So lets start with the basics.
Most people look at houses just as a place to live, houses are also pieces of property that can be bought & sold for profits.
So if your just getting started in this investment "game" there are few things you'll need to learn before you can begin to take action.
Whether you watch HGTV or read the internet, these folks make this game sound much easier than it really is. As with any business that is not an innovative new strategy (start up) there are proven steps/procedures to take in order to lead you in the right direction.
No matter what TV show you watch or blog you read, the best way to learn how to create a successful business in this industry is to get out there and take action, make mistakes, earn respect & be educated enough to be able to minimize your risk when these mistakes occur.
The steps that we will discuss will give you an oppurtunity to shorten the learning curve, avoid making huge mistakes and teach you how to generate a profit through this vehicle of real estate investing.
The Different Types Of House "Flipping"
Before we get to deep into the necessary steps in getting your first "distressed" property bought, rehabbed and sold for a profit, we should probably discuss the different types of "flipping" homes that are present in the industry today.
Distressed Quick Flips : A common way of flipping homes in prior years was to purchase a deeply discounted home from either auctions, foreclosures or bank short sales & turn around and sell them immedietly to a homeowner. This kind of flipping is based on quick sales & quick profits. This vehicle comes with a little less personal risk but also results in much less potential profit. There is no value add to the end user just acting as a middle man in moving the deeply discounted home.
Wholsaling: The concept of "flipping" a contract to another investor or home owner for a fee. Many investors have built lucrative businesses around this model and can be used successfully if you have the right systems in place. (ex) Putting a home under contract for 35,000 (no money down) then flipping or selling that contract to an investor for 42,000. You take the spread of 7,000.
Rehabbing: This is the vehicle we will discuss in detail but in simple terms you are buying a discounted property, fixing the home up & reselling at market value.
House Flipping Steps To Complete Your First Deal
1) Commit To The Flip:
The first step that you will have to take in any business is commitment. Making money in any aspect of life is never easy, so this is no different. It is easy to watch a TV show or read an article and believe that this business is simple or easy. You have to make the decision that you are going to learn everything you need to know to take the proper steps to succeed.
2) Education:
The next step is to get educated on the topic. Educating yourself in life something that is a life long pursuit and should never stop. As with any endeavor it is necessary to educate yourself on the basics before taking the initial steps. By educating yourself on the basics you will limit the oppurtunity of taking a large loss early in your business and be able to adjust when mistakes arise. There are several different ways to begin your education but I believe the first step you should take is reading "The Book On Flipping Houses" by J. Scott. This book will lay out the steps in detail to conquer your first flip. Other good books to read on this subject are "FLIP: How to Find, Fix, and Sell Houses for Profit" & "Flipping Houses for Dummies". There are several popular blogs and podcasts out there that go over different aspects of the business in detail that will also benefit you. Do not get caught up in trying to learn every little thing about this business. Your greatest education is going to come when you are involved in the process and taking action. We just want to educate ourselves enough to get to the action stage.
3) Determing Your Financing:
One of the key components in this business is going to be your access to funds, where you will get these funds and how quickly you can gain access to these funds. Determine how much cash you personally have to invest and then decide which route you will take to get your hands on additional funds. When rehabbing homes, usually the best financing route to take is having access to Cash. This will allow you to have less contingencies involve, close quicker and get deeper discounts.
One good way to fund your first deal is by having an equity partner. In this situation your investor/partner will be funding the complete project & rehab costs with expectations of recieving 50% (negotiable) of the profits. This will allow you to not have to come out of pocket and gain the experience without risking all your money.
*Although losing investors money can be more stressful than losing yours*
4) Market Research- Analyze Your Intended Farm Area:
Next you will want to analyze your surround areas and locate the best areas around you to flip houses. Every market is different so be sure to have a good feel on your local prices, neighborhoods, school districts, crime rates, popularity. Personally I would start by analyzing a small farm area (a zip code or two) and as you gain more experience you can begin to expand.
