the pressure to price the house ever-higher mounts. If the market does not keep up with construction delays, your profits will erode.
| Pros | Cons |
|---|---|
Allows flippers to quickly capitalize on sales if home prices continue to rise | Puts flippers under pressure to sell houses in short order |
May provide significant tax benefits in certain scenarios | Costs may rise quickly if deliveries, work and inspections don’t happen on time |
Skilled house flippers may be able to reduce costs by doing work themselves | Housing market may turn against home flippers at any moment |
The 70% rule in real estate investing
The “70% rule of thumb,” explained Trench, is that the cost of the entire project, including the purchase price, should be no more than 70% of the estimated market price of the completed project. So, if you buy a house for $60,000 and believe that it will sell, fully rehabbed, for $100,000, your construction budget would be only $10,000. For that kind of money, you would have to carefully choose what rooms to renovate and how much work you might take on yourself to minimize the cost. BiggerPockets offers a 70% rule calculator to help estimate a reasonable purchase price.
Common misconceptions about flipping houses
The idea that homebuyers only want move-in-ready houses is largely true, but nobody wants to trade structural integrity for fancy tile and glossy counters. Smart homeowners will always order an inspection from a licensed home inspector, who will find the corners you cut. Once word gets out that you are selling a sloppy flip, you will have to reduce the price, potentially undermining your profit in the process.
Even in a tight real estate market, buyers do not want to inherit legal problems. Always get building permits for the work you do, and make sure that the municipal building inspectors have signed off on all open permits, cautioned Savage. You must have an occupancy permit to sell the house. If you skip the permits and put the house on the market with illegal work, that fact might show up in the title search. As well, if any unpaid contractors put a lien against the house, that will show up in the title search. If somehow you skate through the title search and complete the sale of a house with illegal, unpermitted work, the buyers could sue you.
Rely early and often on an accountant who can guide you on everything from getting a business license to the corporate structure you will need to contain the risk of the project from your own household. If you manage the project yourself, you might have to get a contractor’s license and register with the state. And, of course, the accountant can provide invaluable insight into the net proceeds you might capture under various tax scenarios.
Frequently asked questions (FAQs)
House flipping can be a variation of an overall residential real estate investing strategy, said Savage and other experts. You might first aim to buy and hold properties but then have the opportunity to flip one. Once you’re a seasoned real estate investor, you will have the market knowledge to decide the most profitable strategy for each property you consider. You will want to run the numbers both ways and take into consideration your other life responsibilities.
You will need a down payment for the house purchase and enough working capital to carry the monthly loans, construction costs and, crucially, property taxes, inspection fees, insurance and the cost of professional tax and legal advice.
Flipping houses, properly done, can deliver income, but that income will come only at the point when you sell the property and pay everyone involved in the flip, from the lender to the landscaper. What’s left over is yours — unless you need it as a down payment for your next flip.
