How can your advice help your friends Bob and Jannet avoid the perils of inexperienced flipping?
You have two good friends, Bob and Jannet, who have been married for the last few years and just recently started watching cable TV shows on home flipping. Bob has experience in home repairs and has done the right amount of work on his own home, and Jannet knows a lot of people in the local area.
On the surface, this sounds like a right combination of people to start into the exciting world of home flipping, but what this couple doesn’t understand are the hidden perils associated with the economic investment in buying an investment property.
This is where you can help them with your expert advice.
Bob’s experience in home repairs may not extend to cover him with all repairs that are needed for the property they are considering buying. Have they had a chance to have someone inspect the home which is licensed and trained in enough different disciplines to be able to recognize all the problems that could arise with the house? Each of these problems will be additional money they will need to spend to repair before they can sell the home and if it is something that Bob is unable to do himself, then it will cost even more.
Considering the value of the home, there is an upward limit on how much a home for which a home will resell. Even if you place a million dollar home in a hundred thousand dollar neighborhood, it will never sell for a million dollars. Understanding how much of the value of the property is tied into the location and what the max price the home will be able to sell are all excellent pieces of information they will need to know before buying the home. If the house costs $80k and the most it could sell for is $100k, then there is only $20k available to do any required repairs, upgrades, and collect a profit.
But there is a cost that your friends can easily overlook. These costs are collectively referred to as carrying costs and reflect how much money it costs to own a house for a while. Property is said to appreciate, but this is not entirely accurate. Buildings depreciate over time, but more to the point you have costs to offset any increase in potential future sales without a change in the local economy. These costs include taxes, utilities, and insurance as essential items. If your friends purchased the home on a short term loan, then there will also be interest expenses. The result is a home needs to be sold as quickly as possible after it is purchased and at a high enough price for a profit.
Federal Housing Administration guidelines limit how fast you can sell the home, however. If you are trying to sell the house in Columbus, you will frequently be presented with offers from buyers with FHA loans. In these instances the offer on the home cannot be made less than 91 days before the home was last transferred to the new owners. So, at a minimum, the house will have to be held and carrying costs paid for three months before an offer can be written and then another month before it can be closed.
When you’re on the outside looking in it can appear that many of the rules and regulations are specifically designed to limit how much profit an investor can gain from fixing up property in a given neighborhood, and to a lesser extent, this is true. Protections have been put in place where residents in lower income neighborhoods, who often are renting their homes, are not faced with the threat of raised property costs from rapid investment and gentrification.
So how do the other investors make money flipping homes? Some of your most successful home flippers operate as if they were home builders. They purchase an older home the same way a builder would buy an empty lot. To build a new home in that location and the cost of the house and the lot is a purchase cost for the modern home. Subcontractors working for the investor directly with labor and costs purchased at much cheaper rates than most people can find them and anything that can be salvaged from the previous home will be saved and used in the new house. These investors purchase and sell their own homes and often is a licensed Real Estate broker themselves to avoid paying another company the fee for this service.
Can your friends make money on their plan to flip homes? Yes, there is still money to be made, but they have to be smart about it, and they have to be willing to put in the effort. Let your friends know they need to start watching the auction sites to see what foreclosures are being auctioned off and to develop contacts with banks to see what new properties will be coming on the market. No one will work as hard for you as you when it comes to finding these hidden homes, and you will need to know their potential value. Also, be prepared to sell them by the owner or develop a relationship with a single Realtor for a discounted rate when selling multiple houses over short periods.
Another option would, of course, be to look into buying homes in better shape and renting them, but that’s another topic.