By Ron Wynn
There are a lot of amateurs these days trying to get in on the game. Flipping homes is “the dream” occupation because watching the reality flip programs on Bravo and HGTV make it look like the easiest way to make the big bucks with no downside.
As a realtor of many up and down markets, let me quickly caution you, it’s not as simple as it looks. There are many considerations here, but first and foremost, please enjoy the TV programs and Youtube. Before spending your money or borrowing against the equity in your home, be sure to be well informed about the many factors that determine your final outcome.
The flipper’s secret is “annualized return.” Even after figuring your rehab costs, your closing costs, your proposed selling price, and the possible rise and decline in the market, the time you are either paying for borrowed capital or the time you are tying up your personal invested capital is very important. If you put out $200,000 in cash and borrow $500,000 at 5% interest, planning to finish your project in 6 months, to find out later that it in fact took 12 months, your annualized return was cut in half. If you anticipated a profit of $100,000 in 6 months, but it took 12 months, your return on investment declined by 50%, and then it is still subject to tax reporting based on ordinary earned income.
Of course, there is no guarantee at all to any profit, and a loss could render you bankrupt if you are not otherwise well covered. There is no guarantee that the market will remain stable, and there is always a chance, even if you have strong comparable sales to prove the value for your beautiful, newly remodeled masterpiece that the market may no longer be as a strong seller’s market. There could easily be an increase in the interest rates, or an economic hiccup that might cause a decrease in activity, plus an increase in unsold inventory, more price reductions, and longer days on the market. Have you factored all these possibilities into your equation?
Remember these unknowns:
- Will the cost of materials and labor hold, and will the bids you get be reliable?
- Will unanticipated things come up once you open up walls, ask for city permits, and comply with soil and retaining wall requirements, drainage issues and retrofit nuances?
- Are you being optimistic or realistic about the time required to obtain city approvals, HOA approvals and possible obstructions from neighbors, coastal commission issues and setbacks, neighborhood review boards, or natural causes like rain and what have you?
- Are you factoring declines in sale prices based on previous sales per square foot should there be a shift in the market?
- Are you adequately and realistically looking at adjustments for a busy street, a fixer-upper next door, unsightly power lines obstructing a view, high power transformers nearby, a less desirable school district, a home with low ceilings, a poor floor plan or with poor natural light, or a home that lacks a backyard or adequate parking?
- Could there be an oversupply of homes in your price range with a limited number of buyers by the time you are on the market?
- Will you have adequate reserves if you run short on cash so that you can move forward without needing to scramble for new investors after the fact?
The bottom line: Don’t believe everything you see on TV, and know this is serious business with little room for error. The key is to buy right, from the beginning. Be location conscious, be realistic about your costs, and make good use of your time. Wasting 6 moths to draw plans and obtain permits could be your kiss of death before you even start.
Be realistic, keeping reserves and always anticipating your cost at 10% higher than you projected as you figure your pro forma analysis. If it doesn’t pencil out this way, don’t be optimistic saying “somehow it will come together.”
That’s going to dig you a grave for sure.
Ron Wynn is a local Coldwell Banker agent, who has ranked as one of the top .5% of brokers nationally.