Hello again. Today we are going to do a little think tank experiment about fix-and-flip real estate projects. I’m here to tell you that I’m neither for nor against them. Arguably, they are one way to make fast cash in the real estate biz however, they are also a quick sinkhole for the inexperienced fixer-upper. For those of you who just can’t stand having a reality check, this article is not for you. On the other hand, if you like to know what you’re about to get into before you do something, keep on reading. I, myself, love the idea of taking a little bungalow and turning it into tomorrows Coastal Living magazine cover but, there is so much more to it than just having a desire to make something beautiful again.
Scenario Number 1
First and foremost, I’m going to be brutally honest here. We live in Charleston, South Carolina, not somewhere less traveled so keep that in mind. If…and I do mean IF you can find a home in a neighborhood that is up and coming for less than $50K then you may have found a keeper. The chances are so very slim that you will but, if you do, consider yourself exceedingly lucky. There is a formula that I want you to try out before you start making investments of this nature. It looks like this.
Cost of Home x 3 – 80% = a great investment
That means in the scenario above if you found a $50K house to purchase and you could potentially sell it for three times the price that you bought it for ($150K) but it cost you 80% of the new sales price to fix it up then you’d be doing just fine.
Do you want $25K or $30K?
I am going to preface this by saying that most flippers are looking for a quick $25K-30K on an investment of this price but, the dynamics change a little when you start inching up the initial price of the home.
Scenario Number 2
For example, let’s say you find a home for $75K that you think you could sell for 3x the price after it’s renovated. That would give you a final sales price of $225K. How often do you find a $75K investment house in a neighborhood with homes which are valued between $200K and $250K? I’m willing to bet it’s not often at all. If you do, jump on it. That being said, this scenario will need to be tweaked a bit for you to understand what I’m conveying here. This one looks more like this.
Cost of Home x 2 – 83% = a moderate investment
This example would substantially limit the amount of money you could use to fix up the home and requires you to “Know That You Know” that there will be no hidden costs or unforeseen structural issues. Not to mention that you will only end up with $25K in the end. Hypothetically, the same amount of work as the first example but, less reward. Just keep that in mind.
Scenario Number 3
This one is the sweet spot. It assumes that you have plenty of money to begin this investment project with. Let’s say you start with $200K of your own money. You purchase a home for $125K which is doable in the Lowcountry. You don’t owe the bank anything and you’re not on the hook for the thousands of dollars which a “Hard Money Loan” is going to cost you. Now you have $75K to utilize in your flip endeavor and you will likely use all of it for the record. After this investment home sells, let’s say that you end up with $30K in your pocket. Here is how this one looks. (Roughly)
Cost of Home x 1.85 – 87% = a great investment
Are you beginning to see the trend? There is another angle I’d like to add to this. You must buy, fix and sell the home within about 5 months. You may have more time with scenario #3 however, the other two assume that you borrowed the money to start with and when you do that, the profitability of your investment is significantly affected.
There are no shortage of homes that qualify for a fix and flip. I am saying this because sometimes we pigeon-hole ourselves into thinking that it has to look like one we’ve seen on television in California. I’m here to tell you that it doesn’t. If this is your first endeavor, go slow. Don’t plan on tearing down walls or reimagining the floor plan to include another bedroom by closing in the garage. Yes, people do that but, it will not increase the value of your house. Period.
And Another Thing…While I’m On My Soapbox
I was recently at a showing for a home which was on almost a half acre of land, .45 to be exact. The house probably could have been torn down and would have been easier to deal with but, the sales price was only $54.9K and my buyer really wanted to make something of it. Upon further inspection, we couldn’t make sense of it, at least not for her. She was planning to use a 203 (k) loan for the purchase and it would have cost more to fix it than it would have been worth in the end. This is the opposite extreme. She was a single lady with all the gumption in the world but, she didn’t have a construction crew in her hip pocket. They don’t just appear out of thin air and well, it’s no secret that sometimes they don’t show up at all. So, be very careful about what you get yourself into. Do Not, I repeat, Do Not hire a fly by night construction firm. Do your research and make sure that they are licensed, bonded and insured. Sometimes, even the good guys make mistakes and if they do, at least you’ll be covered.
ROI stands for Return on Investment. It is a simple calculation used for any number of investments from stocks and bonds to real estate and it can help you to easily comprehend the percentage of gain or loss on your transaction.
Here is the formula.
ROI = (Gain on investment – Cost of investment) / Cost of investment
This is what you should consider as the basis for your transaction before you ever begin. You will want to know how much you stand to gain or lose before you invest.
As in Example #1. If you purchase the house for $50K and it costs you $70K to fix it up then it sells for $150K this is how the formula would look.
($150K – $120K ) / $120K = .25 or 25% ROI
For the purpose of this demonstration, I’ve used the most simplistic application of this formula. When trying to determine Return on Investment (ROI) for varied types of transactions, you should include in your calculation the time it takes to come up with the end result.
ROI + Time
Again, for example, if you were doing two fix and flip jobs and you wanted to determine which one was the most profitable. You would want to include the amount of time it took to reach the end result especially if one house took a year to come to completion and the other only took five months.
Let’s use example #2 here.
($150K – $125K) / $125K = .20 or 20% ROI
If, in this example, it took us 5 months to come to completion but, in example #1 it took us 12 months we would have to make an additional calculation. There are 12 months in a year and we would need to adjust for that so…
In example #1 you would calculate .25 / 12mo = .02 or approximately 2% per month as your gain.
And, in example #2 you would do the same .20 / 5mo = .08 or approximately 8% per month as your gain.
Here you can see that while it appears in Scenario #2 you made less money overall, your ROI per month is greater than that of Example #1.
To Be Continued…
There are numerous contributing factors to the profitability of any fix and flip project. Please note that I have only skimmed the surface of this subject and I do plan on diving deeper in future blog posts. For now, I hope you have found this information to be useful. If I can help you to find a suitable property for investment or even for your personal use feel free to call, text or email me anytime.