Making a quick buck flipping a home seems easy on TV. Purchase a run-down home, paint and replace flooring, put in some new grass and then sell for a huge profit!
Unfortunately, in real life things get more complicated. I often get inquiries from buyers looking for a good fixer upper or an investment to flip. They’ll typically give me their info and tell me to call them when I find a “good deal.” I dutifully take their number and sooner or later I usually find something.
Unfortunately, when we run the numbers, it is rare to find a property in Northern Virginia where the potential profit is high enough to justify the risk for a single-property investor.
Great deals do exist. There are people making a good/decent living in today’s market flipping homes. Locating properties at a great price is hard and the price you pay for the home up-front is where the profit is.
Even if you do get a home at a significant discount it is usually at a discount for a reason. It could be issues like buried storage tanks, termite damage, mold damage, collapsed sewers, outdated septic and electric, or missing permits.
My main issue with the typical house flipping program on TV is that it creates an unrealistic profit expectation and downplays the amount of risk, work and effort involved.
The story typically goes something like this:
Jack and Jill bought a fixer upper at $500,000. They spent just 4 weeks and $50,000 to update/change the kitchen, living/dining, master bathroom, master bedroom and the outside. They then got an “appraisal” from a real estate agent at maybe $700,000 for a potential profit of $150,000! Wow, sounds great. 4 weeks of work = $150,000 potential profit!!!
Well, there are numerous problems with the story:
- Real Estate agents are not usually appraisers. An appraiser is unlikely to value the improvements of the home at much more than the actual cost of the improvements. An appraisal at $200,000 extra for some bathroom and kitchen upgrades that costs $50,000 is very unlikely – appraisers usually are very good at what they do and these day are especially cautious.
- In line with the point above, most banks have anti-flipping rules meaning a home cannot be resold within a given number of months for a higher amount without substantive documentation showing why the home is now selling for more.
- The potential profit does not account for any additional and likely expenses like (for the example above):
Initial settlement cost: $10,000
Carrying Cost I: $5,000 (construction)
Carrying Cost II: $10,000 (60 days to sell)
Agent Commission: $35,000 (assuming avg 5%)
Closing Cost: $7,000So, that reduces the “potential profit” from $150,000 to $83,000. We then have to subtract the short term federal and state capital gains tax. Could be 25% federal + 5% state (VA), so we are left with $58,100 potential profit (flippers are unlikely to be able to use a 1031 exchange.)That $58,100 profit will diminish very quickly with a carrying cost of $5,000.
So what is my point?
Flipping homes is a risky business and the transaction and carrying cost will in most cases make it very hard to make a profit by just doing cosmetic repairs.
Adding bathrooms and expanding a home does add value and can make you money. But, unless you are a contractor yourself with the right skills, contacts and equipment you will be unlikely to make enough money for it to be worth the risk.
For the average home-buyer wanting to make money in real estate flipping a home every two years and fixing the home up while living in it will have the best chance of success.
The rapid appreciation in times past made many ordinary people with minimal skills into “flipping geniuses.” With the market appreciating 20-30% per year pretty much anyone with access to credit would make money. It was not the updates and improvements made to the home that allowed you to make a profit – it was the overall rise in the market from when you purchased to when you sold.
There are compassionate professionals that take run-down homes and does a remarkable job in transforming that into a home for someone to move into and love.
Those flippers have a community connection and help normal people get into wonderful and affordable homes. Flipping is hard work done by people that have the right skills and love what they do. If you are looking to make a quick profit in real estate with minimal work you will probably have better luck in the REIT market.