For new investors, the fix & flip strategy offers an outstanding path into real estate. But, buying and renovating a distressed property can also seem overwhelming if you’ve never tried it. It doesn’t have to be this way! To help new investors, I created this article as a step-by-step guide on how to flip a house.
Flipping a house starts with finding a great deal – ideally with purchase, rehab, and holding costs being less than 70% of a property’s after-rehab value. The sales price pays off the hard money loan, and you pocket the remainder as profit.
I’ll cover all the step-by-step details of how to flip a house in the below article. Specifically, I’ll cover these topics:
- Fix & Flip Overview
- Why I Recommend House Flipping
- House Flipping Step #1: Find a Deal
- House Flipping Step #2: Place the Property Under Contract
- House Flipping Step #3: Confirm a Detailed Scope of Work
- House Flipping Step #4: Buy the Distressed Property
- House Flipping Step #5: Renovate the Property
- House Flipping Step #6: Sell the Property
- Common House Flipping Mistakes
- Final Thoughts
Fix & Flip Overview
Unfortunately, HGTV shows about flipping houses do a disservice to new real estate investors. According to these shows, you walk right into the perfect deal, spend a few days fixing it up, and sell it for a massive profit. Nothing could be further from the truth.
In the real world, the fix & flip process begins well before you actually acquire a property. To complete a successful deal, you need to put in a ton of work on the front end. This up-front research and analysis ensures that before you purchase a home, the numbers support a profitable deal. Investors make or break a deal during this initial review period.
In a nutshell, the house flip process includes a few broad tasks. First, investors need to find a distressed property with a purchase price and potential rehab budget to support a profitable resale – the analysis I just briefly outlined. Second, investors need to purchase the home, which may or may not include a price renegotiation after initially going under contract with the seller. Next, investors must supervise the renovation process, bringing the property to a condition that will qualify for traditional financing. Lastly, investors sell the renovated property – typically to primary homebuyers.
If analyzed correctly, the sales price exceeds the total rehab, purchase, and holding costs, with the difference representing the flip’s profit.
Why I Recommend House Flipping
I began my real estate career as an agent, helping investors purchase homes to flip. During this period, I didn’t know a ton about fix & flip deals, but I understood that these investors did extremely well with this strategy. Eventually, I took a leap of faith and bought my first property to personally flip. I haven’t looked back since then, and I absolutely encourage new investors to pursue fix & flip deals. More precisely, I recommend this strategy due to these outstanding advantages:
Ability to 100% Finance Deals with Hard Money Loans
With many real estate investments, investors need to contribute a significant amount of up-front capital. For example, to purchase a rental property with traditional financing, you typically need 20% to 25% down payments. For a $300,000 property, that’s $60,000 to $75,000 – not even including closing costs!
On the other hand, with a particularly good deal, investors can 100% finance a house flip. In other words, you don’t need to contribute any of your own cash, which makes house flipping an outstanding strategy for investors without tons of cash on hand. But how? Hard money loans.
Hard money lenders provide investors short-term financing to buy a distressed property and complete the associated rehab. And, as the name suggests, these lenders base their financing on the “hard asset” – the property itself. More precisely, hard money lenders will provide loans as a percentage of a property’s after-rehab value, or ARV – what the property will be worth after the renovation.
For instance, say an appraiser determines a property has an ARV of $300,000. Do Hard Money issues loans at 70% LTV of ARV, meaning we’d offer up to $210,000 on this deal ($300,000 ARV x 70% LTV). If an investor can buy, rehab, and sell the property for less than $210,000, he or she can 100% finance the deal.
Can Flip Houses with Bad Credit
This house flipping advantage also directly relates to hard money loans. With traditional financing (i.e. your standard 30-year residential mortgage), lenders heavily scrutinize borrowers’ soft assets, that is, their personal financial profile (e.g. income, credit score, debt-to-income ratio, cash reserves, etc.). For investors with low credit scores, this scrutiny makes qualifying for traditional financing nearly impossible.
Fortunately, hard money offers an alternative. As stated, these lenders determine loan qualification based on the deal itself, that is, the property. While bankruptcies and judgements will likely disqualify a borrower, low credit scores will not. As a result, investors can secure hard money financing to flip a house, regardless of credit score.
