What is House Flipping?
If you’ve ever watched Chip and Joanna Gains, The Property Brothers, Flip or Flop, or any other number of HGTV shows about renovating older properties then you probably have a general idea of what house flipping is.
Note, I said an idea of what it is, not how to do it.
I make this distinction because those shows are notoriously bad about omitting details to make the projects much sexier for views and ratings.
For example, at the end of every show, they say things like “we bought it for $100k, spent $60k renovating it, and sold it for $250k, for a total of $90k profit!”
What about the taxes, utilities, and insurance payments they made during the renovation? What about the origination fees (points) and interest they had to pay to any lender they might have borrowed funds from? What about the 6% sales commission paid to the real estate agent(s) for the sale of the home? What about the short-term capital gains tax they will be on the hook for?
None of these things are discussed at all…because they aren’t sexy.
Now, if you ask me, even if you spent $40k on all of those expenses–which is probably higher than your actual costs would be–a $50k pre-tax payout is still awesome, especially if you were able to use other people’s money to fund the purchase and rehab, and weren’t doing all of the labor yourself!
Now that we’ve got that out of the way…
When you break it down, house flipping is the act of taking a beat-up–or outdated–house and bringing it back to life and into the modern era. By doing so you should increase the value of the property enough that you can profit from all of your hard work at the sale.
House flipping is time and energy-intensive, but the profits can be quite large!
How Do You Determine if a Deal Makes Sense to Flip?
As the adage goes, there is more than one way to skin a cat.
I’m going to share the formula I use to determine whether or not a potential flip makes sense, and what my maximum allowable offer (MAO) is when purchasing that property to strike.
There are many other ways to do this analysis. I think it is worth doing some additional research and setting your criteria for buying. Then stay within that box, and don’t deviate because of how you “feel” about a property. Emotions are deal-killers, haha
Alright, here’s my formula:
75% of After repair value (ARV) – rehab costs = MAO
Now, it is important to understand that if you run numbers this simply you aren’t factoring in the 6% commission at the sale, closing costs, or holding costs. That is fine, as long as your ideal profit still fits after accounting for that.
For example, if a property has a $100k after repair value and requires $25k in rehab costs, I wouldn’t pay more than $50k for the property–75% of $100k – $25k in rehab costs.
After subtracting the commission ($6k), closing costs–less than $1k in my market–and subtracting, let’s call it another $6k to be conservative, that still leaves you with a gross profit of $12,000 on the property.
Generally, I want to see at least $10k gross profit on any flip under $100k all-in, $20k on any flip under $200k all-in, and so on.
Again, you want to take the time to create your own “buy box”.
Also, keep in mind that I always buffer 20% of my rehab budget for overages, so if I don’t go 20% over budget the difference gets added to the gross profit.
There are other ways to increase that spread as well. Perhaps you get your real estate license so that you don’t have to pay 3% of that sales commission. Maybe you find less-costly lending sources or are able to fund your renovations with cash to avoid financing costs, etc.
I will tell you that the overwhelming majority of my projects have made more in gross profit than what my buy-box says is okay…with the exception of my first flip, in which I lost $30k–more on that to follow.
How to Estimate Rehab Costs
There are several rules of thumb for estimating rehab costs for your projects. Some people set a price per square foot for different levels of renovation and just utilize that to guesstimate their rehab costs. For example:
$10/square foot for a “lipstick” (strictly cosmetic) rehab.
$25/square foot for a mid-grade renovation
$50/square foot for a full-gut rehab.
*Note, these are not my numbers, I just made these up as an example. Every market will be different, and I wouldn’t personally suggest using this method until you’ve done several renovations and feel very confident in your numbers!
The way I estimate my rehab costs on an appointment is with a one-page repair cost estimate form that I fill out as I walk through the house. This has all of the major items broken down by cost and allows me to easily add up the cost of these items. Here are the top five items on my sheet for reference:
When you’re first building something like this out I would recommend that you show your estimated costs to 3-4 contractors–or other house flippers–in your market to confirm that your pricing is fairly accurate for the renovations you intend to complete.
