The fix and flip strategy requires you to purchase a home—whether it is a distressed home, a foreclosure, or a home owned by a highly motivated seller willing to give you a huge discount—fix it up, and try to sell it for a profit.
Thanks to the big box home improvement retailers, we live in a do-it-yourself society. Making home improvements yourself is so much cheaper than paying someone else (usually a contractor) to do the work for you. However, after learning how to update plumbing and electrical systems, frame, hang drywall, and any number of other home improvement projects doesn’t make you a professional in any of those areas. Many do-it-yourselfers get the bright idea that if they can fix a few things around their own house, they should enter the fix-and-flip investing market to make a few extra bucks outside of their regular job. Most people don’t realize that this is one of the most dangerous and risky forms of real estate investing out there.
The Premise
In the recent past, some people actually made money flipping homes. Back in the days home prices would inflate 5 to 10 percent in just a few weeks, a person could purchase a house, slap a coat a paint on all of the interior walls, clean up the yard, plant a few flowers along the foundation, do a little updating in the kitchen and bathrooms, sell the home again 6 to 8 weeks after purchasing it, and make a $20,000 to $30,000 profit.
Those days are over. Even during the days that people had a chance of making a profit, most people were lucky to break even on their “investment.” When they stepped back to look at the whole picture, they discovered a disturbing reality: a bad fix-and-flip deal can haunt you for years to come!
The following are three possible scenarios for this investment vehicle.
Scenario #1:
You find a nice house that is in good shape but could use some updating. The price of the house is really good and falls at or below the median house price for your area. You purchase the home at a good discount because the owner is willing to let it go. You clean the place up, paint it, make the yard look nicer adding curb appeal, and update a light fixture or two. Your total investment outside of the purchase price falls somewhere between $500 and $1,000. After holding onto the house for two months, you sell it for $15,000 more than you paid for it.
Scenario #2:
You find a nice house that is in good shape but could use some updating. You dump a significant amount of money into the home thinking that your money will be doubled or tripled when you go to sell the home. Your justification of putting a significant amount of money into the home is that a bigger risk will provide a bigger reward. You are performing all of the work yourself in order to save money. Because of this, you find that you spend all of your extra time fixing up the investment property to the point that your own home falls into disrepair over the course of a few weeks.
Scenario #3:
You find a nice house that is in good shape but could use some updating. Before purchasing the home, you did a little homework and found that after the purchase was final you’d have $45,000 in equity after selling. What you didn’t consider is the fact that that equity could be severely depleted by such expenses as capital gains taxes, realtor commissions, mortgage payments, improvement costs, and property devaluation. When you finally sell the home, you are lucky to break even, and may have actually lost money on the deal.
These scenarios present three scenarios present three possible outcomes of a fix-and-flip investment opportunity. They are not, however, the only three possible outcomes. They are simply presented as likely possibilities based on the experiences of numerous people.
On the surface, the first scenario does not sound like a bad deal. It was a quick flip; you held onto the home for 2 months before handing it over to the next happy owner. You didn’t have to put too much money into the home to make it look good for the next buyer. But because you had to hold onto it for two whole months, you had to pay a couple mortgages while the home sat on the market. Depending on your personality, a situation like this may cause you some degree of stress. Worrying about getting a home sold, in any economy, is a challenging, and oftentimes frustrating, life event—especially when you have so much riding on one investment deal. Let’s do the math for this deal. Let’s say you paid $180,000 for this home. The seller paid the closing costs so you didn’t have to worry about it. You put up to $1,000 into the improvements and had to pay two mortgage payments. For a $180,000 home, the payment may be about $1,100 depending on the interest rate. The house sells for $15,000 more than you paid for it, or $195,000. After helping the new buyer with closing costs (which come to $11,700), you have made a grand total of $100 on this deal.
$195,000 - $11,700 - $1,000 - $2,200 = $180,100 - $180,000 to pay your mortgage off = $100
For that amount of money, you essentially donated your time to fix the home up for the new owner, not to mention all of the hassle you had to go through to get the house re-sold. And this is the best of the three scenarios. The other two get uglier and uglier from this point. There are many reasons why fix and flips are not good investments. Among them is the fact that, as an investment strategy, it is completely dependent on the real estate market. Investors are more likely to succeed when the market favors home sellers.