Helps Raise Seed Capital for Other Investments
Many investments – real estate and otherwise – require a significant amount of seed capital to execute. Starting a business, buying an apartment building, private lending, and plenty of other investments generally require a lot of cash. If you don’t already have piles of cash sitting around, this reality can pose a major obstacle to pursuing these sorts of investments. Enter house flipping as a strategy to raise seed capital.
Profit on individual fix & flip deals can vary widely based on property, location, quality, and countless other factors. But, in my experience, I’ve seen average profits of around $30,000. Using this as a rule of thumb, investors can forecast future cash flows.
Say you want to purchase a $1.5 million apartment building with traditional financing. At 80% LTV, that means you need a down payment of $300,000. Divide this capital goal by the average profit on flips – $30,000 – and you see that it’ll take around 10 individual deals to build the capital to fund this apartment building investment.
Builds Your Real Estate Investing Experience
Many people begin investing in real estate to work less – they want to build a portfolio of passive investments to keep cash coming in while they pursue other passions. House flipping is not a passive activity. Quite the opposite, this strategy requires a ton of work both finding and executing deals. But, it provides experience…experience that – when combined with cash – can allow investors to begin private lending.
In basic terms, private lenders are individuals who A) have extra cash, and B) want to lend that cash to other investors and make money on the interest. More precisely, private lenders serve as an alternative financing source for real estate investors. In situations like house flips where conventional lenders (e.g. banks and credit unions) won’t issue a loan, private lenders often will.
Accordingly, many former house flippers eventually turn to private lending. This lets them continue to profit on deals – without the leg work of actually doing the flip. Rather, private lenders analyze the deals up front, determine whether they meet personal investment criteria, lend the funds, then collect the interest. While not fully passive, private lending offers investors a far more hands-off approach to real estate investing than flipping houses. But, to properly analyze these deals, private lenders must have an intimate understanding of what makes a good flip.
House Flipping Step #1: Find a Deal
To find a good deal, investors first need to understand the basic house flip profit formula:
Final sales price
Total costs (Purchase price PLUS rehab costs PLUS holding costs PLUS transaction costs)
Deal profit or loss
This formula frames any deal analysis. Simply put, investors look for deals that A) result in a final profit, and B) ideally, have total costs less than 70% of ARV, which allows for 100% hard money financing.
Typically, investors will not find distressed properties that meet these criteria on the Multiple Listing Service, or MLS. These properties generally list at retail and require little to no renovation, making them a poor fit for house flippers. Consequently, successful investors build strategies to 1) find potential off-market deals, 2) market to owners, 3) set up interviews, and 4) convince owners to actually sell their properties. I highly recommend using our Investor’s Edge software for this process. This software helps investors do the following:
- Find deals: We include a database of over 160 million properties, giving you massive deal potential. And, we include information about how much equity owners have in these properties. This will help you find potentially motivated sellers – all from the comfort of home.
- Save preferences: As you filter through hundreds of potential deals, you need to stay organized. If not, you’ll quickly become overwhelmed – or simply commit far more time than necessary. Our software lets you save all of your preferences with a click, keeping you organized and focused on what matters – closing deals!
- Market instantly: Once you find a deal, you still need to contact the owner. With Investor’s Edge, you can automate this process. Our software lets you print postcards with pre-filled addresses and send voicemails to your saved list of potential deals.
But, you’re not done after this initial outreach. Once you connect with a potential seller, you still need to convince him or her to sell. I like to look at this as problem solving. Typically, motivated sellers have a need that they must meet. Frequently, they need cash for something or other but can’t sell their house due to its current condition. It may be significantly distressed, or it may just require a major repair that the owner cannot afford.
As a result, these owners can only sell to all-cash or hard money loan investors. Enter you as the problem solver. You can purchase this property, and you provide the owner the cash he or she needs. But, I always want to emphasize to new investors: don’t pretend you’re doing this out of the goodness of your heart. This is disingenuous, as you’re doing it for profit – not charity. Rather, you’re looking for a win-win situation. By purchasing the home, you solve the owner’s cash-need problem. But, you also gain a good deal in the process. Win-win.
Here’s the major takeaway: when looking for properties, remember that you’re a problem solver. But, to solve problems, you must first understand the seller’s needs. If you take the time and effort to do this – which requires a little empathy and communication – you’ll find great deals. And, you’ll help people out in the process.
