10 Flipping House Risks – How Can You to Reduce Them?
There are a lot of risks in the
house flipping business but there are also a lot of ways to minimize these
risks. In this article, we review the top 10 house flipping risks- and how can
you avoid them.
All Content on this site is information of a general nature and does not address the circumstances of any particular individual or entity. The information in this content is not advice on financial, investment, tax or other matters. You should always consult your own financial, legal, tax, accounting, or similar advisors. You can trust the integrity of our unbiased, independent editorial staff. We may, however, receive compensation from the issuers of some products mentioned in this article. Our opinions are our own.
The real estate market may appear to be existing
without path or pattern but in truth, it follows a cycle.
Value and popularity of properties rise and fall as
the demographics change for that particular area.
Being able to understand how this cycle operates in
the real estate market and making an intelligent assumption on which properties
are good to buy is the first stage of a successful house flip.
Know
which properties will likely become popular or are within new developments
because they are the ones that are likely to appreciate in value.
Consider the following factors when looking for
a property to buy: new commercial and retail developments like new
superstores or mushrooming of new and trendy restaurants and bars.
Use this information to gauge where to buy and what
steps to do next.
Home builders have an advantage of some sort because
they control the building process from the ground up.
House flippers don’t have this benefit because you
won’t really know what problems are lurking behind the walls or under the
floors of older homes.
Veteran house flippers know that there are a lot of
risks in the house flipping business but there are also a lot of ways to
minimize these risks.
Flipping
House Top Risks
Here are the top 8 risks factors and considerations
you should know to keep your investment intact.
1.
Money Lossing
With physical training, they say “No pain, no gain”
but in business, we say “No risk, no reward.” In house flipping, there is
the potential to make a lot of money but there’s also the danger of losing
everything just as quickly.
A popular venue to purchase homes for flipping is
buying them from auctions or foreclosures.
However, in this scenario, you will not be able to do
a full inspection of the property and identify all of the possible issues ahead
of time. You really have to gamble.
Expenses
that you did not project have a tendency to arise even with the most careful
planning and foresight.
If you run into major issues such as cracked foundations,
molds, termites, asbestos, or an urgent need to replace the water pipes, they
could instantly bring down or eradicate your profits.
The erratic ups and downs of the real estate market is
another factor you have to deal with on a day-to-day basis.
If you can’t sell
your property fast enough, you will have to
continue to pay the mortgage.
This will form part of your holding costs. Every
day that your investment home remains unsold after it is ready is an
opportunity loss and an actual monetary loss for you.
Special note: Some mortgage rules apply to
properties that borrowers want to flip and they may be a cause for problems
once you offer the house up for sale.
Make sure that you clear it up with your bank’s
representative before you apply for a loan.
2.
Hidden Costs
There are two important figures that you would always
want to know for each project: the cost of the (investment) house and the
cost of refurbishing.
But remember that these are not the only costs you
should think about because there are a lot of other expenses that come with
flipping a house.
There are costs like property taxes, insurance, utilities, and
closing. These are some of the items that you won’t see or hear about
when you watch house-flipping reality shows on TV.
When
you’re watching one of these shows, do your own side computation and see how
all the costs add up. You’ll see that many times, they leave out some of
these costs from the equations they show on the screen.
3.
Thin You Can Do Any Task
This is one of the costliest risks you will bear with
if you do not prepare well for it because it will cost you money and time.
That moment when you discover that you do not have the
skills or knowledge about a particular task is the beginning of additional
expenses that often, you have not planned for.
When
you try to do something on your own and fail, you waste material in the process
and then have to hire a professional (usually at a higher rate) to repair the
damage immediately and replace the spoiled materials.
This will push your timetable back and drive your
project off schedule, with the probability that you need to make one or more
mortgage payment and increase the overall cost of your project.
4.
Hiring a Bad or Very Bad Contractor
Hire a contractor that you are comfortable working
with because a good working relationship is essential to success in the
business.
The best prospects are the good ones you have already
worked with or some who comes with references from people you trust.
Even as you’re making a short list, ask your
prospective contractor for additional references. You should not hire the
first contractor you like – try to get at least three bids.
