How House Flipping Works
It looks so easy! Buy a house, make a few cosmetic fixes, put it back on the market, and make a huge profit. At any given time, a half-dozen shows on television feature good-looking, well-dressed investors who make the process look fast, fun, and profitable.
And plenty of homes are getting flipped. Flipped homes accounted for 6.2% of all home sales in the U.S. in 2019, an eight-year high, according to data ATTOM Data Solutions published in its 2019 U.S. Home Flipping Report.1
Yet, the road to real estate riches is not all about curb appeal and “sold” signs. Far too many would-be real estate moguls overlook the basics and end up failing. So, what are the five biggest mistakes would-be Flippers make? And how do you avoid them?
- Flipping houses is a business like any other: It requires knowledge, planning, and savvy to be successful.
- Common mistakes novice real estate investors make are underestimating the time or money the project will require.
- Another error house flipper make is overestimating their skills and knowledge.
- Patience and good judgment are especially important in a timing-based business-like real estate investing.
How House Flipping Works
Flipping (also called wholesale real estate investing) is a type of real estate investment strategy in which an investor purchases a property not to use, but with the intention of selling it for a profit.
That profit is typically derived from price appreciation resulting from a hot real estate market in which prices are rising rapidly or from Capital Improvement made to the property—or both. For example, an investor might purchase a fixer-upper in a “hot” neighborhood, make substantial renovations, then offer it at a price that reflects its new appearance and amenities.
Investors who flip properties concentrate on the purchase and subsequent resale of one property, or a group of properties. Many investors attempt to generate a steady flow of income by engaging in frequent flips.
So how do you flip a building or house? In simple terms, you want to buy low and sell high (like most other investments). But rather than adopt a Buy and Hold strategy, you complete the transaction as quickly as possible to limit the amount of time your capital is at risk. In general, the focus should be on speed as opposed to maximum profit. That is because each day that passes costs you more money (mortgage, utilities, property taxes, insurance, and other costs associated with homeownership). That is the general plan, though it comes with several pitfalls.
Where to Start
The first, best piece of advice is to limit your financial risk and maximize your return potential. Put simply, do not pay too much for a home (by knowing what it is worth) and make sure you also know how much the necessary repairs or upgrades will cost before you buy. Having that information, you can then figure an ideal purchase price.
The 70% rule states that an investor should pay no more than 70% of the after-repair value (ARV) of a property minus the repairs needed. The ARV is what a home is worth after it is fully repaired.2
Here is an example: If a home’s ARV is $150,000 and it needs $25,000 in repairs, then the 70% rule means that an investor should pay no more than $80,000 for the home: $150,000 x 0.70 = $105,000 – $25,000 = $80,000.