Investing in any real estate involves some risk, but what about home flipping? How much risk is too much?
No matter what market you're in, flipping homes is an imperfect and potentially risky business. Once you open a home, almost anything can happen. Even with an inspection (which you should do), you might find old issues that weren't properly repaired, you might not realize you're missing materials and end up with cost overruns, or you might find yourself with a home that you're not making a profit on.
In real estate, we all know that you can sell anything, but the question is, “for how much?” When flipping a house, it's crucial to understand the market in which it is located and who the future potential buyers are. Unlike other types of assets, a home is something that everyone actually needs, but it's much harder to liquidate than, say, a stock portfolio. The amount of risk you're willing to take should be based on the hyper-local market and time frame in which your project will exist.
Resale in today's market
For most flippers currently active, the only real risk they face is running out of money, because there remains a severe housing shortage nationwide. The number of unsold existing homes (the category that flips fall into) continues to decline, according to the National Association of Realtors' October Existing Home Sales Report. Year-over-year, inventory fell 12% to just 2.4 months' worth of homes.
At the same time, despite a lack of sufficient inventory for a wide range of buyers, existing home sales increased 0.8% from September to October 2021. On top of that, the few homes available for sale are selling at high prices, with prices up 13.1% from a year ago to a national median price of $353,900.
In today's market, reselling (provided you do quality work and address any structural and mechanical issues rather than just giving it a lick of paint and calling it a day) is almost risk-free. That's not to say the house can't get out of hand, but it's certainly unusual in this particular market.
Situations that create undue risk
As a flipper, it's important to know the market down to the edge of the block. See as many homes as you can, see them inside and out, and really get a sense of what people expect from the area. The two biggest mistakes I see flippers make are overbuilding and underbuilding, and both are very easy to make.
If your resale home is in an area that demands superior quality, do it right. Spending the extra money on the right décor will attract buyers and get your home appraised the right way. If your area is calling for more affordable housing, use simple, durable materials that will last but not necessarily be expensive. In other words, skip the marble countertops in an area that's full of Formica. There's nothing sinister about Formica; there's plenty of Formica left over from the 1960s that's still in great condition (and in use!).
Another big mistake I've seen in house flipping is one that HGTV mostly instills in people with little to no building experience: You can't just deck out the house and call it a day. You have to start with the less-than-sexy parts: structural flaws, the roof, the HVAC, the plumbing, etc. Once all that is correct, you can paint the walls, sand the wood floors, and put in new light fixtures.
When used homes don't sell
Not only is it attractive, but if you build a solid home, there's little risk because even in the worst case scenario, it will just be a long-term rental property. According to the U.S. Census Bureau, as of the third quarter, the 2021 rental property vacancy rate hit an all-time low, averaging 5.8% nationwide, 0.6% lower than the low in the third quarter of 2020. Additionally, the average rent for a vacant property was $1,203.
Of course, rental availability and rents vary widely depending on where your home is located and even the area. But if you plan your resale so that you're not in trouble if you have to rent it out, you can create an exit strategy to avoid taking on too much risk. As real estate prices continue to rise, so do the benefits: your resale property will increase in value, you'll have a steady rental income, some pretty sweet tax breaks, and you can sell again if you decide you still want to sell when you're ready.
Flipping real estate is great if done right because, by its nature, it's generally a low-risk investment. People will always need housing, and in a tough market like the one we're in now, people need housing more than ever before, both for buying and renting. As long as your property makes sense for the neighborhood and buyers (or renters) you want to attract, the options are nearly endless.