1. Get Prepared – Now that you have decide to start flipping houses for profit it’s time to get your goals and expectations set correctly in your mind. Figure out how much cash you have available for this investment. Make sure that you have enough money to cover a twenty percent down payment, the remodel of the home, and enough cash on hand to cover the monthly mortgage payment until the property is. I know it sounds overwhelming, but I will show you how to reduce the up-front cash and the funds for the remodel. It always make sense to write down your plan. It doesn’t have to be anything fancy, it just has to make sense to you. You can’t possibly know where you are going without a map to navigate by.
2. Identify a good property to flip – Now that you have some idea of your direction, it’s time to consider the type of property that would make a good flip. Figure out if you want to buy a single family home that needs work, or a multi-family home where your intention could be a condo conversion. For our purposes here, we’ll discuss the single family house flip. If you don’t have access to the Multiple Listing Service (MLS) in your area, find a reputable real estate agent who could provide you with access to the MLS. It is wise to have a buyers agent because it’s doesn’t cost you any money. The buyers agent is compensated by the listing broker’s agency. Once you have access to the MLS, you can start searching for properties. I like to search by zip codes in areas that I know to have desirable neighborhoods. In a down market, such as the one we are in now, there are plenty of rundown homes that happen to be in great neighborhoods. Those are the homes that will always sell first. You should focus on bank owned, short sale and foreclosed homes that are on the market. Keep in mind that it doesn’t matter how much the seller is asking for the home, what matters is if the project makes sense. I typically figure out the price I will pay for a home after I figure out the amount of work that needs to be done and how much I can sell it for. Remember, the market tells you what a home will sell for, not a price tag.
3. Inspection and Property Analysis – Before you can make an educated offer, you must know two things. First you must know how much it will cost to bring the house to it’s highest and best condition. You need to appeal to the type of buyer that is most likely to purchase the home. You should have a trusted contractor meet you at the house so they can give you an idea of the costs involved. Now add 20% just to be allow for unexpected costs. Once you know your cost you should consult with your real estate agent to determine what similar homes have sold for and look at the homes you will be competing with. Now that you have a good idea of the future selling price and the cost of the construction, you can now use basic math to add the cost to the purchase price and then subtract that answer from the estimated future sales price to determine if there is a enough profit margin for this house flip to make sense for you. Tip: Don’t forget to add sales commission to your cost if you plan on using a real estate agent.
4. If the Numbers Work, Get Financed ! – Once you know that there is enough profit after your acquisition cost, remodel estimate and sales cost. You now know the most that you should pay for the home. Before you make an offer, you must get your financing in place. This is my area of expertise since I have been a mortgage broker for several years. There have been many changes in the mortgage industry since mid 2006. Money is a little tougher to get, but it is still available with a down payment and decent credit history. Guidelines are always changing, but right now at the end of 2008, a minimum of 20% down payment is required to purchase investment property and the borrower must show income and assets to qualify. If after the 20% down, remodel money and cash to cover the monthly payments, you do not have much money left, you should consider a partner for the deal. You may not be a fan of long term partnerships, but when you are flipping property, you would be looking at a 4-6 month partnership, not a lifetime. If that works out you could always buy more property to flip in the future. It also helps split the risk and the tasks. Just make sure your expectations are set properly. If going the partner route I suggest opening a joint bank and funding it with 6 months of mortgage payments including tax and insurance. If you have more questions about financing, I would be happy to answer them. I will provide my office contact information at the end of this article.
5. Remodel / Rehabilitation Phase – It’s time to get this home fixed up and back on the market as fast as possible. You should now have your contractors come in to start the construction phase. Keep in mind that cheap labor will almost always be more expensive. Make sure that the contractors are pulling the proper permits. The last thing that you want is a forced work stoppage because the required permit was not pulled. Furthermore, if these workers do not know or build to code, it will usually cost you double to correct a code issue. By now you should have a detailed list of everything that needs to be done. Break it down by major systems such as heating, cooling, plumbing, electrical, and any other system that needs repair or service. Then go room by room and make a list of what needs to be done in each room. Joint compound and a fresh coat of paint goes a long way. Just make sure you use modern, neutral colors that would not be offensive to anyone. Make sure you inspect the exterior of the home for repairs and touch-ups. The yard should be clean and landscaped properly. Make sure you check in on the contractors daily to make sure things are on track, don’t assume all is on schedule. Finally, take advantage of using Lowes and Home Depot credit to avoid payments and interest for six to twelve months. You should be able to buy most of the materials with that credit. Just makes sure you pay the entire balance when the interest free period ends or you will get whacked with all of the accrued interest.
6. Sell your House Fast – Now that your home is complete and ready to go on the market. You should already have an idea of how much you will list this property for, but you must once again verify the value. The best way to do this is to have an appraiser or a real estate agent do a comparable market analysis. If you don’t know an appraiser, call your mortgage broker and ask him or her to use their appraiser to help figure out a range for you. I do it for my mortgage clients as free value added service, it’s just good business practice. You may want to sell your home yourself and that is fine, but you must have the time to show it and also be able to list the property on your local multiple listing service. If you are trying to avoid paying a full real estate commission, a local real estate agent will usually do an “entry only” listing for a nominal fee. If you do not have the time or do not want to deal with the hassle of listing the home yourself, hire a real estate agent to list your home. You should have already added in the sales commission fee into your figures before hand. When figuring value make sure that you also look not only at similar homes that have sold, you should also look at your competition. Your home needs to be a great deal when the average buyer looks at it against others in the same price range. Finally, if you are not getting sufficient showings after a week or so the home may be priced to high, don’t be afraid to lower the price. Sometimes a little profit is better than no profit. That is why you must purchase the property that you want to flip as low as possible and estimate the remodel as accurately as possible.
7. Make Plans for your Profit – If you priced your newly remodeled house correctly, it will go under agreement and you will soon close. If you have planned correctly, you should have some profit coming to you. It would be wise to have a solid plan with regards to your profit. Here are some options; You could simply take the profit as well as your initial investment and place it in your bank. In that case, you just created a taxable event or in other words, a long or short term capital gain depending on how long you held the property. That option is better if the profit gain was minimal. If you made a significant profit and were planning on flipping another property, you can defer your taxes through a 1031 exchange. Basically a 1031 exchange is a tax code that allows you to defer capital gain tax to a later date buy reinvesting your profit into another investment property within a certain time frame. There are rules that must be followed in order to make the exchange valid but considering the benefit, it could be well worth it. The advantages of doing a 1031 exchange includes having more money available now and more buying power. It means not being taxed while your are building your real estate investment business. You can flip your profit, just like you flip a house. Here is an idea, why not flip homes until you have enough down payment funds to exchange into a 30 unit apartment building. Then you can turn your money into a cash flow. You could defer paying any taxes until after you sell the last property and actually take the money. It is always wise to speak with an accountant when making tax decisions, so always consult a professional CPA when dealing with tax laws, that is money well spent.
I will leave you with one last thought; Use professionals from start to finish. Licensed professionals may appear to cost more, but they will save you money by getting the job done on time and correctly.