If you know what to do, fix and flips provide an excellent opportunity to build wealth in any market. However, in our current economy, there are certain factors to approach with caution. You make money when you buy, not when you sell. You don’t want to get caught in a downturn where you cannot make a positive return on your investment. So, this blog and corresponding episode of The WealthBuilders Podcast covers five practical steps for success with fix and flips:
1. Research the Market
2. Secure Your Finances
3. Understand Renovation, Holding, and Closing Costs
4. Buy a House According to the 70% Rule
5. Calculate Your Profit
1. Research the Market
Every market is different. We invest in Cocoa Beach, Florida, and the market has not slowed down a bit. Supply has almost gotten tighter. People locked in low-interest rates earlier in the year and are cautiously holding onto their homes. Perhaps you’re in a similar market. Still, keep an eye out for distressed or unkempt properties. The owner could be eager to sell. Having a real estate agent who is 1) an investor and 2) familiar with the market is key to finding great deals in tight markets.
It is important to have multiple exit strategies in mind when dealing with fix and flips. An exit strategy is how you will make money from the investment, and different exit strategies require different kinds of market research.
A common exit strategy with fix and flips is to sell it at the as-repaired value (ARV). With a pure flip, you purchase the property at a price point that allows you to do the renovations, sell the property, and make a profit. For pure flips, research how much renovations will cost and how much the ARV will be to see if you can make a profit.
Buy and holds can be another lucrative option. With buy and holds, you rent to a tenant, and their rent pays for your mortgage, taxes, and insurance. For buy and holds, research the following:
– What is the median household income in ____________? What is the median house sale price? (Divide the first into the second and aim for 3-4X)
– What is the median rent in ________________? (You want an investment property to produce a return of 1-1.5% of the purchase price in rent)
– What is the monthly housing inventory in _____________? (3-6 months is good, 8-9 months and moving down is the sweet spot)
Finally, vacation and executive rentals are a great way to make money from a fix and flip. Research how many vacation/executive rentals are in a particular market, average rental rates, and factors that could make the area an attractive option for vacationers or businesspeople.
2. Secure Your Finances
Before you consider a purchase, you will need money to flip the house. You need to have your finances in order to close on a deal. You can do this through a mortgage, a HELOC, or a DSCR loan (which underwrites the property solely based on the cash flow or ARV opportunity.) We’ve had enough cash to do the required renovations in our fix and flips without loans. Then we typically sell the property or do a cash-out refinance to turn the property into a buy and hold or a vacation rental. Securing your finances and being prepared with an exit strategy will help you withstand any drops in the market.
3. Understand Your Renovation, Holding, and Closing Costs
With fix and flips, it can be easy to fall into the “just one more renovation” trap. We want our properties to look beautiful, but we want them to make a profit, too. That’s why it’s essential to understand your renovation, holding, and closing costs. Tapping into the expertise of a general contractor can help you figure out how much renovations will cost. Once you have that figure, tack on another 10-15% for unexpected costs (I’ve never seen a project completed under budget.) Your holding costs include any electricity, water, or services you must pay for while fixing the property. Finally, it’s important to factor in 3-5% for closing costs.
4. Buy a House According to the 70% Rule
The 70% Rule says that an investor should not pay more than 70% of a property’s ARV, including property and repair costs. Your real estate agent can help you calculate ARV. Here’s an example: let’s say that a property’s ARV is $200,000. First, calculate renovation and holding costs depending on the market. You want to estimate based on the market and how long it will take you to renovate the property—aim at the conservative side. Higher-end properties take longer to renovate and longer to sell. When it’s all said and done, let’s say that renovations and six months of holding costs come to $50,000. $200,000 minus $50,000 equals $150,000. Seventy percent of $150,000 tells me I should pay no more than $105,000 for the property. Isn’t that a helpful formula for staying disciplined?
5. Sell For a Profit
The final practical step for success with fix and flips is to sell for a profit! Profits make investing fun. They allow you to stay in the game, purchase more properties, and maximize your impact. See below for a few summary points to help you sell for a profit.
Summary tips on finding the right market:
– Find a market that has affordable renovation costs
– Invest in an area where there is a high demand for homes
– Do fix and flips in markets with good economic growth
Summary financing tips:
– Get a conventional loan and fund improvements
– Explore private financing options
– Partner with an investor that is willing to front the money. You will get a percentage for your work, and they get their money back in a percentage of the profits.
– Go the 1031 Exchange route. A 1031 Exchange allows you to swap one real estate property for another and defer capital gains taxes. The caveat is that you must live in your fix and flip for a year before you sell it.
If you want to learn more about fix and flips, strategic real estate investing, and tax saving strategies, consider purchasing The WealthBuilders Real Estate Workshop USB. It contains over 20 video sessions and PowerPoints from our October 2022 event. Click here to learn more.