for Every Homebuyer
The Plan:
The fix & flip strategy is fairly self-explanatory: an investor will seek out distressed properties at bargain prices due to their poor (or otherwise sub-optimal) condition, and rehab the property until (generally) it is in like-new condition. Properties are either sourced by scouring the market of interest for good opportunities, enlisting the aid of a reliable property wholesaler or real estate agent, or contacting the owners of distressed, off-market properties that would present attractive investment opportunities.
The saying “easier said than done” was likely created specifically with this strategy in mind. However, the end result of a well-executed flip not only yields significant profits for the investor, but also tends to be immensely satisfying. Properties can be transformed from an unlivable state to something you would see advertised on the front page of a home improvement magazine.
It’s absolutely possible to execute this strategy without any of the following preparations, but it would help for you to have any sort of expertise in construction, real estate, or design. If you don’t, rest assured that scores of successful flippers have no significant experience in any of those areas either, but just be ready to invest money and time into locating and hiring a dependable team of licensed contractors.
Fix and flip projects are also purported to be performed within a healthy margin of safety known as the "70% rule". In this methodology, investors restrict themselves to purchasing a pre-flip property for no more than 70% of its ARV (after repair value), minus the costs of the repairs it will take to reach that new value.
To put this rule into practice, let's say that you find a property you are interested in flipping. Through careful and realistic calculations based on recent comparable home sales in the immediate vicinity of the home, you find that the ARV of the distressed property will be $200,000 after necessary repairs and improvements are made. You then proceed to perform calculations based on the quotes of professionals or dependable personal experience, and determine that the cost of materials and skilled contractors (if needed) amount to $40,000 total.
In the above scenario, employing the 70% rule will result in a maximum purchase price of $100,000. 70% of the ARV of $200,000 amounts to $140,000. However, you must also subtract the costs of repair and improvement from this figure, leading to a final amount of $100,000. This will accomplish two important objectives: maximizing your profit margins, and forming a strong margin of safety to counter the unexpected increase in costs that may appear, as well as any other unwelcome surprises.
Overall, this is a very demanding process, and this basic rundown does not fully encompass the level of the intensity and involvement that will be demanded of you as a fix and flip investor. However, there is a reason this is a firmly entrenched tactic in the real estate investing scene, and those with the drive and desire to watch a scrap heap transform into a gold mine through their efforts will make great use of this method.
Process Breakdown
Step 1: Investor Identifies Opportunity
Find a distressed home that presents solid profit margins while keeping the 70% rule in mind.
These are usually off-market properties, though every so often you can find a good flip through an MLS site. You can use property wholesalers or real estate agents to help you narrow down your search to a handful of potential properties for your project.
Step 2: Investor Thoroughly Evaluates Property
Just because on-paper margins look attractive does not mean you pull the trigger before scoping out the property yourself. Identify any and all possible issues and take them into account before you submit an offer. You should absolutely walk through the property and inspect all pertinent areas, ideally with a skilled contractor who can point out areas of concern as well as provide estimates for the cost of the required work and materials.
Should you find the property a suitable investment opportunity, this is where you will not only form and finalize your rehab budget with itemized expenses covering everything from plywood to professional labor, but also calculate a realistic ARV. You can hire an appraiser to perform a comparative market analysis (CMA), or do a rough calculation using the steps below:
Find a comparable property - Ideally this property has similar square footage and similar features to what your home will look like post-rehab. These comparable properties, or “comps”, should have sold recently (usually within past 3 months) and should be located ideally within 1 mile of your property.
Calculate the price per sq foot of the comps - Simply divide the selling price of the comparables by their square footage. For example, with a $300,000 sold price for a 3,000 sq ft property, the result would be $100 per square foot. Average the results across the comps you found; ideally, you should have found at least 3 comparables.
Use resulting average price per square foot to calculate ARV - Multiply your property square footage by the average price per square foot that you calculated for your comparables. The resulting number will be a rough estimate of your ARV. For example, using the last hypothetical figure of $100 per sq ft, if your property is 2,000 sq ft, your approximate ARV would be $200,000. Bear in mind that in a housing market with a downward trend in home values, you will want an even larger margin of safety for your ARV to account for the potential decline in value during the flipping process.
Once you have carefully carried out the formulation of a realistic ARV and a conservative improvement budget, you are now ready to seek financing.
Step 3: Investor Seeks Financing
Note that it is not always required to complete this step before submitting an offer, but it is highly recommended you do so as to protect your earnest money deposit.