Consider these questions:
How much are the average homes in this neighborhood/ zip code selling for?
Are Homes selling in this area?
How much are foreclosures/REO's selling for?
What property types/locations/ bedrooms/baths are currently popular?
Are there other investors marketing in your farm area? (good thing if they are)
Get a good feel for the types of properties in your area. Try and walk through a couple houses that are for sale in your area and see what kind of finishes they have and what you should expect to be putting in your homes.
5) Build A Team
There are several important phases of your business but to me this phase is right up at the top. The team you develop is going to play a large role in weather you make money or lose money on a specific project. This team will help you find, fix and sell your properties. They will help you delegate certain areas of your business that are necessary so you can spend time working "ON" your business, not "FOR" your business. They will help you speed up the learning curve and will be able to relay invaluable information in order to create a successful business.
Your team will consist of:
Real Estate Agent
Contractors
Insurance Specialists
Accountant
Lawyers
Investors
Wholesalers, Bird Dogs
6) Define Your First Deal
Before you begin your marketing campaigns, you want to have some peramiters to work off so you can target your marketing to persective homes. Here you will learn your education and your market research to determine:
What types of homes you want to buy
How many bedrooms/bathrooms
What neighborhoods
What square footage
What your minimum and maximum price range will be
Now you will have a specific criteria that you & and your agent can work from and you will now have a better idea of what homes you want to market to.
7) Marketing Efforts
When you are trying to acquire your first deal, I recommend that you focus on inexpensive ways to market. Once you get some deals under your belt and have earned some profit you can begin to delegate a certain percentage of your profits toward your marketing efforts. You should develop a marketing plan that will allow you to reach your goals. Some marketing techniques you should focus on to obtain your first deal are:
Driving for Dollars
Craigslist Ads
Networking
Have agent search for REO's and Forclosures based on your criteria
Wholesalers/ Birddogs
Bandit Signs
8) Analyzing Potential Deals
So the whole point of your marketing efforts was to begin to find distressed properties to purchase at a deeply discounted price to allow you to make money of the spread between the purchase price and the sales price and everything in between. At this point in the process you have begun to recieve some leads from your marketing efforts. Now it is time to analyze these deals and see if the make sense for your time and money.
* You should try and analyze any where between 15 & 30 deals before submitting an offer*
This goes back to your education and trying to minimize your mistakes before taking action.
Here are the variables involved in determining your potential deal:
ARV or After Repair Value- This is the most important number in the whole process. This is the number that you feel you can sell your property for when rehab is completed. This number will be based off of what similiar homes in your farm area have sold for at market value.
Repair Costs- This is the second most important number in your equation. These are the costs associated with fixing up the home. Mastering this phase of the evaluation takes time and experience. A good way to get a more accurate number when first starting out is to build a good relationship with a General Contractor and have him walk through your potential deals with you.
Holding Costs- These are the costs that will accrue while you own the property. Those costs associated with this phase are: Utilities, Taxes, Insurance & Commisions. Be sure to includes these numbers when making you final offer because if forgotten can take away your profits.
Minimum Profit Required: This number is the minimum amount of money you want to make for this specific job. For each job I take on I want to make no less than 15% or 15,000 of my total cash invested. You also want to take into consideration how extensive the rehab is going to be (risk) and determine your minimum profit with this variable also.
Maximum Purchase Price : ARV- Repair Costs- Holding Costs- Minimum Profit= MPP
*This is the formula you will use to determine your maximum offer price to the homeowner/bank*
70 % Rule: A quick rule of thumb investors use is the 70% rule which consists of taking 70% of the ARV- Repair Costs. This will give you an estimated purchase price to offer. (ex) ARV= 150,000. Repair Costs= 35,000.
