Curbed University delivers insider tips and non-boring advice on how to buy, sell, or rent a house or apartment. Additional questions welcomed to firstname.lastname@example.org. Today, real estate agent Christian Nossum walks us through the process of flipping a home and whether or not it's a good idea to do in the first place.
Can you still flip houses in Seattle and make money? Sure, but should you? Well, that depends on your level of risk tolerance, experience, knowledge, time, and cash.
In this guide to flipping houses in Seattle, I'll pass on the advice that I've learned over the years as a real estate agent and investor, the "House Flipping 101" rundown, I'll point out spots where many flips go bad and how you can avoid making these costly mistakes, and then I'll tell you what I'd do if I were in your shoes.
The second most popular saying in real estate, right behind "location, location, location," is, "You make your money when you buy, not when you sell." This saying doesn't get as much hype as location, but it's just as important to keep in mind in all real estate transactions. I don't recommend you flip a house if you've never bought or sold real estate before. There is so much to know and learn when buying and selling a house the "normal way," adding in the stress of flipping one is overwhelming for most people.
Finding the right house to flip is essential. For most flippers that means a house that is structurally sound and just needs cosmetic updates. Remember that kitchen and bathroom remodels bring back the highest rate of return on your investment, and improving on curb appeal will make a great first impression.
House Flipping 101 - Flipping a House in Seattle
Between 2004 and 2007, when the Seattle real estate market was crazy and before the market crashed, anyone could flip a house and make a profit. Property prices were increasing so fast that you could buy a place, hold on to it for a few months, and even if you didn't do a thing the house would be worth more than when you bought it. That's not the case anymore. Making a profit on a flip is much harder than it used to be.
Here's the equation that house flippers use to know if a property is a good deal or not:
Estimated after repaired home value (ARV)
-Initial cost of property (again, here is where you make your money)
So let's look at an example:
Let's say that there's a little old house near Green Lake that's priced at $400,000. You estimate that after you put $50,000 worth of remodeling in, it will be worth $575,000. It seems like you can easily make $125,000, but these numbers don't tell the whole story. Let's dive in to the details a little. The estimated cost of repairs is $50,000. Having a great inspector and a great contractor on hand to help estimate costs is key to your house flipping success. Even with this team in place to help you, you'll still find costly surprises along the way.
Holding costs are what you pay each month while you own the property. Keep in mind that after the remodel has been completed, you still need to sell the house. Even if you accept an offer the first day you put the house on the market, it will still take about 30-45 days for the buyers loan to be finalized and the sale to be completed.
Monthly holding costs can vary greatly depending on where you acquired the money to purchase the property. If you got a loan, then you'll have a monthly payment to factor in, as well as the initial loan cost. If you bought the property on the courthouse steps at a foreclosure auction, you have to pay cash, which means that your monthly holding costs will be minimal. But if you don't have $400,000 cash on hand, then you can get what's called a hard money loan. These are not cheap. The interest rate is usually very high, 7-15%, with an additional fee that you pay upfront called "points," which ranges from 3-5% or more of the loan amount. Because hard money loans are so expensive, you'll want to pay them off as soon as possible. Most flippers these days use hard money loans to fund their purchase and remodel costs, so that's what I'll use in this example.
Let's assume that your hard money loan has a 12% per year interest rate (which equals 1% per month), and cost you 3 points upfront. Since you can wrap your repair costs into your hard money loan, your loan amount will be $450,000, plus you'll need to pay $13,500 cash upfront to cover points. These loans are generally interest only, which means your holding costs will be $4,500 each month.
You estimate it will only take 8 weeks for the remodel to be completed, and 2 months to sell.
Let's recap where we're at so far:
$575,000 estimated sale price (ARV)
-$413,500 Purchase price ($400k price, plus $13,500 in points for the hard money loan)
-$50,000 for repairs
-$18,000 ($4,500 x 4 months for holding costs)
= $93,500 Potential Profit Now it's time to talk about the selling costs. This is a step people often fail to plan for, possibly because almost every TV show about flipping houses seems to overlook it. I like to guesstimate (yes that's a real word, at least in my vocabulary), that selling costs are equal to about 10% of the sale price (6% for real estate commissions, about 2% for title insurance, escrow, and recording fees, and 1.78% for state excise tax). In our example, that's $57,500. Subtract that from our $93,500 potential profit, and we're down to just $36,000 profit, and that's if all of our pricing and timing estimates are correct, which they never are. The flippers that I know usually tack on an additional 25% to their estimated timeline, and another 20% to their repair budget. That's an additional 2 weeks on the schedule (which is about $2250 more in holding costs), and $10,000 in repairs.
That leaves us with about $23,750 in potential profit.
What had initially looked like a sure thing, slam dunk, $125,000 profit has turned into less than $25,000, and that's assuming you estimated the sales price correctly and the buyer didn't negotiate with you or find anything wrong during their home inspection. $25,000 isn't $125,000, but it's still $25,000. The question you need to ask yourself is if you have the time, knowledge, money, and risk tolerance to make that $25,000.
Keep in mind I'm not taking into account the potential capital gains tax that you'd have to pay on this profit, and that all of these figures are just estimates.
If after reading this you're not sure if flipping is the right thing for you at this moment, then here's what I suggest you do.
Buy a house as your primary residence, which means that you'll live there. This way you will get the best financing terms, which as of the time of this article is around 4% interest, with as little as 3.5% down payment. You should plan to live in this house for 2 years and fix it up a little at a time. This will 1) give you the experience that you'll need in working with contractors, 2) give you experience in estimating repair costs and timelines, 3) help you understand if you can handle the stress of a remodel, and 4) you won't have to pay capital gains taxes on the profits that you make up to $250,000 because this is considered your primary residence since you have lived there for at least 2 years. I know people who do this every 2-3 years, and they make a lot of money along the way. It's less stressful, it's kinda fun (if that's your idea of fun), and you actually get to enjoy the updates that you've spent your time and money on.
There's a reason house flipping isn't for everyone. If it was easy and didn't take some big cojones, everyone would be doing it. But it's not a sure thing. It takes a lot of money, time, and risk, and not everyone is cut out for it. That said, some people can do it and make a living at it. Others try once and quit after losing thousands of dollars because their estimates were off. That's the game. Do you have what it takes?
[Illustration by Eric Lebofsky]
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