Keep in mind that a house flip you are going to list will most likely utilize more expensive materials than a property you are going to hold as a rental or sell to other investors as a rental.
Once you feel confident in these numbers I would suggest revisiting them every 3-6 months because prices change. A perfect example of this was lumbar costs during the pandemic in 2020/2021. These costs fluctuated a ton, and if you had been using rehab cost estimates from 2019 to 2021 it would have set you up for going substantially over budget!
An added benefit to walking through a house with this form and taking notes on everything that you will need to touch up is that the seller of the house will most likely be with you. As they see you take pictures of and write down, every item you will need to repair, it will make your negotiations seem well calculated, which is good.
Another “pro tip” that I would recommend is always adding 10% to 20% to your rehab budget for unforeseen issues. I would recommend you start with a 20% buffer and only drop to 10% if you feel very confident in your ability to estimate rehab costs–after completing several of them.
For example, if you run through a house with the repair cost estimator form, and it totals $30,000 for the rehab. You would actually make your offer based on $36,000 in repairs in order to account for that 20% buffer in your budget!
Oh yeah, keep in mind that every week your project gets delayed costs you a lot of money. I’ll break down holding costs more in a minute, but time is a lot more costly than you might think when renovating a home!
Financing your flips
When it comes to flipping houses, it can be very capital-intensive. In most instances, you will need to buy the property “cash”–which can include private money, hard money, or any of the other methods I’ll discuss in a moment–without being able to get it appraised/inspected for normal bank financing.
This isn’t a deal breaker by any means, but you need to be prepared to purchase the property and have funds available to complete the entire renovation. If not, you’re setting yourself up for failure.
You do not want to get stuck in a situation of waiting for money to land in your account to complete the next step of the renovation. That is a losing game!
If you have the cash to purchase and renovate your house flips personally, this can reduce the risk dramatically. It can also increase the net profit at the end of the transaction by removing financing costs from the equation.
That being said, you will only be able to take on so many flips with your capital. If you want to scale to 2, 3, 5, or 10 rehabs going at the same time, you will need to be familiar with other methods to fund your flips!
A convenient way to finance your flips is to partner with somebody who can fund the flip. This is similar to paying cash, except your partner is bringing the cash in return for an equity stake in the deal.
Full disclosure, this can be more expensive than some of the other methods, but also lower risk.
How can it be a more expensive and lower risk you might ask…
Because you will most likely have to give them a decent amount of equity or profit-split in order for them to agree to be a “money partner”–think 30%-50% of the spread–but you will only have to pay them out of profit.
Even an expensive hard money loan will most likely be cheaper than a 50% profit share (less expensive), but you will have to pay that hard money loan back with points and interest even if you lose money on the deal (more risk).
Hope that makes sense! With a “money partner” you won’t have to pay them points/interest if you lose money on the deal because they shared that risk with you, but you will have to compensate them well if the flip is profitable…also because they shared that risk with you.
HELOC, Personal Loans, and Credit Cards
Here are some other options to finance your deals without using cash, a money partner, or having to go through the process of landing hard money or finding private lenders. Please note, that I wouldn’t necessarily recommend most of these as your first choice, and I’ll explain why that is for each one.
Home Equity Line of Credit
A Home Equity Line of Credit (HELOC) is when a bank gives you a revolving line of credit up to a certain percentage of the value of your home–excluding debt.
For example, if you have a $200k home that you owe $100k on, and the bank will approve you for a HELOC of 80% of the value of the home–called loan to value (LTV)–then you could be approved for a $60k HELOC.
$200k value X 80% LTV = $160k. Subtract the $100k mortgage balance, and you have a $60k HELOC remaining.
HELOCs are great because they are (generally) low interest, and you only pay interest on the amount of the HELOC you have used. Once you pay that amount back, you no longer have any interest payments to make until you utilize the HELOC again.
They are also simple interest rather than compound interest, which makes it a more reasonable way to borrow.
That being said, the risk with a HELOC is that you’re utilizing the equity in your home. If your flip goes south and you lose $30k, that is $30k of your home's equity that you’re paying interest on until you can pay it down.