As you research potential deals, you’ll eventually find one that looks like a winner. At this point, you’ll estimate a flip budget using rough numbers. It’s not critical here that the numbers be precise. Instead, your back-of-the-napkin budget will let you know whether you should put the property under contract.
House Flipping Step #2: Place the Property Under Contract
If the numbers from the first step support your investment objectives, you next place the property under contract. This will likely entail some back-and-forth negotiations with the seller, but you’ll ultimately sign a purchase agreement for the property.
Of note, placing a property under contract doesn’t mean you need to purchase it. As long as you have a due diligence clause in the contract, you can exit the deal with your earnest money deposit, so long as it’s before this deadline. This is why the numbers don’t need to be precise – just a ballpark estimate to let you know whether the deal looks good.
House Flipping Step #3: Confirm a Detailed Scope of Work
After placing the property under contract, you’ll develop the detailed rehab budget numbers. I recommend doing this by walking the property with your general contractor (GC). As you walk the property together, you’ll talk about everything that needs to be completed during the rehab process. And, you need to document each one of these items (NOTE: I like to record these conversations on my phone, as I can use this as a reference when I’m building the below scope of work).
Once you’ve completed the walkthrough, you’ll document every single item in what’s known as a scope of work form. This form will include a line-by-line description of every task to be completed, the quality of the associated materials, and – eventually – the cost per item.
After you’ve added the tasks and materials to the scope of work form, you’ll meet with two contractors to have a pricing meeting. During these meetings, you’ll assign costs to each of the line items in the scope of work. The total cost for all of these items becomes your rehab budget. And, I recommend meeting with two contractors for pricing bids to solidify a primary and back-up contractor. This will give you flexibility during the rehab process in case one of the contractors A) doesn’t perform, or B) needs to back out for unforeseen circumstances.
Additionally, meeting with two contractors confirms fair market pricing the project. You don’t want one contractor to significantly underbid and then nickel and dime you throughout the rehab. By getting two bids, you’ll have a clear sense of market pricing.
Once you confirm pricing, both you and the primary contractor will sign the scope of work form. That way, if you have any discrepancies in the future, this form will serve as the final arbiter.
With a scope of work form signed, you now need to sign a services contract with your GC. This contract outlines exactly how the GC will complete all of the items on the scope of work form. As a rule of thumb, I assume that, for every $1,000 of rehab budget, a contractor will need one day of work. So, a $50,000 rehab should take 50 days to complete, and then I add a 10-day buffer for standard friction (e.g. permitting delays, weather issues, etc.).
Additionally, I recommend dividing the scope of work items into key milestones. Typically, I’ll look at the project and create 25%, 50%, 75% and 100% milestones. This helps ensure the project progresses on schedule. And, in terms of payments, I will only pay a contractor for a scope of work item when that item is 100% finished. This keeps GCs on task, as they know they’ll only get paid when they’ve completed an item to standard.
All of this occurs before you purchase the home.
House Flipping Step #4: Buy the Distressed Property
With a services contract and scope of work signed, you now have a detailed and accurate rehab budget. Armed with this information, you can decide whether your original contract price makes sense. If it does, close on the purchase. For new investors, our Advanced Deal Analyzer house flipping calculator is a great tool for analyzing a deal’s costs and potential profit.
Sometimes, though, your detailed final budget comes in higher than your initial estimate. When this happens, the contract price may no longer make sense. In these situations, you can bring the final contractor bids to the seller, using them as leverage to negotiate a reduction in purchase price. Most motivated sellers will work with you and adjust the selling price. If not, you can still walk away from the deal with your earnest money, so long as you meet the due diligence period deadline.
House Flipping Step #5: Renovate the Property
Once you close on the purchase, the renovation work begins. I recommend that you go to the property at least once a week, as you’ll want to make sure that the work is progressing as scheduled. At these weekly meetings, I’ll walk the property with the GC and always ask two questions:
- What did you do last week, by scope of work line item?
- What are you doing this week, by scope of work line item?
These questions A) let you track the progress and make sure you hit milestones, and B) let you submit loan draw requests to pay your GC accordingly.
