Reality vs. Reality Show Fix and Flip Economics
Reality shows make fix and flip real estate investment look simple: Final sale price, minus purchase price, minus rehab costs, equals profit, in about three months, right? Following that simple math, you often see a 50% purchase-to-value ratio as what you should expect from a flip project, which suggests your profit margin is 50%. In reality, the purchase price plus rehab costs aren’t close to total costs, including the carrying costs (interest of the fix and flip loan over the time frame of the project before selling the property). If the ratio of total costs to final sale price was more like 80%, would it still be a good flip? No? What if that 20% profit meant $69k profit in four months? Is it enough? Maybe it is, or maybe it isn’t. Whatever ratio you’re looking at, fix-and-flip “success” comes down to the question, “what income do you want, and how do you want to spend your time making it?”
Let’s walk through a realistic example, and we’ll find out that success in the fix-and-flip market comes down to real costs and real, personal choices: choice of income you want and need; choice of how you want to make that income; and then the properties you choose to flip … in that order of importance.
But to illustrate the point, let’s begin with property choices to help identify different types of investors.
Fix and Flip Property Choices
There are generally two types of properties sought for flipping residential real estate properties.
- Repossessed Properties
These properties are in financial distress because the previous owners couldn’t make payments, so the property is repossessed by the lender (usually a bank). The profit potential can be great if you have fast cash to buy, because the bank is motivated to sell low, and the properties may not need much rehab. But that’s a key question; Are they in physical distress as well as financial distress? Repos are in high demand, so how do you get a chance at them ahead of your competitors, and how good of a look do you get before you have to make a decision to purchase?
- Disrepair Properties
These are the more common flip properties. They have fallen into disrepair. Décor and appliances are outdated to the extent of needing significant repair and renovation. Accurate rehab estimating, good knowledge of neighborhood property value, and hard work will make these flips successful. The biggest risk here can be under-estimating rehab and therefore time frame as well.
What kind of person are you? Would you rather spend more time working relationships or a drill? How much money do you want or need to make per month? Are you patient or impatient? This determines everything in success of fixing and flipping houses for acceptable profit. Take a look at the property choices again. If you’re not aligning your project choice and property choices with your personality, temperament and capabilities, the mismatch will take the form of financial loss as well as lack of satisfaction in the flipping business.
The greatest effort in successfully flipping repossessed properties is the effort you put into relationships … with a wholesaler and real estate agents … to get access to these properties when they are in high demand, and to trust the read on their condition without seeing them if speed to purchase is needed. These can be all over town, with profit depending on location, so you may need relationships all over town. You have to work those relationships, and pay for them. If your full-time job is working hard at relationships to get ideal repossession houses with least need of rehab, you can do well in flipping them quickly at better than 20% profit.
For disrepair properties, you might make these flips profitable by working a neighborhood to the point that you know the interior and exterior condition of most homes in the area, so the ratio of purchase-to-value for each home becomes second nature to you. Are you a worker? Knowing what needs to be done and getting it done is your business, and you carry tools. Your relationships are with the home owners and real estate agents, and you might get the inside jump on that next ideal flip because you fixed the hand-rail for the owner last year when you were in the neighborhood and noticed it was loose.
Realistically, these are broad generalizations and you may be a mix of both, but the point is … personal strengths and preferences matter, and if you work too far outside your strengths, it will cost you. You might get a repossessed house that needs a lot of work, or you might need a relationship you don’t have to get that next deal.
Income and Costs
Start with the income you want and need. Combining your basic financial needs and goals with your personality type and the properties you want to pursue, this will determine if your objective needs to be $50k every 3 months, or $150k every 8 months … working the neighborhood fix-and-flips or hunting the repossessions. If you start there, the property choices determine themselves to fit your model.
Regardless of business model, you have to know and manage the costs. Too many beginners look at Flip This House economics (Buy / Fix / Sell). The actual costs, in “reality”, are way off. Getting the rehab costs right are one thing (and difficult for the beginner), but not factoring all of the costs into your first flips will more likely be a reason for flips becoming flops.
Example of Flip Costs
Here’s an example with costs involving a financially distressed repossession that also needed significant renovation, and had a surprise case of mold. The investor was a pro, so he was prepared for all costs and work, and had a successful flip … meaning, the profit met his business model criteria for return on investment, time and work.
- Purchase Costs
Property Purchase: $213,000
Finder’s Fee (to wholesaler): $12,937
Total Purchase Costs: $225,937
- Costs of Money
Lender, Broker, Lawyer Fees* : $10,970
Holding Costs (loan interest, 4 months): $9,500
Total Costs of Money: $20,470
- Closing Costs (at purchase)
Insurance (property & business): $2,357.44
Taxes* : $3,973.23
Title Work* : $1,523
Total Closing Costs: $7,853.67
- Rehab / Repairs
Mold Remediation: $6,950.00
Kitchen Cabinets/Countertops: $5,415.50
Misc. Materials: $5,409.59
Utilities (duration of project): $326.62
Total Rehab/Repair Costs: $69,821.44
- Sales/Marketing Costs
Realtor Fee: $25,200
Total Sales/Marketing Costs: $25,200
- Closing Costs at the Sale
Local Tax : $291.66
Title : $1,071
Home Warranty: $405
Total Closing Costs : $1,767.66
TOTAL COSTS: $351,049.77
FINAL SALE : $420,000
PROFIT : $68,950.23
*Costs not typical with MM Lending financing and closings.
(i.e., no lender, broker, lawyer fees, and title fee paid by seller in KY)
Outcome of the Deal and Summary
You might hear Fix and Flip experts talking about a target 50% purchase-to-value ratio based on purchase, rehab and sale, however if focused on your profit, which you should be … it’s better to think about the final net income over time, factoring all costs of the effort. Ultimately, the deal above yielded a 20% profit on total costs in four months. Doesn’t sound like a target profit margin, right? But it was $69k profit for a four-month project. If you could do that, one project at a time for 4 months each, you’re looking at $210k annual income. Is that good flipping or not? Well … that’s up to you. Is that the income you want for the work involved? As stated previously, your answer helps you determine if the flipping business is right for you, and more specifically, which type of flipping would be right for you.
When you bring a potential deal to us at MM Lending, we’re very happy to review it and give you our thoughts, as well as a competitive rate for a loan. Contact us any time, and we’re looking forward to hearing from you.