Making no deal is preferable to making a bad deal. “Caveat emptor” (“let the buyer beware”) should be the guiding principle of every fix-and-flip investor. A bad deal can quickly wipe out profits accumulated over multiple successful transactions. However, investors can maximize their chances for successful flips by avoiding these five common property investment pitfalls.
Poor Property Location
You’ve found a nice house at an affordable price, and you’re preparing to close the deal. This is the moment to take a step back and avoid a common investor pitfall, namely, failing to consider the character of the surrounding neighborhood. An undesirable location erodes property values and makes it harder to find buyers. Even a great house generates sub-par returns if it’s surrounded by run-down shacks or located far away from basic amenities. Investors can avoid this real estate pitfall by investigating neighborhoods on websites such as Zillow, Trulia and PropertyShark.
Pre-purchase due diligence should focus not only on comparable home values, but also on how long houses in the neighborhood have sat on the market. A sure way to increase holding costs is to buy in areas where homes take many months to sell. In addition to examining comparable sales data, investors should walk around the neighborhood assessing the condition of streets and sidewalks. Rehabbers should know the distance to the nearest grocery store and what the police blotter says about neighborhood crime statistics. If you are reluctant to walk around the neighborhood yourself, prospective buyers will hesitate as well, so think twice before purchasing in sketchy areas.
If a neighborhood is in the early stages of gentrifying and you’re willing to hold the asset for several months, it sometimes makes sense to buy while prices are low in anticipation of rising values. However, if your goal is a quick profit, you should limit your fix-and-flip projects to neighborhoods that already attract plenty of buyers.
A common pitfall for fix-and-flip investors is over-improving properties by adding high-end flourishes that overrun budgets or are inappropriate given the nature of the neighborhood. An investment in remodeling a McMansion, for example, is unlikely to pay off if other neighborhood homes are two-bedroom bungalows. Your main priority when remodeling should be a finished product that appeals to most buyers and blends into the neighborhood.
Unusual designs and amenities can make a property difficult to sell, so it’s best to confer with local realtors before rehabbing to find out what options local buyers want. Your plan should be to spend just enough on upgrades to meet or slightly exceed market demand without overspending. In neighborhoods where Home Depot finishes are the norm, buyers are unlikely to pay up for custom countertops and tilework.
Excessive flourishes should be avoided, but upgrading badly outdated systems and appliances is a necessity. Few home owners are willing to settle for a decrepit AC system or avocado-colored appliances left over from the 1970s. Updating basic systems and appliances pays for itself in the long run by making the house more marketable.
Rehabbers also need to pay attention to outdoor spaces. Most families expect a multi-bedroom home to be surrounded by a good-sized yard. If the yard is already tiny, think again before adding an extension to the house. A lack of sufficient outdoor space can be a deal breaker for many buyers.
Choosing the Wrong Contractor
Successful rehabs begin with the hiring of an experienced, reliable contractor. The right contractor can be invaluable in avoiding cost overruns, keeping projects on schedule, and advising on best construction practices. The scope of the project should help guide the contractor hiring decision. A solo operator working alone may be able to handle small jobs, but major renovations are likely to require the combined capabilities of a larger crew.
You can find a reliable contractor by asking for recommendations from other fix-and-flip investors and networking at REIA (Real Estate Investors Association) events. Rehabbers should plan on interviewing multiple candidates, checking references, and visiting previous worksites to gauge the quality of work firsthand. Once you have narrowed your initial list, ask each candidate to provide a line-by-line quote on the job so that you can compare estimates for hours and cost involved in each stage of the rehab.
When you hire a contractor, be specific about assigning responsibilities. An experienced contractor will know what permits are necessary, but it’s ultimately the responsibility of the fix-and-flip investor to make sure permits are obtained. Beginning a rehab project without the required permits can be a costly mistake that results in fines, pushback from the lender, and a house that can’t be offered for sale.
The most common mistake by fix-and-flip investors is underestimating costs. Every rehab budget should include at least a 15-20% cushion to cover unforeseen expenses. Rehabbers must also include homeowner’s insurance and property taxes in their budget. In areas that are known fire risks, homeowner’s insurance can be prohibitively expensive, and property taxes in some California counties (Marin, Santa Clara and San Francisco, for example) are more than twice the national average.
Costly structural issues can be avoided by hiring a home inspector. Houses can look fine from the outside while hiding expensive problems like leaky roofs, insect damage and faulty foundations. In addition, rehabbers need to be realistic about their own capabilities. Too frequently, investors try to save a little by doing the work themselves, and end up spending a lot on professionals who can fix their mistakes. When in doubt, hire a professional. The work will be higher quality and completed in a more timely manner.
No Exit Strategy
Every investment, including property investments, needs an exit strategy. Experienced rehabbers always have a plan B ready if a property doesn’t sell in a timely manner. This could include renting the property out or selling to a wholesaler. Investors should have already laid the groundwork for implementing a Plan B by researching rents in the neighborhood and having a marketing plan ready that targets renters.
By following these five simple guidelines, investors can avoid all-too-common property pitfalls, and increase their likelihood of consistently profitable flips.