Flipping houses may seem like an excellent way to invest in real estate, at least from what you've probably seen on TV. You buy a house that's falling apart, make repairs, and then sell it a few months later at a profit in the tens of thousands of dollars. Sounds great, right?
While this is certainly possible, and many people earn fantastic returns fixing and flipping houses, there's a lot more to the story.
The reality of house flipping
First off, it's absolutely true that there is big money to be made fixing and flipping houses. But it's not easy money. There are several ways to earn passive income with real estate investing that are far easier. In reality, there are some truths you need to know before you dive in:
- Flipping houses has a lot of expenses, and they can be very hard to predict.
- It can be very difficult to finance a fix-and-flip project.
- You probably need a source of fix-and-flip projects other than the MLS.
- You'll need a team of trained professionals in your corner, and your success (or failure) will depend heavily on them.
For a little more color, here's what beginners should know about each of these points, as well as some links to in-depth discussions where you can learn more.
Beware of the costs involved -- and the uncertainty
I don't want to get too far into the weeds here when it comes to analyzing potential houses to flip (you can check out this guide for a more thorough discussion). But for the purposes of this discussion, it's important to know there are several costs involved with flipping properties, some of which beginners don't typically consider. And the expenses of a fix-and-flip almost never match up perfectly with your projections, which can make your potential profit margin very tough to predict.
First, you'll need to be able to estimate a property's market value and know how much to offer to make your project profitable. This is easier said than done, especially when it comes to properties in truly horrible condition. And if you're a true bargain hunter and buy properties at auction, you might not even be allowed to look inside. Don't forget the closing costs you'll have to pay to actually buy the property, too.
You'll then need to estimate what repairs the property will need and how much they'll cost. And then allow for significant wiggle room because there will always be some sort of repair you aren't expecting. Then, you'll need to estimate the property's market value after the repairs are completed, also known as the after-repaired value, or ARV.
Don't forget to account for the property's holding costs. This is the big one that many rookie house flippers overlook. For example, if you hold the property for six months, you'll have to pay six months' worth of insurance and property taxes. If you finance the property, you'll have to make mortgage payments. And don't forget about utilities.
Finally, when you sell the property, you'll have some costs associated with selling it. Unless you're a licensed real estate agent, you'll probably want to hire one. You'll also have to pay commission to a buyer's agent, closing costs, and other expenses. And if you end up earning a profit, don't forget that you'll have to pay capital gains tax on it.
In a nutshell, flipping houses can be expensive. And you need to expect the unexpected.
Financing a fix-and-flip project can be difficult
Financing a house you plan to fix and flip can be very different than the process of obtaining a mortgage for a home you plan to live in, or even a move-in-ready investment property.
Specifically, banks are generally in the business of making loans on properties that are not in need of extensive repairs. There are some loans that allow for extensive renovations to be financed into the principal, such as the FHA renovation mortgage, but these are made with the idea that the buyer will keep the home after.
So, to finance a fix-and-flip, you'll probably need to look elsewhere. Hard money lenders are an option, but they typically have much higher interest rates than standard mortgage lenders (another cost to account for), and most want to see that you've had successful house-flipping experience before making a loan. As a new investor, you can expect to pay a premium or put more money down than you had expected.
You make your money when you buy
Aside from completely mismanaging the costs of a project, the easiest way to go broke as a house flipper is to overpay for the properties you buy. Just keep this saying in mind: "You make your money when you buy, not when you sell."
Continuing with that point, it's important to be extremely selective (and resourceful) when it comes to finding houses to flip, as well as the purchase price you're willing to pay. Most successful flippers evaluate dozens of potentially attractive properties for every deal they make.
Here's one tip. It is very rare for a "fixer-upper" listed on the open market to be a great candidate for a profitable fix-and-flip. It's certainly possible, but that's the exception, not the rule. In order to be a successful house flipper, you need to think outside the box and have multiple ways of sourcing deals. Just to name a few ideas:
- Get to know some real estate wholesalers in your area. If you've seen those "we buy any house in cash" signs in your area, that's who put them there. Wholesalers find extremely attractive deals, agree to purchase the property, and then assign the contract to investors like you (for a fee, of course).
- Learn how foreclosure auctions work. These aren't for beginners, but if you've ever watched house-flipping shows on TV, you'll notice that many of the properties are the result of auction sales.
- Put your name on the radar of some experienced local real estate agents. Let them know you're looking for profitable fix-and-flip projects and have the funds to move quickly on the right property.
You're only as good as your team
Are you a licensed real estate agent? Are you a home inspector? And can you do all of the repair work yourself? Many investors can answer yes to one of these, and to be sure, you can save a ton of money by acting as your own selling agent or by doing some of the work on your own. However, the point is that in order to successfully fix and flip houses, you'll need to rely on quite a few people other than yourself.
For this reason, any house flipper is only as good as the team around them. And there are some extremely important team members to assemble before you get started, including:
- Real estate agent
- Home inspector
- Real estate attorney
- Insurance agent
There are some specific things to look for in each of these professionals, and you can check out my guide to forming your fix-and-flip team for the specifics.
The best move you can make before flipping houses
With all of the above in mind, there's no easy answer to the question of "is flipping houses worth it?" The best thing you can do if you think flipping houses could be a lucrative side hustle, or even a full-time career for you, is to learn as much as you can about flipping houses before getting started. Here are just a few of our excellent resources to check out:
As a final suggestion, I'd advise you to start small. Choose a relatively inexpensive property that needs significant repairs but not a down-to-the-studs renovation. This way, as you answer the question of "is house flipping worth it?" for yourself, you're dipping your toes in, not diving in head-first on your very first project.