Not everyone sits at home and binge watches HGTV and "sees" first-hand how easy it is to flip a home. While I guarantee 99% of you have, flipping homes is a lot more complicated than it may seem. This week’s newsletter is going to provide some insight into the thought process behind a flip.

In general, here are some things to think about when considering whether to flip a home:

1) Transaction Costs
2) Repair Costs
3) Holding Costs (including Debt service)

Now, what does that mean? Let’s play with some numbers.

To make this work, you need to be buying a bit lower than you probably think. Here is an example:

We find a 3 bedroom / 2 bath house in San Mateo that needs some work, but is identical to two homes that sold for $1MM right next door (i.e., all three homes have the EXACT same floor plan, attributes, etc.). We determine that the prospective home, fixed up, would also likely sell for $1MM. The next question is how much should we pay the seller if we want to make a profit by flipping the home:

1) Transaction Costs: Assuming the property is purchased and we are able to sell it for $1MM, the transaction costs associated with the sale alone will easily account for 7-10% of the sale price. This includes staging, cleaning, transfer taxes and recording fees, reports and inspections, home warranty (if applicable), and agent commissions. Additional costs may also include loan payoff costs, prorated property taxes, and homeowner association transfer fees. For our example, let’s use transaction costs of 8% ($80K).

2) Repair Costs: If you talk to any contractor/flipper with experience, they will tell you that the repair estimate is crucial. There is an art to putting together a good scope of work and the associated estimate. Here, let's assume the property needs $50K in repairs and updates. For example, we will put in some new appliances, hardwood floors, paint the inside/outside, landscape for some curb appeal, and perform other relatively minor items. While this can easily become $100K + depending on the level of work (i.e., kitchens/bathrooms, roof, etc.), for our example, we are only going to add another $50K.
Many people would assume that purchasing the property for anything less than $870K would give them a profit. However, people forget about holding costs.

3) Holding Costs:  Holding costs are costs that owners incur by virtue of owning a property. Most buyers, unlike everyone reading this newsletter, do not have $1MM+ in their checking account making less than 1% a year in interest that they want to pump into a real estate deal. As a result, most flippers usually have to pay some percentage of the purchase price and get a loan for the remainder. This can be tricky because the average person now realizes that if the property is worth $1MM (or $950K without the improvements), there is a reason it is selling for $870K. Most of the time, the reason a property is selling for a discount is because of factors such as inability to get conventional financing, health and safety concerns, etc.
Let's assume you were going to borrow $600K and pay the difference with your own funds ($270K in cash). For this $600K you might be paying 1.5-4 points (i.e. for every $100K you borrow, you have to pay $1K for each point) in addition to a 8-14% interest rate. For our example, let's assume 3 points ($18K) and a 10% simple interest rate for 3 months ($15K). We want to do the updates quickly, so the goal is to complete the repairs in 2 months and sell the property the following month (3 months in total) from close to close. Therefore, the total financing cost for the loan is $33K.

Additionally, we will have to pay 3 months of property taxes, utilities while doing the work, and insurance for the holding period. This will all vary, but let's call it $5K . As a result, the total holding cost is $38K.

Recap: For our flip, we are going to have to pay something less than $832K
$1MM-$80K(transaction costs)-$50K(repairs/updates)-$38K(holding costs) = $832K

For any purchase price greater than $832K, you would actually lose money. Anything less than $832K would result in a profit!

Hopefully this example provides some insight into the process of how to evaluate a flip opportunity. While this newsletter provides a strong overview of the process, there are many other costs that may come up. However, this is meant to get your feet wet. The takeaway, you really need to purchase a property at a substantial discount to make a profit flipping. We encourage you to reach out to us if you need assistance evaluating a property that you are considering to flip.

If you ever have any questions at all, please do not hesitate to reach out. At MinnGo, we realize that real estate is not something our clients think about everyday. Lucky for you, that is what we live and breath.

Until next time.