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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 Loss
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 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
- Emotional Stress – Flipping houses is a more stressful business than others. There are no shortcuts through it and a lot of things can go wrong with your rehab project. You can experience construction delays, deal with change orders, and live with tight deadlines that you would likely miss. Construction problems can drain you emotionally.
- Financial Stress – House-flipping is inherently capital-intensive and we’re not talking about peanuts here. If you’re using your own money, you could find yourself sinking all your funds in one project. If you’re funding through a Hard Money lender, you’ll be paying some 10% to 15% in interest rates. Every delay in your project translates to a monetary loss even if you don’t see the actual money going out of your pocket.
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. In 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 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.