Financing-wise, flipping distressed properties generally strays outside the territory of regular conventional or government loan products, at least while the property is in an uninhabitable state. Lenders offering traditional programs such as agency loans (conventional, FHA, VA) will avoid giving you a mortgage loan if the collateral for that loan is a property that’s rundown and undesirable. After all, the purpose of collateral in a loan is to ensure that there is something of value to sell should the borrower default, thereby allowing the lender to recoup their losses. Collateral that is undesirable to the average homebuyer is an incredibly risky arrangement.
This is where hard money loans often come into play. At face value, the costs and interest rates associated with hard money financing may seem very high compared to traditional mortgages. However, these are interest-only temporary loans only meant to last the duration of your repair work as well as the time it will take to sell off the property. Hard money lenders are the few lending institutions willing to accept distressed properties as collateral for large mortgage loans, and hard money loan programs are easily the most popular programs through which fix and flip projects are financed.
Armed with your itemized repair plan and budget along with skilled contractor quotes, you can approach a hard money lender for a fix and flip program that will not only finance the initial purchase of the home, but also the cost of repairs and improvements. We work with many hard money lenders, and can provide you with financing up to 90% of the initial purchase contingent on experience level and ARV. Upon examining the scope of the project, the budget, your down payment source and your FICO score (income is not typically documented for hard money loans), you will receive a loan approval that will allow you to move onto the next step with the confidence of financial backing.
Step 4: Investor Submits Offer and Negotiates
Bargaining down the price isn’t as easy as it may seem. Experienced flippers recommend negotiating face to face, justifying your offer by pointing out various aspects of the property, the costs associated with improving the property, and how they will affect your ability to renovate and resell. There is no better way to ruin your reputation and turn a conversation sour than to simply demand lower pricing without offering any justification for that pricing in return.
Once you and the seller reach an acceptable price, your offer culminates into a fully signed purchase agreement. Take this back to your lender to begin the loan closing process to receive your purchase and/or renovation funds.
Step 5: Investor Improves and Repairs Property
The completion of your home improvement and repairs should ideally take no longer than 2 - 3 months, but time usually runs over budget. Remember that the faster the process is completed, the less interest you will pay on your loan, the less housing market variables you will have to contend with, and the sooner you can move onto the next project. The quality of your repairs should never be compromised on for the sake of time. Quality improvements will sell themselves, while rushed and sloppy improvements can ruin an entire flip.
Step 6: Investor Markets and Sells Property
Many habitual flippers have a real estate license just to avoid paying commission each time they sell, but in the event that you do not, avoid cutting corners here. Hiring a competent listing agent that will take care of marketing and showcasing the property in your stead can often produce a return on the cost that they ask for their services. It is recommended that you also invest in having your property professionally staged rather than leaving it unfurnished. A well staged property can create a striking impression on home buyers visiting the property.
Once the home is sold, the fix and flip mortgage loan will be paid off in full, and the rest of the proceeds will be your profit. If you were resolute in your efforts to maintain a great safety margin and planned your numbers conservatively, the chances of significant profits in the stage of the process are quite high. The proceeds from the flip can be used for any variety of reasons, but more often than not, they are reinvested into more real estate ventures, whether fix and flips or otherwise.
Summary
Pros:
When executed well, the returns can be incredibly high, sometimes amounting to the equivalent of a small or moderately-sized annual salary for the area for a few months of work.
Flipping can be performed fast compared to other investment methods. Unlike longer-term buy and hold strategies, the entire flipping process can be achieved in a matter of months.
Flipping is a very flexible method, with the degree of renovation and time expenditure being entirely at your discretion. Your personal schedule preferences can be accommodated.
Cons:
This method is inherently riskier than other methods, such as BRRRR or house hacking, as a poorly-executed flip can leave you with a debt-ridden home that no one wants to buy.
The process is intensive, and may be difficult to manage as a side-hustle unless much of the labor is outsourced, which would reduce profit.
Many costs are involved: closing costs, realtor commissions for both the purchase and sale, contractor payments, etc.
Conclusion:
Overall, the fix & flip method is best utilized as a dedicated endeavor for the real estate investor with an eye for great deals in great locations, as well as either experience or connections with individuals skilled in renovation and the real estate market. It is an inherently risky method that likewise presents higher potential returns in a short timeframe, best suited for the more experienced breed of investor, or the well-connected and determined investor with access to mentorship and in a comfortable financial position.