Occasionally, a contractor falls significantly behind schedule. When this happens, I’ll hold a status of rehab work meeting. In this meeting, we’ll discuss a plan for the contractor to catch back up on the work. If not possible, I will bring in the back-up contractor to finish the work. However, I will definitely provide some time liberties if a delay is documented by third parties (e.g. a city delaying permit issuance).
House Flipping Step #6: Sell the Property
Once you’ve completed all renovations, you can sell the home. Until this step, you don’t realize any profit on the deal. As a result, successfully marketing a home for sale plays a huge role in the fix & flip process.
Building a successful marketing strategy hinges on knowing your target market. House flippers renovate properties to the point that they’ll qualify for traditional financing. And, once they meet this standard and appeal to potential buyers, flippers sell the renovated properties, typically at retail to people buying primary residences.
As a result, house flippers need to market their homes to people paying retail for a ready-to-occupy property. Generally, this means marketing to people buying primary residences. But, some buy-and-hold investors will also purchase rental properties at retail, knowing that the property will appreciate during their investment horizon.
When you want to sell a renovated property to retail buyers, you should absolutely work with an agent and list it on the MLS. Simply put, the MLS provides maximum exposure to retail buyers. People looking for primary residences and many investors focus their property searches solely on those listed on the MLS within their market. Furthermore, real estate agents anywhere can access these listings, meaning that you also gain exposure with out-of-market buyers considering a move to your area.
After selling the renovated property, a portion of the proceeds pay off your hard money loan balance and, potentially, any additional gap financing you used. The remainder represents your profit on the deal (NOTE: House flippers must pay taxes on these profits, so make sure to consult a CPA to determine the most effective tax strategy for your unique situation).
Common House Flipping Mistakes
Realistically, new investors need to get their feet wet and make a few mistakes to truly gain experience. But, I want to outline the two extremely common house flipping mistakes in the hopes that you’ll avoid them yourself.
Mistake 1: Underestimate Rehab Costs
The first major mistake new investors make involves repairs. More precisely, they tend to drastically underestimate repair costs and timelines. Often, this results from working with a bad contractor, someone who underbids a job then continuously submits cost overruns.
Say, for example, that a contractor bids $30,000 on a rehab but then submits another $15,000 in cost overruns. If your deal budget initially projected a $20,000 profit, that swing brings it down to $5,000. And, if the contractor also needs more time, your increased holding costs (loan interest, taxes, insurance, etc.) may completely eliminate your profit.
To avoid this mistake, investors should get multiple bids from different contractors (a minimum of two). This lets you confirm an accurate, fair value pricing bid. And, as part of this process, you’ll need to complete a detailed scope of work and services contract with your selected contractor. This ensures you’re both on the same page in terms of A) work to be completed, B) cost of that work, and C) associated timeline.
But, we also understand that working with a contractor can overwhelm and challenge new real estate investors. As such, the Do Hard Money team supports all of our members with experienced project managers (PMs). These PMs will work with you through the entire deal, from initial contractor bidding through rehab and sale of the property. These professionals will mentor and guide you through this entire process, helping you avoid the mistake of underestimating your rehab costs. And, in doing so, you’ll significantly reduce your investing risk.
Mistake 2: Overestimate Values
I often see fix & flip investors make this mistake, as well, and it can absolutely crush a deal’s profitability. And, new investors often make it on both the front- and back-end of the deal. That is, they A) pay too much for the initial property, thinking it’s worth more than it currently is, and B) estimate too high of an after-rehab value (ARV), which inflates their budgeted sales price.
To mitigate this risk, investors must understand how to value properties. However, accurately valuing properties hinges on access to current, reliable data about sales comps in your market. Simply put, you need to know what similar places have recently sold for in order to determine the value of your property.
Without access to the MLS, investors can struggle to find this information. We understand this reality, and our Investor’s Edge software helps solve the problem. This program aggregates data from MLS around the country, providing investors access to over 160 million property records. Armed with this data, you can pull the most recent sales comps for your market. These comps let you accurately estimate property values – and therefore reduce the risk of overvaluing a property during your deal analysis.
Even after outlining the step-by-step process of how to flip a house, I understand that diving into the first deal can seem overwhelming to new investors. We’d love to help! Our Do Hard Money team’s project managers can guide you through the entire flip process, providing you key support during your first few deals. Drop us a note and we’ll get started planning your first flip!