Flipping Houses: How It Works, Where to Start, and 5 Mistakes to Avoid (2024)

The road to real estate riches isn’t all about curb appeal and sold signs. Far too many would-bereal estatemogulsoverlook 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?

How Flipping Houses Works

Flipping is a real estate investment strategywhere aninvestorpurchases aproperty with the intention of selling it for a profit rather than using it. Investors who flip propertiesconcentrate on the purchase and subsequent resale of one or a group of properties. Many investors attempt to generate a steady flow ofincomeby 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 abuy-and-holdstrategy, it's important to complete the transaction as quickly as possible. This limits the time that yourcapitalis 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 priceappreciation that results from a hot real estate market in which prices are rising rapidly or fromcapital improvementsmade 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 maximizeyour return potential. This means you shouldn't pay too much for a home. And make sure you also know how much the necessary repairs orupgrades 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 valueof a property less any repairs that are needed.The ARVis what a home isworth 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.

1. Not Enough Money

Dabbling in real estate is expensive. The first expense is the propertyacquisition cost. While low/no-money-downfinancingclaims abound, finding these deals from a legitimatevendoris easier said than done. And if you’refinancing the acquisition, you’re going to payinterest. 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 tobreak 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 rightlender. Consider using a mortgage calculator to compare ratesthat various lenders offer. Payingcashcertainly eliminates the cost of interest, but even then, there areholding costs and opportunity costs for tying up your cash.

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 youplan 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.

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 fromsweat 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.

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 inforeclosurefor 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 abidto 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 agentsto help sell the house. 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 theprofit marginsare sometimes slim.

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.