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When you consider all the things you need to know about flipping houses—be as prepared as possible. If you want a chance at success in this type of real estate investing, do plenty of research about the processes, the market, and the industry–especially when you are flipping a house for the first time.
We discussed in our blog post on investing in properties that real estate businesses require you to be financially capable and knowledgeable about the ins and outs of the industry. You may also need help in understanding how to manage and successfully rent or sell your property, especially when you're looking to flip homes. To expand your knowledge, you can consult business experts or study books related to real estate businesses to keep yourself updated. In addition, you can join educational or real estate networking communities, such as the one we cultivate on SJREIA, that share valuable and practical insights to help you get started.
Like most business endeavors, there are always outliers and other factors that can affect the goals that you may not have considered previously. So, in the spirit of being prepared, let’s talk about six things that could negatively impact your house flip and how to prevent them from derailing your project and potential profits.
Disclosure from banks
Many homes bought by flippers are foreclosures sold by a bank below market value. This is how some flippers can find bargain deals on homes that are neglected and aren’t being maintained. But that neglect has the potential to cost a fortune. While regular seller-to-buyer transactions legally require the seller to disclose all known problems, banks aren’t required to disclose anything to you, and you may not have the opportunity to walk the property at all before making an offer. So, if the price appears too good to be true, be wary, because you could be inheriting costly problems that could eat into your flipping profit.
How to avoid: Foreclosures have the potential to provide a great deal, but for a potential first flip, find your real estate investment leads through another source like MLS listings, your networks, websites, social media and other creative methods. Or, if the foreclosure is too good of an opportunity to pass up, see what forms of home inspections you may be able to pull off before fully committing to the transaction.
Hidden or unexpected costs of closing and capital gains
There are often hidden costs of flipping a house that sometimes falls through the cracks when putting together your house flipping business plan and strategy.
On average, you’ll pay 5% to 6% of the sale price of a flipped home to real estate agents managing the transaction. Say you bought a house for $250,000 and flipped it for $300,000 a few months later, $18,000 of that $50,000 gross profit is already gone. Additionally, if you’ve owned the home for less than a year, you’ll be taxed capital gains at your regular income tax rate rather than the capped 20% rate. Your capital gains will most likely put you into a higher tax bracket when combined with any other income you made that year. This is different from what a lot of people expect when selling a home that they have lived in for 3+ years and they can earn up to $500k in profit without paying tax.
How to avoid: Plan ahead and make sure your house flipping strategy incorporates a financial plan that accounts for all of the soft costs you may run into while flipping a home.
Holding Costs
Aside from the cost of the property and the cost of refurbishing, there are other expenses that you should consider when investing in flip houses like property insurance, utilities, neighborhood association fees, and settlement payments.
- Taxes
Taxes for flipping houses vary depending on your status, whether you are treated as a real estate dealer or investor, and your status can greatly affect the amount of taxes you have to pay for your properties. If you’re not acquainted with accounting terms and taxation laws, this part can be daunting. However, having an experienced accountant to facilitate tax processes can help you through this procedure. They can help you set and implement long- and short-term financial goals by recommending ideas to maximize your house flipping profit based on your objectives, budget, time frame, and risk profile. Lastly, they can help you apply for insurance, file taxes, and reduce debt while ensuring your real estate business abides by all industry rules and regulations.
- Vacant House Insurance
Applying for insurance is a great way to ensure the safety of your property even during the renovation period since it provides financial reimbursements if any damage or loss occurs to the property. Because there’s no one to watch over the house, they’re more susceptible to accidents like break-ins, fires, or storms. Michelle Ivy shared that the average vacant or unoccupied insurance policy is around $1,842 or more. However, vacancy or unoccupied insurance costs may vary based on location, length of vacancy, and value. To figure out the best type of insurance for your property, consider how long the house will be unoccupied since there are insurances that only cover up to 30 to 60 days.
- Utilities
Even when you’re just renovating the house, you need to pay for utilities like water, electricity, gas, and oil when contractors start working on your property. If you're flipping a house that's been out of commission for a while, you could also need to pay reconnection fees. Therefore, you need to factor in these monthly utility expenses in a house flipping business. The amount you have to pay can vary depending on the usage, size, and condition of the property. If you’re unsure about the average energy consumption of the house, you can contact the previous owner for an estimate of monthly costs. This is why you should carefully consider the timeline of your renovation period since the longer it is, the higher your expenses for utilities will be.
- Settlement costs
Closing or settlement costs are fees paid at the end of a real estate transaction. They generally include title insurance and fees, transfer taxes, and financing fees, which are subtracted from the sales price of the property. Michelle Ivy shared that settlement costs go for about 2% to 5% of the sales price of the house. Apart from these expenses, real estate agent fees are also included in closing costs. The standard real estate agent fees are around 6% of the property price and are usually part of the out-of-pocket expenses of the seller. For example, if the property sells for $200,000, the real estate agent fees you will have to pay should be $12,000.
Government regulations
More stringent regulations came in after the 2008 market crash and many of them were designed in ways that don’t tend to benefit those flipping homes. The Federal Housing Administration (FHA) requires that you own a home for 90 days before you can sell to a buyer who’s using an FHA loan. Additionally, if you sell a home for more than twice your purchase price, the FHA will require two appraisals, and the seller is responsible for the cost of the highest appraisal. This will cost you both time and money.
How to avoid: When flipping a house for the first time, take into consideration how long your project will take and who will be a potential buyer. If your project will take less than 3 months and you think you’ll be selling to a first-time home buyer, you may run into issues with them following through on funding.
Weather
Regardless of where you live in the country, there could always be some type of weather to throw your home renovation schedule and your flipping and selling timelines off course. This is one of the main things you need to know when flipping houses that is easily forgotten or brushed aside when weighing all the other things you need to consider. You can’t paint, garden or lay concrete in just any weather. Also, home buying patterns are different throughout the year and can alter the demand for a home when it is time to sell. The best times to sell are in spring and summer. They are very favorable due to the warm weather and people don’t need to bundle up in rain or snow to see new homes. Also, this is when many people have the desire to start fresh because there are summer breaks from school, or they are ready for a project or change after a winter inside.
How to avoid: Always have a backup plan in case it rains when you need to paint or it’s 100 degrees when you need to landscape. Check weather reports and forecasts weekly and book vendors that it could affect accordingly. Also take into consideration when you plan to have your renovation completed and whether that will be a time when you can expect a maximum return for your property based on market demand.
Theft
Theft often occurs during renovation projects, which can radically impact your budget and timelines due to damage or loss of materials and tools. Aside from theft by those who prey on construction projects, even the people you hire to work on the house may steal from you.
How to avoid: Make sure that you change the locks on bank-installed door locks (you don’t know who else has the keys), remove any valuables or tools lying around, and install an alarm system to monitor the property. Also, vet your contractors thoroughly and ask for references from past clients to make sure both them and their crews are credible and trustworthy with your investment.
Final thought
Sometimes, when we prepare to do a project as big as flipping a house, we are so focused on the nuts and bolts of the task that we forget the obscure scenarios that could negatively impact us. There is an endless amount of information and things you need to know when flipping houses, so do your best to take advantage to ensure your house flip is a success. And don’t forget to think outside of the "happy path" so you are prepared for every situation that could potentially come your way.
Keep these six things in mind that muddle projects and consider your backup plan or preventions for them. You’ll have an edge when first starting to fix and flip by understanding not only what to do, but what could go wrong as well.
Article contributed by Roane Jamieson
Exclusively for SJREIA