Include a cushion in your projections when flipping a house.
As with any other form of gambling, never invest more than you can afford to lose when house flipping. Before you begin pricing houses, setting a rehab budget and reviewing buying and selling costs, determine the amount of money you can afford to lose in a worst-case scenario. Once you have that figure, you can better plan how much house to buy and how to flip it.
Determine the maximum amount of money you can afford to risk on your flip. This might include a lump sum, a loss you’re willing to take in the event you have to sell the house quickly or additional monthly debt payments you can manage if you end up not being able to sell the house.
Divide your budget into four parts: house purchase, upgrades and carrying costs, selling costs and cushion. Determine how much cash and/or how much credit you will use to do the flip.
Meet with a real estate agent to assess your house purchase price vs. your rehab budget. The more house you buy, the less money you will have to upgrade it and vice versa. Ask the agent to show you houses you can purchase and rehab within your budget and what the expected sale price and profit will be if you meet your projections. For each property, request a comp report, which shows the prices for which comparable homes in the area have sold, recommends San Diego real estate investor and flipper Tom Tarrant.
Calculate the buying, selling and carrying costs for several house prices in your initial budget. Include the down payment, real estate agent commissions and closing costs on the purchase and sale of the house, and any inspection fees, taxes and interest. Budget for a full inspection to reduce the chances of buying a house with problems that you might discover only after you begin your rehab work. Consider a commercial insurance policy to give you greater protection, recommends Justin Pierce of Snow Goose Homes, located in Woodbridge, Virginia. Subtract these amounts from the total cash or credit line you have available to determine what you will have left for rehabbing, based on the different purchase prices.
Set a target budget ratio of home purchase to rehab costs. For example, if you have $30,000, you might use $15,000 for a down payment and $15,000 for rehabbing the house. If you can purchase a home for little money down, you can apply more of your budget to the rehab. Reserve 15 percent to 20 percent of your rehabbing cash or credit to deal with unexpected expenses. For example, if you have $25,000 worth of cash or credit for upgrading the house, budget only $20,000 to $21,250 for the rehab. Be sure to calculate and include carrying costs such as utilities and debt service, based on the timeline of your projected rehab, recommends Bill Kring, an Atlanta Atlanta-based financial adviser.
Use the amount of money you have budgeted to guide your real estate agent in selecting a house. Tell the agent your desired profit goal for the flip. An experienced agent will only present a home that you may purchase for a price that leaves you enough money to upgrade it and sell it at a comparable price for the neighborhood.
Review houses recommended by your agent, pricing the upgrades the agent tells you that you’ll need to make to get you your selling price and profit. Meet with contractors to get exact costs on all construction work such as painting, electrical, plumbing, drywall, roofing, tile and cabinetry work. Price cabinets, toilets, sinks, flooring, paint or any other items you will need if you are doing all or part of the rehab work.
Create budget documents for several home prices. List the purchase price on each separate document, including commissions, inspections, and closing costs. Include your budget remaining for rehab costs. Put your 15 percent to 20 percent rehab cushion amount as an expense. Enter your selling and closing costs. Review your total costs to determine if they match your available cash or credit line for the project.
Purchase a home that leaves you enough money to complete upgrades that will allow you to sell it for a price and in a time frame that gives you your desired profit. Base a realistic selling price and timeline on your agent’s assessment of what upgrades need to be made to create a comparable selling price for the neighborhood.
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