ARE YOU CUT OUT TO BUY A FIXER UPPER?
So You Want to be a Real Estate Flipper
“If people are unforgiving up front about assessing the costs of renovation, the value of the property and the neighborhood, and how much money they have, they can come out ahead and buy more house than they otherwise could ever afford,” says Bradley Inman, CEO of HomeGain.com, a real estate sales and information Web site. (as quoted on thisoldhouse.com)
The lure of real estate investing is great. This article outlines what it takes to buy, renovate, and resell real estate.
Find out if this potentially lucrative endeavor is for you in this simple example.
Consider investing $125,000 for a run down home in a nice neighborhood (in a lower cost of living part of the country).
Next, invest $10,000 in cosmetic updates; clean up the yard and plant some flowers, paint the front door, give the inside new paint, carpeting, and upgrade the kitchen counter tops.
Allow another $10,000 for fees, inspections, holding costs, and real estate commissions. Turn around and sell the house for $175,000.
Your total cost was $125,000 + $10,000 + $10,000 = $145,000.
Sell the house for $175,000 for a profit of $30,000 or a 20% return.
Sounds like a great deal doesn’t it?
Wait, the entire project is fraught with challenges and may not pan out as expected. Beware, there’s a reason that the potential returns are so lofty, because there are also outsized risks involved.
If you do your homework and keep costs down, you will increase your chances of success.
My Real Estate Cred
Mom and dad started out poor and built wealth through entrepreneurship. Although involved in several businesses throughout their lives, the longest lasting was a real estate business based on buying poor condition homes, renovating, and reselling them. Today, it’s called “flipping”. Our Sunday’s were spent driving around looking at real estate. At age 22 my dad said, I’m going to teach you how to renovate and proceeded to take me on as a partner in renovating my first real estate property. Over time, I bought houses at sheriff sales, evicted bad tenants, bought dilapidated buildings and renovated them. With today’s low interest rates, if you have access to a bit of capital, time, and a hunger to get your hands dirty, this is a superb road to wealth.
Do Your Real Estate Research First
Research and access to capital are the cornerstones of success. The shows on television about buying real estate with “no money down” are unrealistic. A cornerstone of real estate investing is having some cash, for the renovations as well as for the unexpected expenses that inevitably creep up.
Take a personal inventory; Do you have the qualities to succeed?
Discretionary time each week to allot to the real estate. You need to be willing to problem solve, have extra time and a flexible schedule, as issues come up at odd times, and be in it for the long haul. Once you commit, it’s difficult to get out. Unlike owning a stock market mutual fund, which you can sell in few moments, real estate is relatively illiquid. If you need ready cash, you can’t sell a piece of real estate in a day.
Enough access to cash for a down payment, remodeling expenses, and cash to carry you when things go wrong. Savings are a good place to start, credit cards, and a home equity line of credit are other options. When buying real estate, you can potentially use funds from a mortgage or renovation loan. Be careful not to borrow more than you can pay back within six months or so, otherwise, your interest charges can easily eat up the profits.
Learn the pricing in your desired market. Zillow is a great resource for sold statistics. Realtor.com is another one for current data about properties on the market. Also factor in “days on the market” to project time to sell your renovated property.
Skills to analyze the income, expenses, and cash flow of rental property. Quite simply, calculate the purchase price (don’t forget to include appraisals, inspections, and closing fees), add in renovation expenses (then add about 25 percent extra for unexpected costs). Add in a few months of holding costs to your expenses in case the property doesn’t sell right away. Subtract all of the projected costs from the expected sales price (don’t forget to include a real estate commission). Personally, I wouldn’t touch a project for less than a 20 to 30 percent projected return.
Attention to detail. Spend time researching contractor pricing in your area. It’s cheaper to renovate in Kentucky than California. Know your market. Know loan rates and availability and make sure you can get credit before taking the plunge.
Stick to cosmetic repairs initially. In the beginning, it’s much easier and less expensive to change out carpets, paint, replace a few light and bathroom fixtures, and small electrical fixes. Once you get into plumbing, heating, air conditioning and major systems the dollars and problems add up fast. Build up to larger renovations as your experience improves.
Regional Real Estate Investing
It’s helpful to invest close to home. When a pipe breaks or there’s a problem, you want to be available to drive to the property, take a look, and make the repairs. Owning remote properties are for the more advanced investor.
If you live in a lower cost of living area such as Ohio, Georgia, Mississippi, Indiana, Kentucky, Nebraska, Idaho, or other, it’s easier to buy an initial property. You would need to save less for the cost of the property and likely the repair costs would also be lower.
I currently live in the San Francisco Bay area, one of the highest cost of living homes in the country. Although a friend of mine, Sam from Financial Samurai has managed to parlay his savings into real estate in 2003. Today, after double digit price increases, it’s very difficult to employ a real estate investing strategy today in this region. Sam wrote about his real estate beginnings in Real Estate: My Favorite Asset Class.
Real Estate Investing Alternative
For those of you who appreciate the value, diversification, and wealth building opportunity of investing in real estate but don’t have the cash or time to invest. You might want to consider investing in Real Estate Investment Trusts (REIT). These investments give you exposure to the real estate asset class without the massive capital outlay or management oversight.