(150,000 x .70) - 35,000 = 70,000 (maximum purchase price)
* Remember this is just a rule of thumb and a more detailed approach needs to be taken to ensure profits. Also you may want to use 65 % or 60 % depending how inexpensive the property is because there will be less room for error for you to take your profits*
9) Make An Offer, Make A Deal & Set Closing Date
After you have done your due dilligence, visited several properties, estimated your rehab costs. Now is the time to make an offer to the seller. If you are dealing with a lead that you generated it will be your responsibility to negotiate and close the deal. If you are dealing with a foreclosure or REO your agent can help you with the negotiation process and close the deal with the bank. During your negotiations you want to be sure to stay under that Maximum offer price, so you should start your initial offer 10-15% lower than your top price. By offering a low ball offer your seller will usually counter somewhere in the middle, but what you have done is creating a starting offer that you can work from.
When you and the seller come to an agreement on price you will then have them sign a purchase agreement to confirm the deal and begin your next step in the process.
* Depending on the financing that you chose to use for your first flip, you should try to limit the contingencies within your offer to as few as possible to ensure that you and the seller can come to an agreement on price (try and make the terms as beneficial to the seller as possible, since you are looking for the discounted price)*
* I would recommend atleast including an inspection or due dilligence contingency (5-10 days) so you can put together a detailed scope of work and run your numbers again to see if they work*
After you have the signed purchase agreement in hand. The next step that you will immedietly take is to get this information into the closing companies (lawyer) hands. Along with the purchase agreement, they will also need the abstract & title, property survery, property disclosure and depending on when the home was built a lead paint disclosure. Once all this information is in the hands of the para legal, you will be able to set a closing date to keep everything on schedule.
10) Due Dilligence & Scope of Work
As just discussed briefly, this is the period of time after you come to an agreement on price and sign the purchase contract where you will have an inspection done on the property and put together a detailed scope of work so you can have a more precise estimate on the final rehab budget. The contingencies previously discussed will give you a legal right to back out of the contract during those couple days if you come across issues that were unexpected and will make this project a loss.
*Scope of Work- A detailed breakdown of all repair costs required on this specific job. Off of this document you will be able to create a project budget and a project schedule. Your scope of work will be your most important document for the rehab aspect of your business*
Be sure to follow through with this step because it will minimize your risk and will give you a more accurate look at the profits you will make on this specific job.
11) Estimates from Contractors
After you have put together your scope of work on the details that will be involved in completing the rehab project. Now is the time that you will get estimates on each phase of the project. There are a couple ways that you can go about completing the rehab portion of your project:
Do it yourself
Subcontractors
General Contractor
If you are not familiar with managing and dealing with contractors, I recommend that you hire a general contractor. Developing a solid/reliable/ trustworthy group of contractors to complete your project will take time that is why I recommend hiring a general contractor to help you manage the subs and keep your project on schedule initially. After you gather all the estimates for each aspect of your project, you will be able to put together a project budget and a project schedule. At this point you should have all the data you need to determine fairly accurately what your net profit will be on this job.
* Take this step very serious as it can make or break the success of your project*
12) The Close
If nothing serious has arisen from your due dilligence period and detailed walk through and your numbers still are working in your favor. You will meet the homeowner at the title companies office on the agreed upon date and finalize the deal. During this phase you will go over all the numbers of the deal and all the closing costs that will associated with the final number. Each party will sign the proper paperwork and the deed and title will be transferred into your name as the sole owner of the property.
13) Manage the Rehab Tightly
Whether you decide to manage the project yourself or have hired a general contractor to oversee the project, you still need to be thouroughly involved in the project so you can ensure the repairs are being made on schedule and on budget. Also if this is your first time going through this process be sure to be as involved as you can. You will gain invaluable experience by watching your GC coordinate and run the project.
You have to work fast and efficient during this stage. The longer it takes for you to complete the rehab process, the longer you will be holding the property (holding costs will acrue), the less profit you will make at the end of the project. So be sure to be involved and make sure everyone is aware of the urgency your looking for to complete the job.
