Flipping a Home the Safe Way - Real Estate Investing
Some times a Flip turns into a Flop. Flipping a Home the safe way is very important; especially for the smaller investor that cannot afford to loose money. I think real estate investing is a great way to invest, even for small investors. Over time there is lots of money to be made and it is a physical asset. There are lots of tools and things to consider when Investing in Real Estate. I recommend you request my Book on Real Estate Investing for details. But with any Investment there is always risk.
I once heard a big time real estate investor say that one in six investments ends up going wrong and loosing money. I think the small scale investors I tend to work with have done better than that, but you still need to know what you are doing.
When Buying a Home to Flip basically you are looking for a home that has issues of varying degrees that can range from cosmetic to series defects. The goal is to get the home at a low price, fix it up and sell it for a profit. In general I think flips offer the best short term profits, but also have the biggest risk. What are those risk?:
Your cost of the home and repairs end up exceeding what you can sell the home for. This can happen due to hidden issues you do not see at the time of purchase or bad estimates of cost up front.
Loan cost and other administrative cost, sales cost and such eat up your profits and turn this into a loss.
The market changes. Right now this is an up market and many flippers have been making good money on the rapid rise in prices; but it does not always go up fast, and sometimes it comes down.
Normal risk associated with any business; theft of materials, vandalism, liability issues.
My Background before Real Estate was Risk Management. Two basic ways to Reduce exposure to Risk is to Avoid Loss and Mitigate Loss. In short do not experience the loss in the first place, and when you do experience a loss take steps to cut the cost of that loss.
Loss Avoidance in Real Estate Investing:
The obvious thing to do is not to engage in the activity causing risk in the first place. But that is not realistic. Everything has risk, including putting your money in the bank or in your mattress. At this point we have assumed that Real Estate Investing is where you want to be, so how do you avoid risk? Let's look at the 4 points above:
You need to have a good understanding of the cost of home repairs. Be able to spot issues as you walk a home. Be mindful you might not be able to see everything or have utilities on before you buy. In some situations you may not even be able to get into the house. Many people doing these types of investments have a strong background in the trades, or a good working relationship with people that can do the work.
Keeping cost to a minimum is key. Knowing what buyers want in your market and a good eye for putting in the kind of things that attract buyers at a good cost is essential. For example, in this market Granite Counter Tops sell homes and are generally thought of as expensive. However, there are ways to get Granite Counter Tops economically, by using seconds, left overs, or things with slight flaws; piecing is generally acceptable (as long as there are not too many seams).
One time I was with a clients and we were looking at a property with flip potential. They had a total of 13 offers. They wanted a highest and best. We looked around and wondered if we won the bidding what we might be missing. We just let it go. I know that who ever bought it had to hold it a long time before they could flip.
Loan and administrative cost can be very expensive. It is not just the interest on the loan (which can be well above market for a flip loan), but points and other cost. There is Title Insurance and Escrow Fees, and lastly those Real Estate Agents need to be paid.
Every situation is different, I understand the importance of Leverage in Real Estate, but this might be a situation where you might want to pay cash if you can. But be sure to include these cost in your budgeting of the project. If you have a regular real estate agent you should get a good price on the listing fees, but beware of trying to sell it yourself or using an agent that will cut corners when marketing the property. Don't be penny wise and pound foolish.
Know your market inside and out. Read and get opinions about where the market is headed. This is where a good real estate agent can be helpful. Most good agents have a gut feeling about the market before the stats make the newspapers. Do not make decisions on hopes and dreams, but on solid evidence. Be mindful know one knows the future for certain, you can make educated evaluations.
First off make sure your property is well taken care of, remove hazards or fence them off (protect and isolate). Make sure the people you hire to work on the property have insurance, including workers comp, and get yourself named as an Additional Insured on their policy for larger job. On small piece work you should get and Indemnification and Hold Harmless Agreement in the contract.
Secure your material and property against theft and intruders. Consider an alarm or a security company on larger jobs.
Now in life things go wrong. The more you do the more likely something will go wrong. You flip enough properties and something will go wrong on one of them, no matter how much you do to prevent loss. So let's look at steps to mitigate your loss when something does go wrong:
If the loss is not too big you can just sell it, take your lumps, move on and make it up on the next property. However, it might make more sense to hang onto the property and even rent it out, selling it at a later date when the property has appreciated more. When buying the property keep the rental potential in mind, in the event something does go wrong. Another problem/consideration is that generally speaking I do not generally believe in upgrading a rental as much as a flip. You may have a lot of flip upgrades into a home before you realize you may be better off renting it. You will have to give some consideration as to how much to fix up the property and how much rent you might get out of it by upgrading more. Financing is a big part of this solution and that is in point 2.
How you financed or purchased the home will have a big impact on loss reduction. If you bought and financed with Investors who are sharing in the risk, well you don't take all the loss yourself. But they may not be as anxious to get on board for the next deal, or may want more control.
If you financed the Investment the odds are you have a very costly short term loan. If you find yourself needing to hold the property for a while you need to refinance out of this short term loan. Consider how much you will need to put into the property before you can refinance out of the short term loan; have your emergency exit plan planned in advance. Consider the cost of this next loan.
Perhaps you put all cash into the property. So you don't need to finance out while you hold it, but maybe you do need to and should. If you have sunk a lot of cash into the property and need to hold that is money you cannot use on another project (I am very big on leveraging your cash as an Investor.) So maybe you need to now do a cash out finance of your property to get some of your capital back for the next investment.
If you do the math you might find that the cost of holding and renting out leaves you with just as much capital in your pocket at the end of the day as selling at a loss. But do the math and consider your options.
So what happens if your well thought out and well planned flip all of a sudden hits a market down turn that no one (especially you) anticipated? Well sell at a loss or lease and hold as noted above. Make this decision quick as the longer you wait to move on it the harder (and more cash) it will take to finance into a longer term loan.
Now there are “Never” and “Never's” in life, but real estate prices may go up and down, but rents “Never” go down. If your rents can keep you in or near the black on the project you can wait for the prices to head back up.
Make sure you Insure your risk, especially with the right type of insurance. Both Liability and Property insurance. Make sure it is a builder's policy that will cover your materials. Thinking of hiring under the table labor in front of the Big Box Hardware store? It varies by state, but you still better have Worker's Comp Insurance in place.
Lastly when you hang onto the property get a Home Warranty. Those warranties have lots of exclusions and deductibles and stuff, but what they do get you is a reasonably priced service call by a professional if you have a problem. Also if you sell the right home warranty can help prevent litigation or save you some cost in that regard.
When Investing Hope for the Best, but plan for the Worst. Always be safe and consider what you can afford to loose. Never Invest in Real Estate without a REALTOR that knows what he is doing with Real Estate Investments.
Let Home Point Real Estate Point you in the right direction. Located in Brentwood Ca Home Point Real Estate provides service to the East Contra Costa County Communities of Brentwood, Oakley, Discovery Bay, Antioch, Pittsburg and beyond. Give us call at 925-260-4321 about Buying a Home, Selling a Home, or Real Estate Investing. Get the Free Real Estate Investing Book!
Originally published at HomePointBrentwood.com
Get an E-Mail Subscription to this Blog!
By Gene Riemenschneider
Broker and Owner
Home Point Real Estate - 925-260-4321 - Turning Houses into Homes
Ask about the Free Book of Real Estate Investing!
Find Me at these Sites:
Home Point Real Estate
50 Sand Creek Road, Suite 316
Brentwood, CA 94513