Each home flip project is unique, with costs varying widely for the acquisition, repairs, costs to hold the home, and sales expenses. Investors have many factors to consider and tools that will help analyze whether a potential investment will be profitable. Since no two situations are alike, each potential investment requires combining the available tools and calculations.
How Does the 70% Rule Provide Guidance?
One method of vetting a property is the 70% rule — a calculation that only requires two numbers. This rule helps investors determine how much they should pay for a fixer-upper house. Serving as a guide but not a firm rule for all situations, investors shouldn’t spend more than 70% of the after repaired value of the home.
Investors add repair costs to the purchase price; this figure should be less than 70% of what they expect will be the sale price. To accurately determine the potential profit margin, the after repaired value and cost of repairs need to be known. This requires knowing the local real estate market in detail and being able to predict repair costs accurately. The 70% rule only looks at two things — the after repair value and repairs costs. It doesn’t consider taxes, insurance, interest costs, or costs for buying and selling.
In addition to the 70% rule, consider the following four main costs involved in flipping a house, each of which has variables unique to each situation:
The purchase price of the targeted investment is just a number, but many factors determine whether this figure will lead to a successful investment. Factor in the purchase price and closing costs — title insurance, transfer taxes, and financing fees. The purchase may include appliances and other fixtures, depending on the home. Purchase prices generally don’t include taxes or insurance. Closing costs vary but are roughly 2-5% of the purchase price and need to be considered, as they affect the return on investment and budget.
Determine a fair purchase price by reviewing comparable recent sales in the area. Then, consider the 70 percent rule—compare the purchase price plus repairs against the after repair value.
Repair Costs of Flipping a House
Repair costs vary from cosmetic updates that are easy to spot to structural issues that could create a money pit. Factors include the necessary repairs, size of the property, and costs of material and labor. Closely review several factors to determine this major cost more accurately.
Material and labor affect the cost as well as the timeline of the project. Some materials may need special order and delivery arrangements that add time and money to the project. Materials include things like lumber, siding, sheetrock, and paint, as well as appliances like refrigerators and furnaces. Labor is typically costed on a project-based contract and includes general contracting, plumbing, and electricity.
Repair costs vary greatly depending on the condition of the property. Those with limited experience in flipping properties will find that homes needing cosmetic updates are a safer option with fewer hidden expenses. Repairs can be classified as:
- Cosmetic repairs. Cosmetic repairs are easier to estimate and require less money as well as less time to complete. Homes with solid plumbing, foundation, roofing, and electrical systems may be good candidates for cosmetic repairs entailing painting, replacing or refinishing floors, updating cabinetry, and updating landscaping. Cosmetic repair projects may also include updated appliances, lighting, faucets, and minor repairs.
- Moderate repairs. Moderate repairs likely will require a contractor. Moderate fixes include renovating the kitchen and modernizing bathrooms with new cabinetry, counters, fixtures, flooring, and appliances. Exterior paint and more extensive landscaping work may be required as well.
- Extensive repairs. Extensive repairs likely will require a contractor, permits, and a longer timeline; such homes usually have structural issues or require a full rehabilitation. Extensive repairs include roofing and foundation fixes, adding square footage with a new room or bathroom, or constructing a garage.
Carrying costs vary depending on the timeline for fixing and selling a property and financing, closing, appraisal, and marketing costs. Investors will need to have a budget covering utilities, taxes, financing, and homeowners insurance during the rehabilitation and selling process.
Financing costs depend on how the investor pays for the home — most commonly through short-term “fix-and-flip” loans and possibly other methods like credit cards or cash. Investors likely will face origination fees and higher interest rates. Investors may pursue hard money loans that use the property as collateral.
Consider the amount of property taxes for carrying cost calculation as well as after renovation. Investors may need to prepay taxes or cover them monthly. Ensure that taxes aren’t too high, as they vary depending on the municipality, and cut into the bottom line. Insurance will look different, as investors may be required to purchase a special policy for an unoccupied property that provides coverage for things like vandalism, storm damage, and liability.
Utility costs will also accumulate over the carrying time. Utility costs may be estimated based on the size of the property, and providers often require advance notice to ensure utilities are hooked up.
Marketing and Sales Costs
Marketing and sales expenses include real estate agent fees, advertising costs, and closing costs. Real estate agency fees are negotiable and average about 6%. Agency fees include marketing the property. Marketing won’t be a significant consideration for investors who use a real estate agent versus selling the property themselves. For those who sell the property themselves, advertising, signage, online listings, and open houses will be budgeted.
Closing costs are part of real estate agent fees if an agent is used. Investors who sell the property themselves will have to cover closing costs. Be mindful of additional costs at the time of the sale for flipped properties, including unpaid property taxes and utility expenses.
Flipping a house may be a profitable business venture as long as investors thoroughly understand the process and the money needed to buy, fix, and sell a property. Homes needing cosmetic fixes will be cheaper and faster to fix, but profit margins are lower. On the flip side, homes needing a lot of work will require more time and money to fix but have a higher profit margin. Profit margins and timelines can vary greatly depending on repairs and the time it takes to complete them. Finding a good balance between costs and timeline can lead to a profitable venture.
If you’re interested in learning more, contact us at Titan Funding. Our team would be happy to answer any questions you may have.