As I shared with you in an earlier post, I have decided to start flipping houses as an additional side hustle to enhance my retirement savings. Yesterday my business partner and I closed on our first sale. As I reflect on the overall experience, I can definitely say that I learned a lot and will certainly be a much wiser investor going forward. I am very excited that I made a profit on my first house! Today I want to pass on to you the Top 10 things I learned from my first deal:
No. 1 You Make Your Money When You Purchase
I have read many blogs on house flipping, listened to countless hours of podcasts, and have read most of the leading books on the subject. One thing that really makes sense to me now is the saying, “you make your money when you buy.” My first house had many unforeseen repair problems and the renovations cost much more than anticipated. That said, I used the following three popular formulas to decide how much to pay for the property:
- Profit= Sales Price – Purchase Price – Fixed Costs (taxes, closing costs, holding costs) – Rehab Costs
- 70% Rule = 70% x Completed Sales Price – Estimated Rehab Costs = Maximum Purchase Price
- 50% Rule = Purchase Property at 50% of retail and it will be sufficient to cover renovation and holding costs
I used all three formulas to determine whether my purchase was a good deal. I ended up purchasing my property for just 42% of sales price! At the time I purchased it I thought I was buying it for around 50% of as-completed value but ended up selling it for more than anticipated!
No. 2 Have Your Home Inspected Before Purchase (If Possible)
There are 5 main ways to purchase a house:
- purchase before MLS listing (ex. estate sale, distressed seller)
- purchase from MLS listing
- REO (bank owned) listing
- Gov’t listing (i.e. HUD)
All of these options other than foreclosures allows you to inspect the property thoroughly before making your purchase decision. I can tell you from experience that a good inspection is worth its weight in gold. Unfortunately, in my case I was unable to inspect the property in advance because I purchased it at a foreclosure sale. Accordingly, I had to use my purchase amount formulas set out above, hold my nose, and purchase based solely on the fact that I was getting the house extra cheap. When I received my inspection report I couldn’t believe how much had to be done to my house. It was quite overwhelming. However, because I purchased my house at 42% of retail I still made a profit on my first flip.
No. 3 Interview Multiple Contractors
Armed with my awful inspection report, I interviewed contractors. One contractor was so expensive that it would have guaranteed a financial disaster. However, another contractor was extremely reasonable and was the key to my deal being successful. If you are looking for a contractor, one popular tip is to go by Lowe’s or Home Depot at 6:30 a.m. and check out the contractors who are hitting it early each day. I did that myself once and wrote down a couple of contractor names in case I needed them in the future. Another great idea that worked for me is to reach out to established landlords who have apartments or duplexes and get a referral. Experienced landlords establish long-term relationships with contractors and are a great resource!
No. 4 Don’t Underestimate Your Renovation Budget
Don’t deceive yourself when you are putting together your renovation budget. Problems always arise during the renovation that were unanticipated at the time you completed your projections. For example, on my house the HVAC Contractor said my entire system, including the duct work, was in decent shape and needed minor repairs. Later, after foundation work was completed, the HVAC contractor revised his quote upward and said all ductwork under the house had to be repaired due to damage caused by the foundation repairs. Before you choose your contractor, list every repair item from your inspection report on an excel spreadsheet and get detailed estimates from the contractor for materials and labor. After that, assume you will spend at least $10-15k more that projected.
No. 5 Beware of Inefficient Workflow
Once you have your project spreadsheet made, including detailed material and labor costs for each line item, spend some time discussing sequencing or workflow with your contractor. Create a detailed job schedule. Even if you don’t do it by precise calendar days, at least have a list of each project in the order it will be completed. This will enable you to keep the job moving along efficiently because you are always aware of what is coming up next on the project. For example, cabinets and countertops come to mind. My job was delayed a solid month because I waited until late in the project to order cabinets and countertops. Bottom line: get your cabinet/countertop supplier out to the property as soon as demolition is complete so they can take measurements and get to work fabricating. When they have your materials ready they can always hold them at the warehouse until you need them at the job site.
No. 6 Interview Multiple Realtors
I definitely failed in this category. I hired my partner’s near relative due to familiarity and, well, laziness. It turned out to be a bad situation. Without going into detail, let me say that there was a complete lack of communication at every phase. Most of the time my calls went unanswered and the voicemail was full. I cannot overemphasize the importance of good realtor communications. Even if the news is bad you must have it communicated to you regularly so that you can make good decisions when negotiating with buyers. We turned down a great offer early on because we didn’t have all the facts about the buyer’s unique situation.
No. 7 Don’t Estimate the Negative Impact of Holding a Property
When my house went on the market I had a very patient investor mentality. I wasn’t desperate to sell the house and I knew that I was in this for a profit. Accordingly, I turned down an offer I received in the first 30 days in order to hold out for more money. Boy was that a big mistake. Although my ultimate purchaser offered an additional $6,000, that gain was destroyed by the holding costs I sustained while waiting. These costs included interest carry on the line of credit used for the job, real estate taxes, utilities, general maintenance, and repairs that came up during the delay. To make matters worse, unlike the early offer, my ultimate buyer had to have a lot of help with their closing costs due to first-time home buyer status. Finally, time is money. I could have purchased a second property, renovated it, and sold it during the time-delay I experienced. Bottom line: look long and hard at early offers, run the numbers, and don’t be greedy. It is much better to take a good offer early, cut off your holding costs, and get on to the next deal.
No. 8 Carefully Study the Contract
I am an attorney and pride myself on my ability to read boring legal documents. When I was about to sign the sales contract, I was concerned about detailed language regarding my contribution towards the buyer’s closing costs. I thought the language was too broad and could be interpreted to allow the buyer to use my closing cost contribution for non-required expenses, such as a loan interest rate reduction. My realtor spoke to the buyer’s realtor and told me they had a clear understanding that I would get any unused closing cost contributions that were not necessary for closing. I have to admit, I didn’t want to be the difficult attorney so I let it go. In the end, I should have insisted that the contract be clarified on this point, as I ended up funding discretionary closing cost items that I did not intend to fund. Bottom line: if a verbal agreement doesn’t make it into the written contract it’s meaningless.
No. 9 Know When to Stop
As a new company I wanted to put out a superior product that would put upward pressure on real estate comps in the neighborhood. I was successful — my house sold for $10,000 above the comparable neighboring property that was sold about the time I started construction. However, I probably did too much. I made sure every surface of the property was new from roof to crawl space and everything in between. As you go through your renovation plan, ask yourself whether each proposed renovation is going to add value at closing. If not, skip it … even if it offends your “type A” personality.
No. 10 Never Pay a Contractor Early
This is a really small thing, but I broke a window when I was putting the finishing touches on the punch list. I hired a local handyman to repair the window 3 days before closing. I was scheduled to meet him at the property and understood the repair would be complete upon arrival. However, he told me the glass shop was closed by the time he got there. He suggested that I go ahead and give him the check so I didn’t have to make a second trip out to meet him. I hesitated big time, but went ahead and gave it to him in an effort to be a more trusting person. You can probably guess how this decision turned out. The handyman never made the repair, but kept assuring me it was made. He even told me and my partner that he took pictures of the repair and would send them “as soon as his cellphone charged up”. Another time he told my partner the repair was completed as my partner was standing in front of the broken window. Under threat of prosecution I was informed that a refund check is “in the mail.” We’ll see.
Flipping houses offers a great opportunity to investors who have sufficient cash to get in the game. However, as with all investment options, it is critical that you read, learn from others, and personalize before you jump in. Hopefully, I’ll learn from all of my many mistakes when I flip my next house. I’ll keep you posted.
Have a great weekend!