July 31, 2022
House Flipping Basics
You've seen it all over T.V. Investors spending a minimal amount of money on the quick renovation of a property, and then quickly doubling their investment a few weeks later.
The term "Flipping houses" has become increasingly popular in recent years. With headline T.V. shows bringing the idea to the mainstream people have become more familiar and comfortable with the concept.
However flipping a house is not as simple as portrayed on reality T.V. There are various steps of the process that the average American is not aware of. This leaves the potential danger of incurring heavy expenses unless prepared.
The more familiar you are with the processes and dangers associated with flipping houses the more likely you are to make a substantial profit.
- House flipping is a real estate strategy for improving homes and reselling for higher value
- Knowledge of construction and marketable an investor to execute seamlessly
- Manage the finances by budgeting and creating timeless
What is House Flipping
House flipping refers to renovating a run-down house and then selling the house for a profit as soon as possible.
Let's run through an example to explain the process better. Say you're an investor looking to invest in an up-and-coming neighborhood. While most of the homes within the neighborhood range anywhere from $750,000 to $900,000, you are able to find a home for $600,000. These homes that cater best to prospective investors are found at a significant discount due to a variety of reasons, but it is most commonly because of foreclosures, bank sales, and general deterioration. Once you finalize the purchase, you inspect the house and find it needs renovations worth $75,000. These renovations can range from simple issues such as dated appliances and fixtures to significant and expensive structural issues. After putting in $75,000 worth of renovations, the market value of the home has increased by $150,000 and is now worth $750,000. Having invested $675,000 into the home, as soon as you sell the house for its market value, you will have made a $75,000 profit.
In order to be successful when house flipping, the price of the home should be only a part of the decision-making process. There are many homes that can be found lower than their market value, yet all will not be sold after being renovated. It is essential for investors to look at the demand for the property and its surrounding area before finalizing a purchase. Renovating a home in a bad neighborhood or declining city will have a significantly smaller pool of buyers in comparison to the opposite.
Using the rule of 70 is an excellent measure to prevent any potential mishaps. When house flipping, the rule of 70 measures the maximum price a house should be purchased to flip. You take the after-renovation value (ARV) of the house you are looking to purchase, multiply it by 0.7, and then subtract your potential renovation costs. The final value you are left with is the maximum amount you should look to spend on the property. Here's an example: You have done your research on a property and find that after spending $50,000 in renovation the property will be worth $500,000. By employing the rule of 70 you will find that $300,000 is the maximum you should spend on the property. $500,000 * 0.7 = $350,000 - $50,000 = $300,000
What to Watch Out For
Purchasing a home is an intricate and expensive process. Adding on to that unique financing options and the renovations that have to be completed, maintaining a budget throughout the process of house flipping is essential. When first purchasing the investment property, using the rule of 70 is an excellent measure to prevent you from going over budget. When it comes to the renovations, having estimates on every facet of the renovation by experienced contractors is necessary to having an accurate budget. Furthermore, having inspectors scoping out the property for any potential major issues will also provide you with an accurate estimate on the money needed to renovate, but can also prevent you from making an expensive mistake.
Many people aren't aware of how long it takes to find, buy, renovate, and sell a property. When it comes to market research alone, investors can spend weeks to months finding a property that they believe has the best potential for resale along with a fair price. Once investors have narrowed down a property, it can take a couple weeks to finalize the purchase of the property. Depending on the project, renovations can take a significant amount of time, and depending on the number of interested buyers selling a property can also take weeks. With large amounts of money being invested throughout the process, it is important investors are aware of how long it will take until they receive a return on the initial investment.
Throughout the majority of the house flipping process the investor is in charge of making all decisions. As a result of this, a lack of knowledge or familiarity when it comes to different parts of the process can cause extra costs and wastes of time. When it comes to dealing with people such as independent contractors and real estate agents the more experience you have the more likely you are to find success in what you are trying to achieve. While there is no reason not to jump into house flipping, making sure you are completely familiar with the process and interacting with people who have gone through the process before are ways to prevent any negative actions from happening.
Step by Step
- Market Research
- Find a house suitable for Flipping (cheaper than surrounding properties, follows the 70 rule, good neighborhood, desirable location)
- Get an estimate of the repairs needed
- Purchase the house
- Repair the house (sort out permits(if needed), hire contractors, architects, and engineers)
- Sell the house
How to Finance House Flipping
House flipping is not a cheap endeavor. Unless you are a hardened investor, you will likely encounter unique financing options when attempting to house flip. But as with any real estate loan, the basics of the process stay the same.
The easiest way to finance house flipping is by paying in cash. By paying cash, you are saved from paying any interest, and gaining any debt on the property. However this is very rarely used, especially by those attempting to house flip for the first time. Paying by cash offers less risk and a unique degree of flexibility yet finding the funds needed is the main issue.
Hard Money Loan
A hard money loan is a short term loan secured through private investors or companies. The catch of a hard money loan is the high interest, which can reach as high as 15%. These loans can get extremely costly very quickly, especially if there are any fees attached to the loan. Usually wealthy investors are the ones using hard money loans in order to avoid the lengthy processes of bank loans.
Cash Out Refinance
A cash out refinance loans in money based on the equity you own in your current home. If the equity you own in your current home is greater than the equity owed, you are able to cash out on the equity owed into borrowable funds. If your home has also increased in value since the original loan, you may be able to have both increased funds to spend on a house flip as well as a lower monthly payment.
Home Equity Loan
When using a home equity loan your current home is used as collateral in the loan. You are able to loan money based on the equity in your home, and then pay back the money owed in monthly installments. This loan option is extremely risky. Any potential to not fulfill the loan could lead to dangerous consequences.
The Bottom Line
House flipping is an effective way to invest and grow your money. Yet there are many factors that can prevent you from maximizing your investment. For new investors, it is essential to be aware of all the steps throughout the process. Finding the best avenues for market research and repairs are things that can save you any future costs or headaches.