Have you ever wondered how much money real estate investors make from flipping a house? The answer might surprise you. If everything goes according to plan (sigh, a pipe dream), real estate investors are happy to walk away with a 15% net profit after accounting for all expenses. So, if an investor sells a house for $200,000, they hope to pocket around $30,000. That doesn’t sound too bad, right? Flip two houses per year and they’ll earn the average US household income. Flip five houses, and they’ll be in the top 10% of all US wage earners. When looking only at the end result, this seems like a terrific way to make a living, but before passing final judgement let’s dig a little bit deeper into the anatomy of a house flip.
What’s in it for you:
Everything is relative. Making $30,000 all at once is an outstanding payday (and for many people this would represent a life-changing amount of money), but to achieve that amount of profit, real estate investors take on a massive amount of risk. For example, if the house mentioned earlier sells for $200,000, the investor had to risk $170,000. Furthermore, the average lifespan of a home flip is 6-months from the date of purchase to the date of sale, and the profit is only made once, and it’s made at the very end. Keep in mind that there is no guarantee of any profit at all. A recent study by RealtyTrac concluded that real estate investors lost money on more than 28% of their flips.
How does this happen? We live in an unpredictable world. Novice investors might under-estimate the overhead expenses and/or the rehab expenses. There could be hidden damage such as foundation, electrical, and plumbing problems. The house could take longer to sell than expected or sell for less than expected. Contractors could take advantage of inexperienced or out-of-town investors and charge exorbitant fees for their services. There are many variables that investors must negotiate, and if just one of them goes awry, the entire profit, along with 6-months of hard work, can be wiped out.
No matter the location, condition, or situation, every house flip will have certain fixed overhead expenses. These expenses can be broken up into three categories: acquisition costs, holding costs, and disposition costs. Cumulatively, they represent about 20% of the home’s after-repair-value (ARV). We’ll break down these expenses in detail below.
Acquisition costs (2-5% of the ARV)
Not including the purchase price of the property, acquisition costs include title insurance, attorney fees, appraisals, surveys, recording fees, and many other nominal fees. Additionally, some real estate investors sweeten the pot by offering to pay the commissions of the listing agent, which saves the seller 3% (but increases the investor’s acquisitions costs by an equal amount). Good Vibes Homebuyers goes one step further by offering to pay the seller for a free local move!
Holding costs (5-7% of the ARV)
The average holding time (date of purchase to date of sale) for a flip is six months - two months to rehab, two months to list on the open-market, and two months to close. Every day that the real estate investor holds the property costs money, which cuts into final profits. Holding costs include property taxes, homeowner’s insurance, utilities, and lawn care. Here’s an insider secret – almost all investors use other people’s cash to purchase properties. That’s right, they get cash from high-net-worth individuals in the form of private or hard money loans, which have a short-term (12-months or less) and a high interest rate (10-15%). Why do they do this? It’s simple - this strategy allows the investor to acquire multiple properties without running out of cash. However, this further increases the holding costs because they must make monthly interest payments to the private or hard money lender throughout the duration of the home flip.
Disposition costs (9-11% of the ARV)
Disposition costs represent half of the overhead expenses that real estate investors must pay when flipping a house, and most of these disposition costs come in the form of agent commissions. For every transaction, there is an agent for the buyer and an agent for the seller. Each agent makes 3% of the sale price, for a total of 6%. Who is responsible for paying these commissions? Typically, the seller pays the commissions of both agents (an exception would be the example mentioned earlier). Therefore, real estate investors budget 6% of the sale price to paying agent commissions.
Pro tip – if you’re looking to buy a house, you should absolutely have a real estate agent represent you. Since their commission is paid by the seller, having your own agent won’t cost you anything.
No home is perfect, and home inspectors are paid to find these imperfections. Buyers use home inspections as leverage against the seller. Experienced investors budget 1-2% of the sale price for making inspection repairs or providing the buyer with a repair credit. Additionally, most real estate investors budget a 2-3% closing cost credit to the buyer, which helps to lower the buyer’s out-of-pocket expenses. Check out this article to learn why this is a good strategy for both the buyer and seller.
Rehab costs (variable)
Estimating rehab costs is typically the most challenging part of the house-flipping equation. There is no rule of thumb, no magic formula, and no secret shortcut. The good news is that since all the other expenses are relatively fixed and predictable, once the rehab cost is determined the investor will know exactly how much they can pay for a property.
Costs of flipping a home - Putting it all together
In this article we discussed how real estate investors target a 15% profit when flipping a house. We also discussed how the fixed overhead expenses add up to 20% of the ARV. This means that if a house was in perfect condition and needed no repairs, an investor would have to buy it at 65% of the ARV to make a 15% profit. So, if a house in perfect condition has an ARV of $200,000, the maximum price an investor could pay would be $130,000 ($200,000 x 0.65). What if the house needs repairs? The same principle holds true, and a universal equation emerges. No matter a property’s location or condition, the maximum amount of cash a real estate investor can pay is equal to 65% of the ARV minus the cost of repairs. So, if a house has an ARV of $200,000 and needs $50,000 in repairs, the maximum price an investor can pay is $80,000 ($200,000 x 0.65 - $50,000).
1. What is the number one reason that so many real estate investors lose money when flipping a home?
a. Paying too much for the home. The rule of thumb is that real estate investors make money on the “buy,” not on the “sell”. It all comes down to negotiating a low enough buy price to cover all overhead costs and rehab costs while still leaving enough room for profit.
2. Why would anybody ever agree to sell their house for such a low price?
a. Typically, real estate investors purchase properties that require costly repairs from homeowners who don’t have enough capital to pay for these repairs. Although they may sell at a discount, homeowners don’t have to come up with any money out-of-pocket, and they avoid all the risks and hassles described above.
3. What is the average profit margin for Good Vibes Homebuyers?
a. We target a 10% profit margin, meaning that if you’re considering selling your home, we can offer you 5% more than other investors!
As investors, we’ve seen a lot of unscrupulous and unethical practices. We take pride in our honesty and transparency, and we’d be happy to give you our professional opinion on your home selling needs. Contact us today and get started!
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