I have used my HELOC several times, and I’m okay with this option provided you understand the risks, and ensure you pay off the HELOC once you sell the flip.
I used a $50k personal loan in 2019 to fund the renovation of a home that I had purchased for $12k–that should speak volumes about the condition of this home, haha–Unfortunately, I also lost $30k on this flip, and to date I’m still paying off the remaining $17,181 of this personal loan.
Now, I could have paid it off earlier, but I rolled that cash into another deal that earned me a greater return than the personal loan was costing me.
That being said, personal loans are expensive AF (as the cool kids say these days). I’m currently paying 7.98% after refinancing the balance to a new personal loan last year. My original interest rate was 10 or 11 percent!
These can accomplish the mission, but you’re limited to how much you can borrow, they’re expensive, and you’re going to need to be disciplined enough to pay them off once you (hopefully) profit on the deal!
The very idea of using a credit card to flip a house gives me the heeby jeebies.
That being said, I’ve been guilty of this in the past.
Think personal loan, but even higher interest rate–that is compounding–and can wreck your credit score if abused.
Like personal loans, These can accomplish the mission, but you’re limited to how much you can borrow, they’re expensive, and you’re going to need to be disciplined enough to pay them off once you (hopefully) profit on the deal!
I think this should be your absolute last option, and honestly…if this is what you’re going to have to use, then you aren’t ready to take down a flip yet. Never assume the risk of ruin, and if a credit card is the only way to finance your flip, and it goes wrong, that could definitely ruin you.
I would say the only time it’s acceptable to use a credit card is if you go over budget, and have to use the card to get the project across the finish and get it sold. Even then, hopefully, you can scrounge some cash instead, haha.
Construction loans seem to vary a lot from lender to lender.
The gist of a construction loan is that a bank lends you money on the purchase price in the same way it would for a normal home purchase. Additionally they lend you money for the renovation in order to complete the project.
Upon completion, they will automatically refinance the property into long-term debt based on the new appraised value of the property.
Most banks will also require you to conduct draws for the renovation, which is kind of a pain, but still better than not being able to complete a flip due to lack of funds. Generally, the draws are done by either A) a percentage of the renovation budget given to you at certain milestones, or B) You pay out of pocket for some repairs, and then bring them receipts to be reimbursed as you go.
My lender–a hyper-local portfolio lender that holds all of its loans in house–will fund 85% of the purchase price and 90% of the renovation costs, and once the project is completed and appraised they will refinance up to 85% of the value (LTV) with 25-year amortization and an adjustable-rate mortgage (ARM) that currently starts at 4% and we have a ceiling set at 7% for the duration of the loan…with no balloon payment.
My understanding is that these terms are pretty generous, and what you’re more likely to see is something like this:
The bank will fund 70%-90% of the purchase price and 70%-90% of the renovation price with a refinance to long-term debt at 70%-85% LTV, based on the new appraisal, upon completion of the project.
I believe two of the main factors for your terms with construction loans will be A) the type of lending institution you’re working with and your relationship with them, and B) your level of experience flipping houses.
You will find that in a lot of these financing options your terms can improve once you’ve completed a few flips with them.
For example, I know of a hard money lender that will fund up to 100% of the purchase and renovation for members of my buddy Bill Allens’ coaching program…once they’ve successfully completed a number of projects with that company to prove their ability to operate their projects and repay in a timely manner.
Hard money lending is one of the most common ways for people to fund house flips. These are lenders that loan on the asset rather than your credit and personal finances. As such, they are easier to work with, but also more expensive due to the inherent risk they are taking.
Often Hard Money lenders will require you to pay 1-3 percent of the total price of the project (purchase and renovation) in origination fees. These are called points, i.e. one point equals one percent of the total loan. On top of that, you’re generally looking at anywhere from 8-15 percent interest rates, and I would say 10-13 percent is the most common.
Generally, hard money lenders will only loan the money to you for 6-12 months, and if you miss those deadlines they will impose additional points or increase the interest rate to compensate for it.
As you can see, this is an expensive way to fund your projects, so why would so many people utilize hard money lenders?
