Top 5 Things to Know and Do When Flipping Property
February 20, 2018 By Larry Arth
I have been having a great time this week previewing and researching property to help an investor to purchase property. This particular investor happens to be a Realtor herself from another state and she is interested in acquiring a property as a tool to help her build a foothold here in Sarasota Florida.
Flipping her way to financial abundance
I am blessed to live in an area that is filled with lifestyle investors. Anyone who follows my blog knows I live by the Motto, “Live where you wish – invest where it is best.”
Why Sarasota Florida?
With all the different markets she can invest in, including her own backyard why would someone come to Sarasota Florida to invest in a fix and flip property? Simple she wishes to live here someday. Sarasota is a wonderful place to live, a small city with big city amenities, wonderful weather and of course the number 1 beach in the country.
Is it the best place in the country to expect maximum returns? Not necessarily. It does however offer a lifestyle investor the ability to manufacture growth.
The Rules are changing
Seasoned investors are great at making every real estate market an opportunity. If you ever watched the movie starring Danny DeVito, “Other People’s Money”, he does a great job illustrating this very topic when he says the game never changes only the rules change.
In real estate investing the game is making money in real estate. The rules to accomplish this change with the changing times and changing markets. Those who adapt to the changes necessary (the rules changing) are the ones that win the game. Investors were fortunate over the past 5 to 8 years to be able to buy property anywhere and everywhere that made great financial sense.
The rule then was more in line with buy everything you can get your hands on and you will be able to make money. I mean you almost had to try to lose money in the market that we have had in the past 5 to 8 years. Investors crawled out of the woodwork. Today most of those deals are gone and interestingly enough most of the investors have gone as well. For those who change with the times, as they adapt to the changing rules they will continue to invest and prosper.
Today’s investors win by manufacturing growth
Manufacturing equity (something I like to call “The Value Play”) is simply taking a piece of property and quickly adding value to it. You may have heard the expression used by appraisers “highest and best use”. It is the simple principle of making changes to a property that will give it more value. There are many ways this can be done.
- Rehab a property: This is a common practice of buying a property, remodeling it with updates that will increase the value of the property and give you quick equity. The idea is to be smart about the rehab, remember you are not going to live in it. You want to do improvements that will maximize a home’s attributes and minimize its flaws. Properly done you have created manufactured equity.
- Increase its rents: For true income producing properties such as multifamily rental units, the values are established by the revenue it generates. If you are able to raise rents the value will go up, creating instant manufactured equity. Example… you do some minor updates and replace old white appliances with new stainless steel appliances. You attract a different caliber of tenant that are willing to pay more in rent. I once raised the monthly cash flow of a 4 unit building by 12 hundred dollars per month with this strategy and the extra cash flow generated increased the value by an additional $100k. That was quick equity.
- Changing properties use: As the term “highest and best use” implies when you utilize a property for its highest and most efficient use the values will match that highest and best price. As an example rezoning a residential home (on a street that is now becoming a popular main traffic road within a city) to an office space such as dental, real estate, attorney office this newly zoned property on a street is much better utilized as an office building on the busy street than a residential property.
I trust you see a pattern emerging. It is easy to manufacture equity when you get creative and think outside the box. The best investment opportunities are often ones that are passed by. When thinking outside the box it is possible to create equity and manufacture growth rather quickly. This is something I often call the Value Play.
Top 5 things to do when flipping property
So if you want to manufacture growth, you will want to follow the most efficient rules of the game.They are what I believe to be the top 5 things you want to be sure and do.
1. The Exit strategy:
A well thought out exit strategy is paramount and perhaps the single most important detail you want to give attention to. Notice I said “give attention to detail” selling for a profit is to vague and one I hear too often. How will you sell for a profit, who will you sell it to. What do these buyers look like, where do you find them, how do you know you will be able to sell for a profit. Taking time to detail this exit is a very crucial step toward ensuring a successful flip.
2. Knowing what you will buy and why:
Are you buying a house or a multifamily and why. Most people flip houses so do you buy a 2, 3 or 4 bedroom home and why. What is the most highly sought after property in your market? How many bathrooms, the more baths you have the more you have to renovate and the higher your budget is, but consider the return on investment. Your exit strategy may suggest you are best served with a 2 or 3 bath home. When you take the time to know what your market demands are, you can see that the cheapest homes may be your worst investment. Learn what the best selling property is and back into your investments and know the purposeful reason you are selecting what you invest in.
3. Have a true budget:
I know this may be hard to believe, but many people’s budgets are plucked from the sky. Investors research the price they can get for a home based on comparable and then subtract their desired profit and the cost to buy the property and the money that is left over is their budget.
Purchase price $60k, sell price based on comparable is $100K. 20% profit based on sell price is $20k so repair budget is $20k. Wow this works on paper, but is it reality? You cannot back into the numbers and expect the needed repairs to magically fit that number. If the property requires $30k in renovations to make the property worth $100k, you need to budget $30k. if the numbers do not work you want to pass and on to the next investment.
To be an effective flipper you want to sell good quality homes with great repairs or you may brand yourself as selling low quality garbage.
Finding fix and flips that make sense is a numbers game. You will have to crunch numbers on a number of properties before you find a property worth buying. Establish your buying criteria and find a great calculator for computing purchase price, renovation costs, acquisition costs, liquidation costs, holding costs and you will be buying only those properties that have true potential for successful profitability.
4. Have a proper Contingency Fund:
Much of the drama created in flipping can be avoided by expecting the unexpected. When renovating you will often run into unforeseen expenses. When these needed repairs are uncovered it is important to have contingency funds to cover them.
While you always want to estimate the value of each item you want to repair as accurately as possible, often these prices can be higher than expected. Sometimes the cost to retrofit new to old may have unforeseen costs. Having contingency funds to cover this will keep you on budget and save lots and lots of stress..
The amount you want to allocate to contingency funds will depend on things such as how accurate your estimates are, the depth to the types of renovations you will be doing, etc. I have used as little as 5% and as much as 15% depending on how detailed the renovations are.
Cosmetic renovations for example have fewer surprises than gutting down to the studs and upgrading entire rooms.
5. Considering all acquisition, liquidation and holding costs:
This goes hand and hand with budgeting, but as these are intangible expenses I repeatedly hear that they are often overlooked. Even when purchasing with your own money in the form of cash, you want to consider the time value of money. This money tied up is costing you money. If it is your money it needs to be making you money each day.
Often it is borrowed money and you have interest accruing every day. The number of days or weeks or months you are making interest payments needs to be added to your costs. The cost of the loan and any closing costs on both the purchase side as well as the sell side all need to be factored into your total costs.
I always hear passive investors who now want to invest in fix and flip real estate who overlook these expenses. Fix and flip real estate investing is very much an active investor’s sport. While the game may be the same, the rules are a bit different. It takes a great deal of personal involvement and understanding of all expenses incurred to win.