You've seen all those TV shows about flipping houses. They make it look so easy, right? Buy a house, fix it up, sell it for big profits. But it's not as simple as it looks on TV.
Don't get me wrong, it's not impossible. But you need to know what you're doing before you jump in.
The Golden Rule of House Flipping
The most important thing you need to know is that you make your money when you buy, not when you sell.
You've got to buy that house at the right price. And the right price is 30% to 40% off its retail value, minus the fix-up cost.
Let's use an easy example. Say you've got a house worth $400,000 fixed up. That's about an average house in America today.
Now, let's say it needs $100,000 worth of work. Here's what you need to do:
- Take 70% of $400,000. That's $280,000. (We're using 70% because we want a 30% discount)
- Subtract the $100,000 fix-up cost.
- Your ideal purchase price is $180,000.
Remember, we need to buy at a 30 to 40% discount. If we go with a 30% discount, we're paying 70% of the after-repaired value.
Now, if you are thinking, “Why can't I just buy it for $350,000 or something like that, or $250,000, and then spend $100,000 fixing it up and make $50,000?”
Well, the point is you won't make $50,000.
By the time you're done paying a realtor's commission, your interest cost, the taxes while you own it, and let's not forget accounting for overruns on construction costs (which are very common), that $50,000 will disappear fast.
I've never been involved with a construction project that hasn't gone over budget for some reason.
Often, you just find something else that needs to be done or decide you want to do something extra, so your original budget doesn't turn out to be quite enough.
That's why you need to build a good margin. Again, the margin is 30 to 40% less than retail, and then you deduct the fix-up cost from that.
This will protect you from all those extra costs and give you room to profit.
Where to Find These Deals
Now, you're probably wondering, “Where do I find houses that cheap?” Well, you won't find them through realtors.
That's like trying to buy discount clothes at a high-end department store.
There are two main ways to find these deals:
- Market to motivated sellers: These are people facing foreclosure, going through nasty divorces, or owning long-vacant properties. You need to send a lot of direct mail and be ready to field calls.
- Foreclosure auctions: I used to do this. You can find good deals at both mortgage foreclosure and tax foreclosure auctions.
But here's the catch with auctions: You need cash.
These aren't the kind of deals where you can get a traditional mortgage.
You might be able to use a hard money lender, but you'll need to build a relationship first.
The Risks of Foreclosure Auctions
Buying at foreclosure auctions can be profitable, but it's not without risks.
Sometimes, former owners fight the auctions, and sometimes, they file for bankruptcy after the sale. You might have to deal with legal battles and delays.
Your money could get stuck in litigation.
You also need to be sure all liens are cleared. In some foreclosures, not all liens are wiped away.
You could end up with a property that still has debts attached to it.
The bottom line: If you're going to buy at foreclosure auctions, get good legal advice and know what you're getting into.
Why I Switched to Overages
Because of all these headaches, I eventually switched from flipping houses to the overages business. Here's how it works:
Let's say that $400,000 house sells for $180,000 at a tax sale. The owner might have only owed $50,000 in taxes.
The difference—$130,000—is called an overage. The former owner can claim that money.
In the overage business, we find these people and help them claim their money for a percentage.
It's less risky, and you're helping people instead of taking their houses.
When House Flipping Works Best
House flipping works best in a rising market. When property values are going up, you can buy at 20% off retail and still make money as the market rises.
But be careful. You never know when the market will slow down or drop.
You're in trouble if you're stuck with inventory when that happens.
House flipping is better in fast-growing cities such as Boise, Idaho, or Austin, Texas.
The influx of people drives prices up—it's simple supply and demand.
In flat markets, it's harder. You need to find up-and-coming neighborhoods. In declining markets, forget it. That's the time to buy rentals or look at different strategies.
Final Thoughts on House Flipping
Here's what you need to remember about house flipping:
- Buy cheap – 30% to 40% off retail minus fix-up costs.
- Be prepared for problems, especially if you're buying at forced sales.
- It works best in rising markets.
- Be careful in flat markets and avoid declining markets completely.
House flipping can be profitable, but it's not easy money. Getting started takes work, knowledge, and a good bit of cash.
If you're not ready for that, you might want to look at other real estate strategies.
Remember, in this business, you make your money when you buy, not when you sell.
If you can find the right deals and manage the risks, house flipping can be a great business.
But if you can't find those deals, don't force it. There are other ways to make money in real estate.