Flipping Houses: How It Works, Where to Start, and 5 Mistakes to Avoid

Avoid the pitfalls that novice flippers overlook

Reviewed by Chip StapletonFact checked by Vikki Velasquez

The road to real estate riches isn’t all about curb appeal and sold signs. Far too many would-be real estate moguls overlook the basics and end up failing—and this includes flippers. These are individuals who purchase and renovate properties before putting them back on the market to make a profit. If you’re going to flip a home, make sure you have the cash, time, skills, knowledge, and patience before you lose out. But how do you avoid these mistakes?

Key Takeaways

• Flipping is a real estate strategy that involves buying homes, renovating them, and selling them for a profit in a short period of time.
• Flipping houses is a business that requires knowledge, planning, and savvy to be successful.
• Common mistakes made by novice real estate investors are underestimating the time or money that the project will require.
• Another error that house flippers make is overestimating their skills and knowledge.
• Patience and good judgment are especially important in a timing-based business like real estate investing.

How Flipping Houses Works

Flipping is a real estate investment strategy where an investor purchases a property with the intention of selling it for a profit rather than using it. Investors who flip properties concentrate on the purchase and subsequent resale of one or a group of properties. Many investors attempt to generate a steady flow of income by engaging in frequent flips.

So how do you flip a building or house? The key is to buy low and sell high. But rather than adopt a buy-and-hold strategy, it’s important to complete the transaction as quickly as possible. This limits the time that your capital is at risk. In general, the focus should be on speed as opposed to maximum profit. That’s because each day costs you more money in mortgage, utilities, property taxes, insurance, and other costs associated with homeownership.

But the flipping plan often comes with several pitfalls. Any profit you make is typically derived from price appreciation that results from a hot real estate market in which prices are rising rapidly or from capital improvements made to the property—or both. For example, an investor might purchase a fixer-upper in a hot neighborhood, make substantial renovations, then offer it at a price that reflects its new appearance and amenities.

Where to Start

Limit your financial risk and maximize your return potential. This means you shouldn’t pay too much for a home. And make sure you also know how much the necessary repairs or upgrades will cost before you buy. You can then figure out an ideal purchase price once you have this information.

There is a rule called the 70% rule. It states that an investor should pay no more than 70% of the after-repair value (ARV) of a property less any repairs that are needed. The ARV is what a home is worth after it is fully repaired. Here’s how it works:

• If a home’s ARV is $150,000 and it needs $25,000 in repairs, then the 70% rule means that an investor should pay no more than $80,000 for the home: $150,000 × 0.70 = $105,000 – $25,000 = $80,000. 

Like any other small business, flipping requires time and money, planning and patience, skill, and effort. It will likely wind up being harder and more expensive than you ever imagined. Take it lightly at your peril: If you’re just looking to get rich quickly by flipping a home, you could end up in the poorhouse.

Below are the five mistakes to avoid if you are thinking about flipping a house.

Important

Even if you get every detail right, changing market conditions could mean that every assumption you made at the beginning will be invalid by the end.

1. Not Enough Money

Dabbling in real estate is expensive. The first expense is the property acquisition cost. While low/no-money-down financing claims abound, finding these deals from a legitimate vendor is easier said than done. And if you’re financing the acquisition, you’re going to pay interest. Consider this:

• The interest on borrowed money is tax deductible even after the passage of the Tax Cuts and Jobs Act (TCJA), but it is not a 100% deduction. Every dollar spent on interest adds to the amount you’ll need to earn on the sale just to break even.
• If you use a mortgage or a home equity line of credit (HELOC) to finance the purchase, only the interest is deductible. The principal, taxes, and insurance portions of your payment are not.

Research your financing options to determine the best product for your needs and to find the right lender. Consider using a mortgage calculator to compare rates that various lenders offer. Paying cash certainly eliminates the cost of interest, but even then, there are holding costs and opportunity costs for tying up your cash.

Warning

Even if you manage to overcome the financial hurdles of flipping a house, don’t forget about capital gains taxes, which will chip away at your profit.

Making a profit is tougher than before and they are dropping. Flippers grossed about $67,900 per property across the country in 2022 or a return on investment (ROI) of 26.9%. That’s a 3% decrease from 2021 when flippers earned about $70,000 per property. This doesn’t mean you can’t make money. it’s just that you’ll need more care.

