Getting Started: Understand the Potential and Risk in Flipping Houses
Why invest in real estate? What is house flipping?
There has been a boom in people investing in real estate over the last few years as many now view buying real estate as a safer investment than the stock market, and certainly more profitable than savings accounts or bonds. When purchased for the right price, real estate can show significant appreciation over even a short amount of time, especially when buying a distressed property and rehabbing it.
House flippers generally buy properties that are in a distressed condition, selling below market value. By rehabbing the property, and bringing it up to average or above average condition for the neighborhood, rehabbers are frequently able to sell the properties at market value, making a good profit, even when considering rehab and holding costs.
RFG has several customers who make an excellent living from flipping properties full time. It is not unusual to see our borrowers achieve a 20% or greater profit from these projects. Of course, no results are guaranteed, and it is incumbent upon the flipper to buy the property at the right price, get the rehab done in a timely manner, and keep a tight control on costs.
Do I have enough money? How much money do I need to borrow? How much do I need to have personally?
Each lender has different requirements for how much cash they will need to see in order to approve a borrower for a loan. This section will speak specifically to RFG's cash requirements with regards to loan approval. You may find that you do not need as much cash as you think you do.
RFG will lend up to 65% of the after repaired value ("ARV") of the property for the purchase and rehab of the property. What this means, is if you are buying the property for $40,000.00, and it needs $25,000 in repairs, you will need $65,000.00 for purchase and rehab. If an appraiser finds that the ARV of the property is $100,000.00, and you are otherwise financially qualified for the loan, RFG would lend you up to $65,000.00 for the project, meaning you would not have to put any of your own cash into purchase or rehab.
In this case, RFG would look at your cash situation to make sure that you have enough money to close (you would have to pay all closing costs, including RFG's costs, in cash), enough money to get the rehab started (we will reimburse rehab costs as you get things finished at the property) and enough money to make the monthly payments to RFG on the loan.
With regards to how much you need to borrow, that would really depend on how much cash you have and how much of your own money you want to invest in the purchase price of the property. There are many borrowers who want to keep their loan amounts small, so will put a significant amount of their own cash into it. Others do not want to tie up their own cash, so borrow as much as their lender is willing to lend towards the purchase and rehab.
It is difficult to put an exact number on how much cash you would need to show in order to be financially qualified for the loan, but as a ballpark figure, we would need to see a minimum of $12,000 cash for a smaller loan, and at least 10-15% of the loan amount for a larger loan. RFG's minimum loan amount is $50,001.00.
Get to know the neighborhood you want to invest in.
What do I need to know about the risks of flipping houses? What are the risks that I should be aware of, which ones are avoidable and how?
HOMEWORK! HOMEWORK! HOMEWORK! If you do your homework before hiring a real estate agent, entering into a contract of sale and hiring a contractor, you will be far more likely to avoid the risks of real estate investing and rehabbing than someone who does not put the time in. When hiring a real estate agent to help you find a property, hire an agent that specializes in Real Estate Owned ("REO") or distressed homes. These agents frequently have the inside track on new listings on the market (see our blog post How to Find a House Flip - 6 Smart Steps for more information about hiring an agent).
Get to know the neighborhood that you want to invest in. Go to open houses, see what is for sale, the condition of the properties, the sale price and the value per square foot. Look at websites such as Zillow.com and Realtor.com to get a sense of value and provide comparables for properties that you are interested in. Ask your realtor (if you are using one) to prepare a Comparative Market Analysis ("CMA") for you. You should use all of these methods - never rely solely on what others tell you, do your own work and satisfy yourself as to current value and ARV.
When hiring a contractor, make sure that you are comfortable with the person you are hiring. First start with someone you have worked with before, or get references from people you trust. Once your contact someone, ask them for additional references. Even if you like the contractor, make sure to get at least three bids. You will be surprised how much variation there is in pricing.
Treat the bid appointment like a job interview. If the contractor is late, that can foretell their ability to manage time and whether your project will be done on time. Make sure that your selected contractor is licensed and insured. Make sure that you understand the time frame and the parameters of the bid, as well as how the payment schedule works, and that the contractor's required payment schedule works for you. Make sure that there is a timetable for completion and a monetary penalty to the contractor if it is not finished on time. Making sure that both the borrower and contractor are on the same page can make a big difference to the success of a project (see our blog post 10 Tips on How to Hire a Contractor For Your House Flip for more info).
Can I do this on the side, or should I leave it to the professionals? Is it possible to do a little of each?
Many borrowers hold full time jobs and also rehab properties. The key is that they need to have flexibility in their full time jobs. If the borrower has a job that permits them to leave during the day to check on the progress of the property, it tends to work well. If the borrower's job only permits them to visit the property on off hours when the contractor is not there, timelines tend to get extended, profits diminish and problems occur. The borrower needs to be hands on despite their full time job. Full time rehabbing or side gig rehabbing can both work, but the borrower needs to be able to effectively manage the process.