Well, because they specialize in this. A lot of hard money lenders can fund a transaction as fast as seven days! That is a huge advantage in competitive markets and when you need to add a project to your pipeline quickly.
Also, they will generally give you better terms after you have completed a few projects together.
Do yourself a favor and shop around with several hard money lenders, and ask local investors who they use for hard money in your market, before deciding on a company to work with.
I have a really good friend who is a hard money lender in Hawaii, and we’ve never been able to work together because the minimum loan cost he will lend on is substantially higher than any of the cost of my project, haha.
As with anything, network, ask other investors, and do your research before deciding on a hard money lender to work with!
Private lenders are the best. The very thought of this type of financing gets me aroused!
Okay, maybe not that kind of exciting, but private money is (in my opinion) the single best way to finance your projects. I’m not alone in this either, as all of the largest and most successful house flippers I know are constantly working to increase their Rolodex of private lenders!
The reason private lenders are the best is that they are easy to work with, don’t involve an application process, have no credit requirement, and still have very comparable terms too!
For example, on all of my flips in the past year, I have paid one point and 10% interest, all paid at the sale of the property. This allowed me to fund, renovate, and sell the properties without making any payments to the lender until the end. To make this even more awesome, all of those deals were funded with 100% of the purchase price and 100% of the renovation cost!
Now, if I go over budget I come out of pocket for that until we sell the property, but as long as I stay within my budget this allows me to purchase, renovate, and sell (or refinance) a property without any of my own money in the deal. This is huge for me, as I would rather hold my capital for overages and unexpected issues, as opposed to having it all tied up in deals.
The only exception to the above terms was a private loan I'm doing that is a second position lien.
The seller is carrying the note of the original transaction on this property for 0% down, 0% interest, and no payments due for 12 months. Since we got such incredible seller-financing terms on this transaction it was still cheaper for me to pay an arm and a leg to a friend for the renovation loan, than it would have been to pay interest on the renovation and purchase of the property.
For this loan I paid two points, 10% interest, with an additional point and the interest rate jumping to 12% after 6 months. We also agreed to a 5% profit share with this lender. As I said, expensive terms, but it got the deal done, and I’m okay paying friends well when it is mutually beneficial.
The way this process has worked for me is simple enough that it baffled me the first few times it happened. I send an email to people that have expressed interest in private lending or investing in my market that outlines the deal and terms I would like to offer. In almost every case somebody has responded that they will lend me the money within 24 hours, which is incredible. In fact, in a couple of instances, I had three or four responses within an hour! I then complete a Deed of Trust and Promissory note, send it over to the title company, ensure the private lender has the wire information, and sleep easy knowing my deal is going to be funded by somebody I know personally. At closing they wire the funds, I sign the docs, and the title company hands me the check for the renovation funds.
It is probably worth pausing to say that I have a separate checking account for each of my renovation projects. Never comingle funds from your different lenders!
I know you’re wondering what the catch is, so here you go. You most likely won’t be able to find private money when you’re first starting out. Maybe, but it isn’t likely.
Other investors aren’t going to give you access to their private lenders–and honestly, asking is just going to frustrate the investor.
Finding private lenders is 100% networking!
You need to be telling everyone you cross paths with what you’re doing, and the opportunities you’re offering for private lenders. Go to local real estate meetups and network, and post your projects, or at least what you’re working towards, on social media. Tell your friends, family, and anyone else who will listen to what you’re up to.
The reason I was able to fund $600k worth of projects with four emails over four months is that I had been building my social circle for 3-4 years before I ever tried asking people to fund my projects.
You’d be surprised how many people you know have money in the bank–or their 401k or individual retirement account (IRA)–that they would be willing to lend to you if they know, like, and trust you, and you’re offering them a solid return on investment.
If you want to fund your projects with private money–and you do–then you need to get out there and start networking with potential investors immediately!
A word of caution about contractors
If you ask any house flipper what their biggest struggle is one of the top answers will inevitably be “finding good contractors”.
Now, this isn’t entirely true. Finding a good contractor isn’t that hard; finding a good contractor, who is reasonably priced, and doesn’t have months of work already lined up, is hard.
