House flipping gross profits averaged $58,250 nationally in early 2016, which was a ten-year high according to RealtyTrac. Average gross ROI (Return on Investment) exceeded 47% and was the highest quarterly ROI since 2012. It’s not surprising that these record profits have led to a surge in house flipping activity nationwide. Across the US, 60% of the markets tracked by RealtyTrac are experiencing higher rates of fix-and-flip activity this year when compared to 2015.
The enticement of robust profits has attracted many newcomers to the industry. While fix-and-flip can be a profitable venture for seasoned veterans, inexperienced rehabbers often make mistakes that can not only erode profits, but turn a profitable project into a cost overrun disaster. Here are a few common mistakes industry newcomers should try to avoid:
- Woefully inaccurate estimates of “as is” value, the renovation budget and ARV (After Repair Value). The biggest costs of any fix-and-flip project are the expenses for acquiring the property and the renovation budget. One of the best ways to hold the line on these costs is to invest in a pre-purchase home inspection. A professional home inspection sometimes uncovers hidden defects such as a crumbling foundation or leaking roof that may cost thousands of dollars to repair. Even if, after the inspection, the issues discovered are not enough to make you walk away, rehabbers can use these as bargaining chips to negotiate the purchase price.
Renovation work can range from inexpensive cosmetic fixes such as new paint to costly structural upgrades such as room additions. The best way to get a handle on renovation cost is to prepare a budget repair spreadsheet, which is used to track the various repairs needed throughout the house, and then walk through the property with a general constructor who can help you estimate repair costs. Rehabbers should also set some funds aside for unexpected repairs that become necessary after work is underway. A good rule of thumb is to reserve 10-15% of your overall budget for unanticipated fixes.
Work with an experienced real estate agent to build a more accurate estimate for ARV. Just because houses are near each other doesn’t mean that a price comparison will be meaningful, so plan to visit the neighborhood and evaluate the surrounding properties. Hire a licensed realtor who knows the area to help you calculate ARV, rather than relying solely on comparable sales data from online web sites such as Zillow and Realtor.com.
- Not having a detailed plan or exit strategy for the property. Before investing in a rehab project, you should always have an exit strategy and a plan for how to monetize the asset if the property doesn’t sell immediately. Exit strategies may include renting or selling wholesale to another rehabber.
When establishing the asking price for the rehabbed property, be careful not to over-price it. New listings attract the most attention and an overpriced house runs the risk of discouraging the initial interest of potential buyers. This can result in a house that sits on the market for many weeks with no bids. An outdated listing makes the sales process more challenging since potential buyers will assume there are hidden defects that make the property undesirable. Avoid the time, expense and numerous headaches of re-listing a property by setting a reasonable asking price upfront.
- Neglecting to recruit the necessary experts to your fix-and-flip team. Unless you are an expert in construction, undertaking a rehab project without assistance from a general contractor can be a recipe for disaster. You run the risk of cost overruns and repairs that are not up to code. Even if you have construction skills, a renovation project can require hundreds of hours, making it infeasible for rehabbers to work on multiple projects simultaneously without help from a general contractor.
In addition to hiring a general contractor, rehabbers should enlist the services of an experienced realtor and an attorney specializing in real estate law. Contacts, experience, and familiarity with the local market are all needed to market a property successfully. A savvy realtor can make the difference between obtaining full asking price and selling below market so it is usually well worth the cost of the commission to hire a good realtor. Similarly, an experienced real estate attorney can help you deal with brokers and oversee negotiating and executing a sales contract. Some states require assistance from an attorney to close a real estate sale and others limit the power of non-attorneys at closings by prohibiting them from drafting legal documents. Real estate laws are often vague and require interpretation by an attorney. Rehabbers should also build relationships with experienced hard money lenders. These lenders specialize in fix-and-flip loans and have the expertise needed to close financing deals more quickly.
- Over-improving the property. The goal of most rehabs is to maximize ROI, not create the most expensive house in the neighborhood. Over-improving a house can erode potential profits since buyers won’t pay full value for the upgrades. Typical over-improvements include adding too much square footage, making the house the largest in the neighborhood. Buyers may appreciate the extra space, but most expect the house to be priced within a range common to that neighborhood. A good guideline is that the house should be slightly better than or similar to the properties around it.
You can find out what upgrades add value by talking to local realtors who know what home features drive a higher sales price. According to a study by Remodeling.net, the three home improvements that usually pay for themselves are new garage doors, front doors, and roofs.
By avoiding these four common fix-and-flip mistakes, rehabbers ensure the best use of their time and resources, therefore maximizing the return on their investment.