Renovation and other costs (real estate taxes, utilities, and other carrying costs) can cut your profit by around two-thirds. Add to that an unexpected structural problem with the property, and a gross profit can become a net loss. So if you plan to fix and sell a house for a profit, the sale price must exceed the cost of acquisition, renovation costs, and holding costs combined.

And remember: timing is everything, especially in real estate.

2. Not Enough Time

Flipping houses is time-consuming. It can take months to find the right property. Once you own the house, you’ll need time to renovate. This means you’ll have to give up personal time on demolition and construction if you have a day job. If you pay someone to do the work for you, you’ll spend more time than you expect supervising the activity, and the costs of paying others will reduce your profit.

Once the work is done, you’ll need to schedule inspections to make sure that the property complies with applicable building codes before you can sell it. If it doesn’t, you’ll need to spend more time and money to bring it up to par.

Selling the property also requires a great deal of time. If you show it to prospective buyers yourself, you may spend plenty of time commuting to and from the property and in meetings. If you use a real estate agent, you will owe a commission.

For many people, it might make more sense to stick with a day job, where they can earn the same kind of money in a few weeks or months via a steady paycheck, with no risk and a consistent time commitment.

Note

Flipped homes accounted for 8.4% of all home sales in the United States in 2022. This is the highest percentage of flipped homes that were on the market since 2005, according to data published by ATTOM Data Solutions.

3. Not Enough Skills

Professional builders and skilled professionals, such as carpenters and plumbers, often flip houses as a side income to their regular jobs. They have the knowledge, skills, and experience to find and fix a house. Some of them also have union jobs that may provide unemployment checks all winter long while they work on their side projects.

The real money in house flipping comes from sweat equity. If you’re handy with a hammer, enjoy laying carpet, and can hang drywall, roof a house, and install a kitchen sink, then you have the skills to flip a house.

But if you don’t know a Phillips-head screwdriver from a flat one, you will need to pay a professional to do the renovations and repairs. And that will reduce the odds of making a substantial profit on your investment.

Note

Flipping is also called wholesale real estate investing,

4. Not Enough Knowledge

You must know how to pick the right property, in the right location, at the right price. In a neighborhood of $100,000 homes, do you really expect to buy at $60,000 and sell at $200,000? The housing market is far too efficient for that to occur regularly.

Even if you get the deal of a lifetime like snapping up a house in foreclosure for a song, knowing which renovations to make and which to skip is key. You also need to understand the applicable tax laws and zoning laws and know when to cut your losses and get out before your project becomes a money pit.

Big-league lenders have also started to seek profits in the flip-loan marketplace, with global investment firm KKR joining other private investment firms seeking a piece of the action.

5. Not Enough Patience

Professionals take their time and wait for the right property. Novices rush out to buy the first house that they see. Then they hire the first contractor who makes a bid to address work that they can’t do themselves. Professionals either do the work themselves or rely on a network of prearranged, reliable contractors.

Novices hire real estate agents to help sell the house. Their commissions can eat into your profits (even after changes arising from the National Association of Realtors, which will eliminate advertising buyer’s agent commissions on the MLS). Professionals rely on for-sale by owner efforts to minimize costs and maximize profits. Novices expect to rush through the process, slap on a coat of paint, and earn a fortune. Professionals understand that buying and selling houses takes time and that the profit margins are sometimes slim.

Do I Need to Have a Cash Offer to Flip a House?

No. Cash can be more attractive to sellers, so you may see more cash offers accepted on home-flipping shows. Nationwide, 62.7% of house flips are purchased with cash. However, many people do finance their house flips. It all depends on the situation.

Which Cities Are the Best to Flip a House?

This depends a lot on what you’re looking for and your bankroll. But according to New Silver, which provides capital to real estate investors, the best cities for house flipping are Jacksonville, Atlanta, El Paso, Charlotte (North Carolina), and Hartford (Connecticut).

How Long Does It Take to Flip a House?

The average length of time it takes to flip a house is about four to six months from the purchase date to the selling of the finished home. Keep in mind, though, that each project is different. In some cases, it may take a month or so but others may require heavier work.

The Bottom Line

It looks so easy! At any given time, a half-dozen shows on television feature good-looking, well-dressed investors who make the flipping process look fast, fun, and profitable. But making a nice profit quickly by flipping a home is not as easy as it looks on TV. Novice flippers can underestimate the time or money required and overestimate their skills and knowledge. If you are thinking about flipping a house, make sure you understand what it takes and the risks involved.

Read the original article on Investopedia.