4 Things to know before flipping a house

February 13, 2021 / 6 minutes of reading

Flipping houses is one of the best ways to make money in real estate. Not only that this business allows you to make your own schedule, but you also make good money if you manage to find good deals. Before you start flipping houses, however, you must understand that your success will depend on how you approach the business.

How much you know and the research you do, your budget, location, bargaining power, and much more will determine your success. Even if you do house flipping on the side as a hobby, you should treat it like a business to avoid losing money.

Here are 4 things to know before flipping a house to improve your success rate.

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1. Preparation is essential when it comes to flipping houses

Just like any other business, you should have enough preparation before you flip a property. Your preparations should go through an evaluation of your resources, location, budget, education, research, etc.

When going through your preparation phase, try to answer the following questions.

How much money will I need to flip a property?
Can I afford this house?
How will I finance all costs (purchase, interest, insurance, renovations, etc.) related to the property?
How long will it take to sell the house?
Who is going to be my contractor?
What customers I am targeting?
How long can I afford to hold the house without affecting my finances or losing all gains?

Answers to these questions will help you get started and give you an idea of what you are dealing with. Also, these questions will help you formulate an appropriate budget for each property.

A well-prepared house flipper is one who has done a lot of research about the real estate market in the area they want to conduct their business. For example, you must know how long it takes to sell a property in the area and whether you are in a seller’s market or a buyer’s market.

Related: How To Invest In Real Estate?

2. Do not ignore the rule of 70%

One of the most important things to know when flipping houses is that numbers matter. Everything in real estate is about numbers. You should run your numbers before putting your money down.

If your numbers do not add up, walk away. This is because most projects cost a little extra due to unforeseen conditions which pushes your budget a bit higher. So, if the numbers are not looking good on paper before you tear the house down, you will definitely lose money on that deal.

When flipping houses, take into consideration some rules used by many successful house flippers around the country.

The most important rule to know is the rule of 70% or the rule of 70.

What does this percentage mean? Why 70%?

As noted by Anchor Loans, the rule of 70 says that a house flipper should pay 70% of the after-repair value subtracted from any other expenses associated with the houses such as rehab, interest, tax, insurance, etc.

Example of the rule of 70

The following example can help you understand the rule of 70 and how to apply it.

Let’s assume that you want to flip a house in your favorite neighborhood. After doing a little bit of homework, you realized that its after-repair value (ARV) is $500,000. Your job is to calculate how much you should buy the house for and make a profit if you will resell it for $500,000.

From the rule of 70%, our first step is to calculate 70% of the after-repair value(ARV) which is $350,000 (70% of $500,000).

After talking to your contractor, you estimated that it will cost you $50,000 to do all renovations.

You also learned that you will hold the property for 3 months before it is sold. During this period, you will spend $20,000 in holding costs (mortgage payments, insurance, tax, and other expenses).

Now let’s calculate the total amount you will spend on the house after buying it (but before it is sold).

With quick math, you will spend a total of $70,000 ($50,000+$20,000).

Now let’s subtract this amount from the 70% we calculated earlier. So, $350,000-$70,000 = $280,000

From the rule of 70%, you must pay at most $280,000 to buy this house.

Paying less money to acquire the house will help you financially in case you have to hold the property much longer or encounter other costly problems.

Related: How Much Does It Cost To Buy A House?

3. Time is money when flipping a house

Before flipping a house know that house flipping returns are time-sensitive. The longer you hold a property the more money it costs you.

Why would this be true?

Most people finance their house-flipping businesses with loans. The downside of loans is that you will pay interest and monthly payments as long as the house is still in your hands. There are also other payments you should expect such as mortgage insurance depending on your downpayment.

In order to minimize these expenses, you should get rid of the property as soon as possible. A common mistake people make is to hold a property longer than they are supposed to due to higher price expectations.

This is not a bad thing as long as the house is worth the value. However, you could end up losing your gains through loan payments, interest, insurance, and other related expenses.

You might also like: How to avoid private mortgage insurance?

4. Do not bite more than you can chew

Understanding your budget is very important. A common mistake people make when flipping houses is to buy houses that are too big to flip.

Some house flippers run out of money in the middle of their projects. This is because they:

Buy big houses: A much bigger house will require more time and money to flip. Big houses take a lot of resources and manpower to renovate. In addition, there is less demand for big houses. These factors increase your expenses on the house, make you hold the house longer, and reduce your return on investment.

Buy old houses: New house flippers fall for old houses. They think that you can make a ton of money if they buy cheap old houses. This is a bad idea. Matter of fact, you should stay away from really old houses. Think of old houses as very old car that can fall apart at any time. You take it to a mechanic for an oil change and later learn that you need a new battery, engine, brakes, etc. This is the same case for old houses. You never know what to expect with old houses. You could discover that the house has structural problems, plumbing issues, etc. after tearing walls apart. Or maybe past renovations used materials that are no longer accepted by the building code in your area. Always remember that you cannot bury problems once they are discovered.

Never done proper budgeting: Underestimating the true cost of the house is differentiating winners and losers. The cost of the house should include every dollar you will spend on the house from the day you buy it until it is sold. Knowing this amount will help you decide whether you can afford the house or walk away.

To avoid all these problems, you must flip houses that correlate with your financial capabilities and market conditions.

Image credit: Warp1 From Pixabay