It's tough to resist the entertainment factor in those reality TV shows like "Flip That House." But here's a little secret you may not know: Not everything on TV is as it seems.
In fact, I would guess that based on my experience of watching people try and flip properties for profit, 90 percent who try it once never attempt it again.
I'm not saying it isn't possible for this to be profitable, and I know people who do it full time and do make money at it. But the odds are highly against the average person succeeding. However, if all those reality TV shows have piqued your interest, here are a few items to consider if you want to attempt this strategy.
Buy Low, Sell High
First, you will have to buy a property at significantly below market value or sell it above market value to make money. If you buy it and sell it at the market, you will lose money due to commissions, time, and renovation costs. So your best bet is buying a property below market value. That's not simply below what it sold for four years ago, it's below what is the current market value after taking into account all the distressed property sales in the area. And if it's a decent property, you're probably going to be fighting many other individuals trying to buy the same house. And when lots of people are vying for one piece of real estate, the price gets bid up and you probably are going to pay market value.
What about adding value with a renovation? While there is no question you can add value by renovating a property, you probably will not add more value than the cost of that value. (Check out the Hanley Wood estimator, especially "cost recouped" column.) You might put in a $20,000 kitchen that only adds $15,000 in value. More than likely you will go way over budget on the rehab and spend way more than the value you add.
Another tough challenge is the costs on both sides of your flip. There are significant transaction costs on the buy and sell. Probably 3-to-5 percent in costs when you purchase property, and up to 10 percent when you sell property. So you really need to sell the property - and this is without regard to any rehab costs or holding costs - for about 20 percent greater than you paid. That's just to break even.
Those holding costs also come into play. You may think you will resell the property in three months, and you might. But what if it takes six months, or nine months. You will be making mortgage payments, property tax payments, insurance, some maintenance, HOA fees, and all other kinds of costs as you hope to get the property sold quickly. And they add up, wait until you are the one writing the checks each month.
Fuzzy Math on This Flip
An individual I knew bought a property for $100,000 and sold it for $140,000, netting $40,000 in six months - so he told me. Then we talked about the costs involved. Purchase and finance costs, including $5,000 for rehab costs; $8,000 for holding costs; $6,000. He was up to $19,000 in costs before he even transferred title to the new owner. Sales costs added about $10,000 and he gave the buyer a $3,000 credit, too. That added another $13,000 in costs.
Here is the revised math on his flip: Sale price was $140,000, less total costs of $32,000 ($19,000 + $13,000), less his $100,000 purchase left him with $8,000 in profit for six months of work. So much for the $40,000 profit.
This result is more typical with profit-making real estate deals. Some people do score on short term, get-rich=quick attempts. Most of them are doing it full time and taking significant risks with their investing choices.
Luckily. the guys flipping properties on TV are making a living producing TV shows and getting paid by advertisers. That means their house flipping is more theater than business. There's a much better chance they will make a living that way then trying to actually flip properties for a profit.
Leonard Baron, MBA, CPA, is a San Diego State University Lecturer, a Zillow Blogger, the author of several books including "Real Estate Ownership, Investment and Due Diligence 101 - A Smarter Way to Buy Real Estate." Read useful tips for real estate buyers in his blog, Making Smart and Safe Real Estate Decisions. See more at ProfessorBaron.com.
Note: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinion or position of Zillow.