Home Flipping 101

Happy month of June!  As we enter another hurricane season, here is last year’s article on hurricane preparedness to get you refreshed.

Otherwise, this month we will talk about Home Flipping 101!

Q:  I am very handy in doing home repairs.  I am interested in learning about rehabbing homes and get into the home flipping business.  Can you help me get started?

Certainly!  We get asked quite often about how to get started in rehabbing and flipping homes.  Many people have seen shows on HGTV about home flipping.  These shows tend to be more for entertainment than education.  They can create false expectations.  What we will share here are from our actual experience of working with home flippers in Orlando.  It may not be comprehensive, but it is accurate.

The general idea is to buy a fix-upper property below market value, renovate it, then resell it at a higher price for a profit.  It is important to plan out the entire operation from the beginning.  This includes finding the right property with sufficient margin, have a clear understanding of what work needs to be done and how much that will cost, and last but not least, know how much you will likely receive from the sale, which pays for the whole project and hopefully with a profit.

Let’s break this down step by step:

1     Funding

This should be your first consideration.  You should be prepared to purchase with cash.  True profitable flipping opportunities are usually with homes that need a lot of work.  Homes in such condition are usually not financeable.  That is, you won’t be able to find a bank that will lend you money because of its condition.

If a home only needs a fresh coat of paint and minor repairs, you won’t get it much below market value.  So, understand that the best opportunity is with homes that others won’t touch. At the extreme, I’ve seen homes with water damage, mold issues, even fire damage turned into profitable flips.  This need not be the case of course.  Many profitable flips are with very manageable renovations.

The source of your funding can be your own money if you have the cash.  Some clients use home-equity loans on their primary home to fund their flips.

Other clients use “other people’s money”.  This includes an equity partner/investor who puts up the cash, a group of partners that pools their money together, and lastly, “hard money lenders” that make short term loans for home flipping, but usually at an interest rate above 10%.

2    Finding the Right Property

In part, the availability of funding will determine the type of property you can flip.  More money you have, higher price point you can go, and more ambitious project you can undertake.

A very important thing you must do with your real estate agent from the onset, is a realistic valuation projection of the finished home.  That is, you need professional advice on what the renovated home will fetch in the current market.  This is how you can calculate the acquisition price, renovation budget, selling expenses, and profitability.  If the numbers don’t work out, skip the property.  It is not the right one.

I’ve seen failed flips where the flippers did not consider the resale market.  They presumed that as long as they added fancy improvements to the home, buyers would buy it.  This can result in over-improvement.  For example, if a neighborhood’s average sale price is around $250k, it may be difficult to sell a home at $300k price point, even if it’s nicer than the other homes.

This is where a real estate agent is critical to your success.  You should have the right professional help in purchasing and selling of the product of your hard work.

3     Rehab Work 

This is the area that you may be most familiar with already.  You can do the work yourself if you have the time and skill.  Hire professionals if you don’t.  It’s all about budget. Everything eats into the potential profit.  Some flippers ultimately make money by employing themselves to do the renovation, others operate as contractors and coordinate various vendors.  Staying on budget is critical.

4     Resale

This is an exciting step.  You’ve completed your work.  The once ugly property is now a beautiful home.  Your real estate professionals can come in and do their work to stage and market the finished home.  If everything is planned well, this is the realization of all your projections.  Hopefully you will have the right buyer that successfully secures a mortgage and purchases this home!

5     Calculations

This is a recap on running your numbers.  The sale price minus the closing costs, renovation costs, and purchase price is your net profit.  Remember that profit is a short-term capital gain, IRS will claim a part of that at year end.

Bonus

In wrapping up, I want to mention another way of doing home-flips if you are not a professional flipper.  Some people buy a fix-upper or outdated home, move into it, and slowly improve it over 2 years.  Once the 2 years is up, they sell the renovated home and do the same thing all over again.  This method allows them to avoid paying capital gains taxes.  Because it is their primary home, once they meet that 2-year holding threshold, the current IRS rule allows tax-free gains of $250k for singles and $500k for married couples.  Pretty nice right?

I will stop here.  Please feel free to contact us if you have an interest to explore this further!

Until next month, take care and stay cool out there!

~ Yien and the Yao Team

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