I love reselling houses.
You get a great sense of accomplishment from seeing before and after photos and a check to deposit in your bank account, but the TV shows featuring home flipping bear little resemblance to the reality of the business, with real estate gurus once again lining up to sell books and classes that tell you how easy and risk-free it is to flip a home.
Let's talk reality.
I love breathing new life into old homes, but let's be honest: very few people get rich doing it. Most successful flippers go into other fields like development, wholesaling, commercial real estate, or they do it as a supplement to other businesses. You won't find home flippers on the Fortune 500 list.
Here's why you need to be realistic about your expectations when it comes to flipping a home.
It's an expensive business
Flipping houses is an expensive business. It requires the cooperation of dozens of professionals, all of whom must be paid. No one can do it all by themselves, and even if they could, it probably wouldn't be a good use of their time. For the most part, I feel like I'm good at making money for others.
There are a lot of people between me and my last paycheck.
I have to pay lenders and investors a fee for the use of their money. Nobody is going to spend all their money on this thing. If you have a million dollars in the bank, don't bother with the hassle of flipping a house. Just lend the money to other people and let them chase deals and wrestle with contractors.
Pierce: Want to become a home flipper? Let's start by doing the math.
I am a licensed real estate agent in Virginia, but I still have significant agent fees. I need to move quickly, so I have to pay agents who introduce me to buyers. I have tried to eliminate agents, but it has not worked. The costs are higher than the savings.
I also have to pay lawyers, contractors, suppliers, inspectors, appraisers, and the IRS bills me 3-5 times for the same transaction.
On a recent transaction we closed in Montgomery County, Maryland, we paid over $10,700 just in state and local transfer fees. We also paid about $6,000 in property taxes for the time we owned the home, and then paid income tax on the gain. In some counties, you may also have to pay gross sales tax on the sale of the property.
These are the government transfer taxes and fees I paid on the Montgomery County transaction. I paid the fees when I bought the house and again when I sold it a few months later.
Government Fees at Time of Purchase: Government Registration Fee $290.00 Transfer Tax $1,845.00 State Registration Tax $1,931.00 Deed Tax $836.60 Subtotal $4,902.60 Government Fees at Time of Sale: Government Registration Fee $100.00 Transfer Tax $2,575.00 State Registration Tax $1,881.25 Deed Tax $1,287.50 Subtotal $5,843.75 Total Government Fees for Project $10,746.35
There are lots of other costs that could be accounted for, but the point is, there are a lot of hands involved when flipping a home. I've been in a lot of deals where I looked at what I was left with after all the hands were taken and thought, “Is this worth it?” If you don't love this, the answer is probably, “No, it's not worth it.”
Having a lot of professionals involved in the business means costs are high. It also means a large part of the business is outside of your direct control. It leaves you feeling pretty helpless when a contractor ruins your project and walks away.
Low profit margins and high risk
Sure, you might make $40,000 profit on a project, but if you have to spend $600,000, that's a very low profit. Most retail businesses aim for a 40-50 percent gross profit margin. I aim for a 10-15 percent margin.
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Contrary to what the experts say, this is a very risky business, especially for beginners. You have to rely on a lot of people. The biggest risks are assessing the value of the property, deciding on renovations and managing the construction. If you get the value of the house wrong and end up buying it for too much, you're doomed before you even start. You can never be 100% sure of the value of a property. There's always a chance that you'll miss something in the appraisal.
You never know what you're going to find when you open a house. Everything is repairable, but it's a question of cost. And really, the biggest issue for me is the contractors. You never know how they're going to perform on a particular project. If you've been flipping houses for long, you're going to have bad experiences with contractors.
Time-consuming and difficult to delegate and scale
Another thing you hear real estate gurus talk about all the time is passive income. Flipping houses is far from a passive business. You have to be involved from start to finish. In fact, at least half of the work in flipping a house is finding that house in the first place. In this market, it's very rare to find a good resale property across multiple MLSs, and it takes a lot of work to even find and review them. So you end up spending a lot of time flipping before you find a home to work with. Many people never find their first deal, give up, and walk away from the business without getting anything worth their time and money.
Once you find a business, you need to secure financing, define the scope of work, and get contractor bids. Don't just put together a scope of work; if done well, most projects will require several different scopes with different levels of renovation. Next, you need to determine how much the home will sell for at different levels of renovation. Then, decide which option will maximize your profits and proceed accordingly.
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For example, I had a home and I knew I could completely resell it as-is, do a standard renovation, or add a second floor. All options were viable. I determined the scope of work for each option, got bids for each scope, and added up the costs for each scenario, including holding and financing costs. Adding a second floor would cost about $175,000 in direct renovation costs, plus take an additional nine months to complete, increasing holding and financing costs by several thousand dollars. It would also add opportunity costs and increase risk. I decided to put the home on the market as-is and sell it as a home in need of repairs.
Every transaction is different. It's very difficult to systematize. That's why it's a hard business to scale.
To manage your business, you need to know at least a little about a lot of different things. In my opinion, the most important knowledge is the ins and outs of the real estate market. You must know how to assess the value of a house and what buyers want, including popular designs and decorations.
Construction is a valuable skill, but I've seen many contractors get into trouble by over-renovating or under-renovating in an attempt to resell a home. Still, it's very difficult to succeed in this business if you don't have a solid knowledge of construction, including the dozens of specific trades required to build a home.
In addition to these items, you also need to know about real estate law, business law, insurance, contracts, negotiations, project management, etc. Honestly, if I knew how little I didn't know before I tried flipping my first house, I probably wouldn't have tried. Thank goodness for my ignorance.
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No, there are no house flippers in the Fortune 500. There's nothing better than making $50,000 in 4-5 months on a successful flip project, but working for months and not making anything or even losing money can be really tough. If you're a professional in a fun, well-paying profession with little to no real estate experience, house flipping is not the place to start. I invested in real estate for about 5 years before trying my hand at flipping my first house.
If you're a well-paid, well-benefited professional, you won't need to get distracted by the minutiae of a property flipping project. Even if you haven't been highly paid in your career, you probably don't want to jump right into a property flipping deal as your first foray into real estate investing. We recommend purchasing a small rental property as your first real estate investment.
In my next post, I'll look at what kind of results you can expect if you buy just one relatively inexpensive rental property each year for the next 20 years. I'm talking about properties costing between $50,000 and $100,000 in markets with favorable landlord-tenant laws and favorable rent-to-purchase price ratios.
Justin Pierce is a real estate investor and real estate agent who writes regularly about his experiences buying, renovating, and selling homes in the Washington area.