14) Manage the Financials
You also need to ensure that your bills are being paid including: utilities, contractors, insurance, materials and other expenses as they add up. Keeping close tabs on all of these expenses will help ensure that your project stays on budget. This is an aspect of your business where a "system" (will be discussed in another post) needs to be created so that you can make this process as simple as possible. If you are not familiar with managing bills & being organized, this part of the project can become very tedious and overwhelming.
* The best advice I can offer for this stage is to stay organized. Whether it is creating a project binder where you hold all your bills & set up an automatic payment for the first of the month to ensure they get paid or you develop spread sheets to track all your labor & material costs. Just ensure that you develop an efficient system to track & pay these bills to eliminate the hassle of dealing with this*
15) Develop A Final Punchlist
Finally, after the rehab process has been completed. It is now time for you to jump in and put together a list of items that were not completed completly or your contractors forgot to do.
With every contractor that you deal with, they will inevitabally forget to complete certain aspects of the rehab that was agreed upon. So this list will ensure that you can complete these minor tasks as quickly as possible to keep the project moving along on schedule.
16) Put Your Home On The Market- List It
Now that you have a final product, a beautiful fully rehabbed home, it is time to get that baby on the market.If everything has went as planned up to this point (which it rarely does), you have reached the point in the process where it is time to put your house on the market and find a buyer.
Once again you will fall back on another team member, this time it will be your real estate agent. From this point on, your putting this phase of the process into the hands of your agent. You will have to sign a contract with your listing agent that states:
The Sales Price
The Agents Commission
Length of the listing
and much more
Your agents job will be to list your home on the MLS and market your home to gain maximum exposure to ensure offers come in, in order to get your home sold.
17) We Have An Offer- Be Patient
So you finally get an offer! Your projects finally complete! Right!? Wrong, well atleast not 100% complete.
In my experience it usually takes atleast a couple offers to get the price and terms that you are looking for. Many investors do not take this stage into consideration and for some reason just think this process always runs smooth. If you dont have a talented real estate agent on your team, this couldnt be farther from the truth.
Evaluate each offer as a business proposal- What are the terms? Is the Price right for you? What about the contingencies, do you agree with them? Has the buyer even been approved?
These are all items that you have to consider when accepting an offer. So take your time & make sure you get what you feel will benefit you and your hard work.
18) Buyers Due Dilligence
You have already been through this process when you were on the other side of the deal as the buyer. So as expected, the buyer of your home will want to do his due dilligence on the property and make sure everything passes inspection and is up to code. If you did the proper due dilligence on your side and final walk through with your contractor when completing the punchlist, you should not have any major issues. Most of the time, the buyer will try and come back with some minor items they want changed or fixed but if these are basic cosmetic issues you do not have to oblige. (Everything in real estate is negotiable).
Additionally during this time, the buyer will be finalizing there financing and completing the necessary tasks to purchase your home.
19) Its Closing Time! Pay Those Taxes & On To The Next One
Now is time to celebrate, crack that bottle of champagne or pour a little glass. All the complicated tasks are out of the way and you made to the final step.
*You should be proud of yourself*
On the day of closing, you will meet your buyer over at the Title & Escrow company to sign the final documents in order to move the title & deed from your name into there name. Be sure to look over the paperwork/ documents to ensure that no mistakes were made along the way. Once all the paperwork is signed and you hand over the keys to the home, it is official, you have completed your first "rehab" project and made a little cash.
* Dont forget that all the money you just made isnt yours. Make sure you delegate your funds so the tax man can get his share, so when it comes time to pay your not caught off guard. With real estate in general there are several tax breaks you can get & that is why it is important to have a CPA that is familiar with real estate on your side.*
20) Conclusion
House flipping can be a lot of fun, just make sure you continue to educate yourself through books, blog, podcasts etc along with taking action and getting 1 on 1 help from your team or mentors. If you are serious about flipping houses - please do not just rely on this information alone - try and take in as much information on this topic along with business,project management etc.
Always be on the look out for the next deal & goodluck with your future endeavors. If you have any questions, leave them below.