Anyone who has done a flip knows that this can be an exciting and rewarding experience. Flipping can reward you well as long as you stick to your original plans. It seems for every tenth flipper I encounter I hear stories with very negatives outcomes. Every single time these outcomes involve a flipper who did not have a defined plan, a defined budget or a defined renovation list for that matter.
Buying a property and throwing an arbitrary renovation budget that is nothing more than grabbing a number that you think you want to spend and calling it a renovation budget. Not having a budget is a recipe for disaster.
A renovation fueled by emotional attachment that went bust
I have a friend back in Minnesota who I grew up with as a child and we remain good friends. He always loved following my investments and he also wanted to make money doing some fix and flips.
All excited about a new property he bought, he called to share with me news of his new purchase. A 3/2/1 which he purchased for $102,000. This was in an area of $150,000 to $160,000 homes. He shared with me his renovation plans. He would do most of the work himself as he enjoyed renovation work. He would spend his nights and weekends and should be able to wrap up in about 4 to 6 weeks.
I, of course, shared the time value of money and asked if he had considered the holding costs within his budget. I could tell by the grunts and the groans that he had not, though he would not actually admit to overlooking it. I wished him good luck and asked him to keep me posted.
About a month had passed and I had not heard from him so I expected he was very busy with his flip. So I picked up the phone to check in. He stated things were going well, but was surprised at how long things actually have taken to complete when you have limited time per day to work on the project. He suggested he should be done within the next month or so, perhaps just a couple of weeks late.
So as another month passed I checked in again. I could tell by his voice and comments he was proud of the way things were looking. Really awesome place here, a place I would not mind living in. I shared his excitement and asked when it is going on the market. Just as soon as the new driveway is paved and the new deck gets added he said.
Surprised by these comments as driveways and decks were not mentioned in his original plans I asked him to elaborate. Yes, in talking with his wife they decided to widen the driveway from single wide drive to a double wide because they felt they would not like having just a single wide drive as they have 2 cars and a double would be nice to have.
As for the deck they thought it would be nice to double the size of the deck and to make it pop they would convert the back door to a double patio door.
Surprised by these comments I asked how he was able to fit this into his already tight budget. He chuckled and stated “well the budget was already blown” so they figured they would do these extra nice things to it and try to sell it as more of an upscale property.
O.K. I trust you know where this story is going. Indeed they let their emotions get involved and decided to renovate this to match their taste. Everything they originally planned to do they did top notch. He has always been a perfectionist and likes the nice things. While I totally applaud doing things the right way and doing them nice, you have to renovate to match the caliber of the price point home you are working in.
Needless to say he over improved for this neighborhood. He had $162,000 invested in a home that could only bring in $160 perhaps the $162k that he has in it. However this does not cover any selling costs or closing costs let alone any profit. Essentially he was not able to even get paid for his time. He eventually wound up renting the property and is waiting for the market to rise.
- Renovate to match the area, not to your taste
- Have a defined exit strategy and selling price established before the purchase
- Know exactly what your renovation punch list is before the purchase
- Have a built in contingency fund as renovation costs often generate expensive surprises
- Build in the holding cost of the property including mortgage, taxes and insurance
- Build in labor cost even if you do the work yourself
- Build in liquidation costs
Most successful investors have learned many similar lessons. As my friend went on to do many more successful flips, the lessons he learned may have served as a tool to help him hone his skills and become more purposeful.
When these failures are made and corrected they often turn into the most valuable lessons. The fact he was able to rent it and at least cover his holding costs was a break even win for him. His final lesson of course is to always buy a property that you can at least rent for a cash flow should the flip not go as planned.