In a perfect world, you would find an amazing contractor right as they’re starting their business, and you’d be able to grow alongside them in order to make your projects profitable, and help them build their business with constant work…good luck timing that right!
The reality is that you are going to go through a long of contractors and sub-contractors.
The adage “good work isn’t cheap, and cheap work isn’t good” is a useful one to remember here. You can’t expect HGTV quality renovations from a really affordable contractor, and you can’t expect affordable pricing from a contractor who specializes in luxury remodels.
Your best bet for finding decent contractors is to get networking. Ask other investors for recommendations, go to Home Depot early in the morning and see what contractors are already there picking up materials for the day, and attend local real estate investing meetups to ask around.
You’ll find somebody, but you’ll definitely need to manage them well too!
I like the idea of asking the contractor for a date that he will be finished with the project, adding a week to his timeline, and then telling them “if you complete it on or before that date I’ll pay you a 10% bonus, if you go past that date I will deduct 10% from your pay”.
Some contractors are cool with this, others are not…but whatever you do, do not pay them upfront for the job!
Take it from me, they will rob you blind!
Managing your projects
There are a million ways to manage your renovation projects. Everybody has their own method, and I don’t think there is necessarily a right or wrong way as long as you’re holding your team accountable for the work they said they would conduct.
That being said, here are a few best practices that I recommend utilizing when managing your projects.
- Take the original scope of work that you and your contractor worked out and turn it into your budget tracker, which I would track using a Google Sheet. Add columns for “budgeted” and “actual” on the right, and update it weekly to ensure you know exactly where you’re going over (or under) budget on each item.
- Never, I repeat never, pay any of your 1099 contractors until you have received their completed W-9 for taxes. Otherwise, you’ll be running around trying to get them to fill out this form acknowledging they need to pay taxes–which they don’t like to fill out anyway–after you’ve already paid them and have no leverage. It is much easier to say “If you want this paycheck, give me your W-9” than to hunt them down after the job is completed, trust me!
- Walk your project before paying your contractor their draws to ensure the work that was completed is A) actually completed, and B) completed up to your standard.
- Renovate your projects up to code, and don’t do shotty work. It will come back to haunt you one way or another.
- Utilize a lockbox for the front door of your homes for contractors to gain access without your presence being necessary.
- Build out a list of preferred materials. For example, we use the same grey and white paints, LVP flooring, and lighting fixtures in all of our renovations. Doing this makes budgeting your projects easier, and allows you to buy in bulk periodically to save on supplies. We recently bought five pallets of LVP flooring when we only needed four pallets worth because it enabled us to get an additional $0.20 per square foot knocked off the price. That saved us about $190/pallet, which means that we got the fifth pallet at half price!
- Inspect what you expect, and don’t operate on trust. If you’re like me, you would love to operate all of your businesses via “handshake agreements”, but unfortunately you can’t rely on other people to have that level of integrity. Every time I’ve lost a substantial amount of money in real estate has been because I trusted somebody too much. You don’t want to learn this lesson the hard way.
The Secret Killer of Deals – Time (break down holding costs and opportunity costs)
Rules of Thumb to cover your ass
- The renovation budget should never be larger than the purchase price
- Always buffer for overages
- Always pay your contractors in draws
- Always keep tabs on your projects, and verify work is actually completed before paying said draws.
- Always expect the worst, and prepare for it!
My $30k Mistake!
In 2019 I bought a house for around $12,000 from a local wholesaler. The house needed about $50,000 worth of repairs, and would have been worth just over $100,000. I say “would have” because we never made it that far and I ended up losing $30,000 on this project.
So what went wrong?
Well, I utilized a contractor that two local investors had recommended. They had both worked with him before, and said he would be able to handle the project. What they didn’t account for though, was him biting off more than he could chew with the business.
This contractor took on a few too many projects, and was bringing in new subcontractors quickly in order to stay on top of them. Unfortunately, that meant he was using unfamiliar subcontractors on my property.
It also meant that he was swamped, and unable to make it by the project regularly to stay on top of things, and ensure the work was being done adequately.
