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Flipping Properties to Homeowners

Countless books, TV shows, weekend seminars, and group discussions have been dedicated to the topic of flipping properties. By no means do I intend to comprehensively cover this topic. However, through the thousands of properties I have purchased, fixed, and flipped, I have found some nuggets of valuable advice, and developed formulas I use over and over to make sure I’m getting a good deal and hitting my targeted profits. So consider this chapter as something you can refer to down the road once you have completed a few flips. If you have already been in the game and done some deals, then you will know how “true” and valuable these pointers can be.

Let me start by digging into the most common mistakes other investors make when trying to flip properties.

1. You make money when you BUY: Fledgling investors will show me detailed spreadsheets illustrating how much profit they will make because they are borrowing money and the rate of return on their cash goes up (completely forgetting they are taking on more risk to offset that return). Or they will show me how they conservatively estimated the repair work, and they’re just sure they can get it done for cheaper (thereby driving up the return). Finally and possibly the worst is that they will show how the appreciation will drag the value up on the property by the time they have rehabbed it. While these are all good things which happen to improve cash on cash return, nothing can replace getting the property for pennies on the dollar. Instead, buy it for 50 cents on the dollar. After repairs, financing, and closing costs, you’ll be no more than 70 cents on the dollar into the deal.
2. Construction decisions and pricing: I have flipped millions of dollars’ worth of properties since 2000. I have broker’s licenses in multiple states. I own construction companies and have real estate agents working for me. The two elements of the process I never take on myself are construction finishes and listing price. I have learned to rely on my power team of experts: architects, expert local market realtors, and contractors with experience rehabbing residential flips. Decisions around trying to figure out whether to put white pine or bamboo flooring, or if the house should be listed for $109k versus $119k, I leave for my staff, whose experience in that area will give the best results.
3. Screw up ARV and forget costs: Deciding on a listing price for a property is like forecasting the weather: it’s an educated guess. ARV changes like the wind and should only be decided by an agent who has specific neighborhood knowledge. I prefer agents who live in the area where I am listing the home, who do flips themselves in that area (sometimes I meet them at auction competing with me to bid on homes), or who have more than 30% of the listings in that area. Someone who can give property by property details for that area over the past six months is vital to me. If they don’t know their market that well, then I worry about leaving money on the table or listing a property too high.

   As far as costs and expenses, many rookie investors focus on the gross profits on the deal and forget commissions, closing costs, pro-rated taxes, repairs resulting from home inspections, construction insurance, utilities, attorney fees, and title and escrow fees. In my experience, these fees average 10% of the sales price of a deal. That is a lot of money if you are only calculating 15% gross profits!

4. Choose the wrong neighborhood to begin with: I always joke that everyone wants to invest in “sexy” deals and show their friends the “sexy” properties they own. Think about the reaction from telling other investors you are a “commercial developer” vs. a “mobile home park owner.” There is a mental hierarchy in the type of investing many investors think they want to do. When it comes to flipping, most investors want to flip houses in the same type of neighborhood where they live or want to live when purchasing their next house.

   If you were to take the town you live in, and map out all of the homes that have been listed and sold for the past 18 months, and then drive through those areas, you would be shocked at where the highest concentration of activity is taking place. No matter where you go in the U.S., the highest percentage of homes bought and sold tend to be in the blue collar neighborhoods. These are the neighborhoods where people are graduating from renter to starter home or from starter home to second home. Generally these would not be considered “sexy” areas. One house flipper I know considers her properties “works of art,” allowing her ego to be wrapped up in the deals, which results in her putting too much money into the rehab. In fact, she really ends up splitting the profits with her contractor.

Last, remember that it is much harder doing flips for higher- end clientele. They are picky about everything, and I don’t like to guess likes and dislikes. Entry-level buyers are simply happy with granite in the kitchen, and don’t mind the color (at least not as much as a higher-end client would!).

Formula: Calculating the Deal

A couple of months ago, an investor I know asked whether she could have all the formulas I use to calculate deals. I laughed and responded that if it was that neat and tidy, I would have created a smartphone app long ago and made a fortune from it! Beware of any company or app advertising that they have some special calculator or software that tells what to pay for deals or where to find the best ones. In my opinion, I have not seen any software, app, or website that will replace specialized knowledge of the following items:

• After Repair Values
• Construction Amount
• Rent Rates
• Current Market Value
• Expenses

Every tool I have seen breaks down with the assumptions that have to be made in order to get a value or profit amount or sales price. By the time you have entered in all of the assumptions, there are so many “guesses” involved that the results you come up with become useless.

Here is the way I evaluate a flip:

Flipping Formula

• Purchase price $25k
• Rehab $50k
• All in $75k
• I will not flip this house unless I can net 25%.
• 25% of $75k = $18,750
• If we can’t sell this house for $103k or more, then I will wholesale it.
• Don’t forget you pay about 10% on the back end—closing costs, commissions, repairs requested by the buyer, etc.

As you can see, it is a simple formula, all based around the target return on investment. When doing a flip, I must make at least 25% or I won’t move forward on that deal. We completed a deal in Dallas, Texas, in 2014, and when we ran the numbers initially, I thought I would make 30%. However, we miscalculated the ARV and had to drop the price—TWICE. Then, when we finally got a buyer, the inspector found an issue with the hot water heater and several other items, repairs for which cost me several thousand dollars. Some vandalism to the property incurred more cost to me. When all was said and done, I made only 19% on the deal.

Looking at cash on cash return only is a mistake. Rookie house flippers will often say, “Look, I only put $10k down with my Hard Money Lender and made $10k in profit, so my return on investment was 100%. What a great deal!” I personally don’t like running the numbers this way. Assume you are doing the deal with all cash. What will your net return be after you sell the house? If it’s 25%, then it’s a good deal. I will hear other investors say, “But Aaron, that just isn’t realistic in San Francisco, or Miami, etc.” My answer is, “Then you shouldn’t be rehabbing and listing those deals. Just mark them up 5k or 10k and sell them to some other sucker dumb enough to do a flip on tight margins less than 25%.”

One of my best secrets for making money in a hyper market like Denver or Phoenix or California is to flip mobile homes. Yes, I’m talking about single wide, double wide, manufactured homes sitting in RV and mobile home parks! More and more Boomers are looking to downsize, and many first-generation immigrant workers are looking to graduate from renting to owning. I always encourage my clients and partners from these hyper-markets to educate themselves on mobile homes and mobile home parks and begin flipping there.

One final thought: “EVERY PROPERTY IS A FLIP AND EVERY PROPERTY IS A HOLD.” It’s naïve to try to classify a property as one or the other. Let’s say you have a property you call a “hold” or a “rental.” Don’t you need insurance for both “flips” and “holds”? Don’t you need a good tax strategy? Don’t you need to hold properties in an entity like an LLC or S CORP? Don’t you ultimately need title and escrow? Whether you hold a property for three months or 300 months, doesn’t it amount to the same outcome? I’ve had properties I thought I would flip in a couple months, but took twelve months before I could sell them. If I...