You will be amazed that three different contractors
could have a wide variation in the pricing of their services.
Treat the bid presentation like it’s a job interview
and you’re the HR manager.
If the contractor is late for your appointment, that
tells you a lot about how he manages his time and most probably, his
projects. Check for the basic things like his valid professional license
and insurance.
Study the bids to make sure that you understand the
time frame and conditions of the bid, how the payment scheme works, and that
the payment schedule is something that fits your cash flow schedule.
See to it that there is a detailed timetable for
project completion and a provision to cover damages if the contractor, by his
own fault, fails to complete the project according to schedule.
Just the fact that you and your contractor are on the
same page can spell the difference between success and failure in your project.
5.
Assume Selling Is Easy Task
Sadly, the real estate climate today is not at its
best as very few properties in many cities are selling as fast as the sellers
expect.
In a case like this, a house flipper should be ready
to face the worst-case scenario.
He can either hang on to the property and absorb the
loss which can lead to a serious financial hardship or even bankruptcy.
Or, he may rent out the house – but that would negate
everything he did to rehab the property. It is a house
flipper’s nightmare to be unable to sell a house that he has spent time, money
and effort to rehabilitate.
In this case, it is better to cut your losses by
dropping the selling price than hanging on and risking more possible financial
losses in the future.
The
common mindset that house flippers aren’t doing anything but still profiting
from the seller’s plight is not entirely accurate nor a regular occurrence in
the real estate business.
However,
it is what usually goes through the mind of a seller.
To be able to broker a deal, you have to be extremely skilled at it.
In fact, you can say that it is even more important than being able to fix up
the house, secure a loan, or negotiating the mortgage.
Connecting a buyer and a seller to the point that they
will reach an agreement is the most satisfying part of the deal.
6.
Wrong Valuation
Your
financial success in any deal would depend significantly on the eventual
selling price of your rehab property.
They call this the “after
repair value” (ARV). A good real estate agent would be able to
determine the correct selling price by doing a comparative market analysis
according to your rehab plans.
On TV shows, an investor will buy a house, do some
rehab, then bring in a realtor to look it over then quote a selling price.
A true-blue investor should never do this. We
make our original offer to purchase according to what we determine will be our
definite selling price later.
You might want to get a broker’s
price opinion from a broker who has the training, experience
and appropriate credentials.
For example, those who do BPOs are the ones who are
usually behind a desk most of the time and write BPOs but do not spend so much
time in the field.
It is better to work with an active agent in a
particular market where your property is situated.
Another source of value is an appraisal report.
Get an appraiser who can do an ARV appraisal based on your rehab plans.
If you are not sure, get multiple valuation
opinions. If you make a mistake in the purchase price of your rehab
property, you minimize your opportunity to make money on your house flip.
7.
Stress And Uncertainty
8.
The Unknown Risk
The last risk is the type that you neither can see nor
anticipate. We should not forget what we experienced in the days after
9-11.
Many unforeseen or unexpected things happen every
day. The market can crash, or a big conglomerate can suddenly announce it
is going out of business, like what happened with Enron and World Comm and how
they negatively affected local economies. I
n such scenarios, it will take a while before the
market can recover from the shock. It can seriously affect house flippers
because they will feel the impact of the actions of these companies the same
way as those that were victims of circumstance.
In any given day, something could happen that we have
no control over.
Often, these are the ones that greatly affect us, and
this is the same principle in play when it comes to property investment.
How the economy is behaving, how the housing market in an area is doing, and
surprise developments can largely influence the overall real estate business
climate.
Investors may suffer, but in some instances can also
strike a good deal. The key is how they can properly manage the risks involved
in the business.
As
a Result
As you may have noticed, flipping houses is not for
the faint-hearted because it is more elaborate than what they show on TV.
A beginner may convince himself that it is the right
place to launch his journey into real estate greatness, it is really a
difficult entry point without the assistance of a good mentor or coach.
And although one can start with a small capital to get
the ball rolling in the house-flipping business, there is a demand for
adequate knowledge of a lot of things.
If you are not careful, you can find yourself in a
sticky situation with an angry seller or a frustrated contractor.