None of this would have been that big of a deal if I had proper systems in place. At the time, I was stationed out of state, and relying on this contractor's word as to how things were going. He was sending me pictures here and there and telling me things were going well, and I trusted that. Blindly.
Unfortunately for me, he wasn’t actually keeping tabs on my property. When he said that things were going well, and I paid him the draw for the following week's renovations, he didn’t know how things were going, and I was trusting him, rather than having my property manager–or anybody for that matter–go by the home to inspect the progress.
As a result, I was basically paying for work that wasn’t being done, and I had no idea.
In fact, it wasn’t until I came into town on leave for a week that I realized how much I was being taken advantage of. There was work that wasn’t done properly, and a ton of work that wasn’t done at all…which I thought was done, and had already been paid for.
The contractor told me he would fix it, and I gave him a chance.
A week or two later I get a phone call saying that around $10,000 worth of supplies and materials had been stolen from the home by the disgruntled subcontractor who had been “working” on my project.
The contractor didn’t believe it was his responsibility to replace the items. As I started digging, he didn’t even have receipts. He was trying to get me to pay for $10,000 worth of supplies that I had supposedly already purchased, without any receipts to prove it.
Ultimately, I let the contractor go, got a few more bids, and realized that I would be underwater on this property if I borrowed more money to finish renovating it.
I got the state attorney general's office involved to see about going after the contractor's license in order to ensure this didn’t happen to anyone else, but they never got ahold of him.
I ended up selling the property to another investor just to get out from under it, and when all was said and done I lost $30,000 on the project.
Turns out that the contractor had begun robbing peter to pay paul, and the two investors who had recommended him also got burned in the process.
The moral of the story is always to inspect what you expect when it comes to work being done to your homes. Any respectable businessman will understand that you’re covering your rear, and won’t have a problem with that. Have contracts and criteria that must be met before giving the contractor that next draw payment.
Learn from my mistake!
A Way to Improve Your ROI When House Flipping!
One way to improve your return on investment as a house flipper is to find your own off-market deals. This is definitely more work, and I wouldn't necessarily recommend learning to do this at the same time you're learning how to flip houses.
You should focus on learning one, and then maybe integrate the other into your game plan as time goes on. That being said, if you have an interest in learning about how to find your own off-market deals, check out my course which will teach you everything you need to know to get started along that journey!
Start Finding Off-Market Real Estate Deals Today!
Pros of Flipping Houses
- Can be very profitable
- Gives you the opportunity to refinance into long-term debt and hold onto the property as a rental the “buy, rehab, rent, refinance, repeat (BRRRR) strategy”
- Makes for great Instagram before/after posts and content
Cons of Flipping Houses
- Extremely active income
- You have to manage a lot of variables and people
- Can be a lengthy process, so if the market shifts you may get stuck with a house for many years, or be forced to sell at a loss
Additional Resources for Flipping Houses
FREE YouTube Channels and Podcasts
- 7-Figure Flipping (both)
- Ryan Dossey (YouTube)
- Ryan Pineda (both)
Courses and coaching
- Create Cash Flow (CCF) – hosted by Ryan Dossey
- This is the community that I joined to learn about wholesaling from soup to nuts. It will run you about $10k, and is a great community for the aspiring wholesale\
- 7-Figure Flipping – hosted by Bill Allen
- Bill Allen is a friend, and I know a ton of people in this community. I even spoke at their event in 2021! It will run you $15k or $25k depending on what level you’re at and is a great community for wholesalers and flippers who are looking to build a 7-figure business.
Action Items to get started House Flipping
- Get educated – Start consuming free content, and books, and looking into some courses or coaching.
- Decide on a market (local is beneficial, but not necessary when starting)
- Decide how you’re going to find good deals
- Network with local wholesalers and investors
- Make offers on deals presented to you that fit your buying criteria
- Get bids from various contractors–unless you have one on your team that you trust
- Decide how you’re going to finance this project
- Ensure you get insurance on the house, and have utilities placed in your name before closing
- Close to the house
- Renovate the house and manage your contractors every step of the way
- List the house for sale!
- Repeat until rich or moving into more passive options 🙂