You buy the property right, you line up the funding and you forecast a nice profit but what is the one primary aspect of a flip that could turn that profit into a loss?
Your right, the rehab!
You don't have to look to far to find an outspoken guru or a TV show preaching about the large profits you can make from flipping a house. Unfortunately, these people do not accurately depict the true details and miscues that can occur during a flip. With that being said, real estate investing and flipping houses has gained a tremendous amount of momentum and for good reason, it can be very lucrative.
No matter how much due diligence you do on the front end of your project, there will always be unforeseen changes that occur and in project decisions that you can make to cut costs and stay under budget. We want to do our best to explain to you some of the common rehab mistakes that real estate investors make, so that you can avoid them and begin earning more money and making a bigger impact in your community. With an increase in competition in the industry, there is a fine line between profit and loss because the margins on our investments are becoming smaller. These tips will hopefully allow you to create a more efficient rehab and allow for less error throughout the process.
The due diligence process that you have in place for your rehabs is the main way that we mitigate risk and ensure the profits on our projects. Before we go under contract and close on a property we need make sure we have a great understanding of the property and all of the major tasks associated with a renovation. Whether this is your first flip or your 50th, we suggest that you bring the proper team along to your walk through's and have a system for your Acquisition Managers to properly document and analyse repairs on their initial appointments. When you are purchasing properties at a discount, you want to try have and your contracts as clean as possible, meaning no contingencies. However, one contingency we suggest you ad is a 5 - 10 day home inspection. This will give you the ability to back out of the contract if through your inspection (either professional or GC) you discover a deal breaking unforeseen, you can terminate the contract with no repercussions.
1) Pre-Acquisition Scope of Work - This is the document that you will use on your initial appointment. This will allow you or your Acquisition Manager to document the high level repairs associated with the property.
2) Photos / Video - At your initial meeting, always take quality photos and a video of the property so that you can revert back when running your analysis.
3) Home Inspection - This will happen after you have the property under contract. You will have a 5-10 Home Inspection Contingency in your contract and during this time you will schedule your team to visit the property to get a more thorough look at the property. During this appointment, your team should be present. This will be you, Acquisition Manager, Home Inspector and possibly foremen/GC.
2) Underestimating The Rehab
One of the most difficult tasks for new real estate investors is accurately estimating the rehab costs of a project. Your "due diligence" period will help you gather all of the necessary information about the property you need to properly document the tasks involved in the rehab. This tip is not only about underestimating the tasks involved in the project but also underestimating the costs associated with those tasks. Before you enter into a rehab, you should create what we call "the construction documents". These documents will consist of:
Scope of Work
Budget
Material List
Schedule
If you are unfamiliar with construction, these documents can be difficult to create. However, these documents will will allow you to plan, stay organized and operate efficient renovations. One reason that real estate investors have trouble profiting on flips is because they underestimate the rehab costs on their initial analysis. They do not have a good understanding of there numbers going in and they put low ball guestimates next to tasks to make the numbers work.
If you are just starting off, utilize all of the resources that you have available to you to come up with accurate tasks and costs. If you are going to be subbing your tasks out. Breakdown which tasks you want a general contractor to take on and which tasks you will have subbed out. This will allow you produce apple to apple estimates to help get accurate numbers from your contractors.
Once you do a couple projects, you will begin to get a better understanding of what tasks costs (both material & labor) and you will begin to produce more accurate rehab estimates. For all of your projects be sure to include a contingency line item. The amount of contingency that you hold for a specific project will be determined by your comfort level with the repairs for that specific project. A standard contingency for a project will be between 5% - 7% of the total costs of the project.
If the numbers still work with these buffers, then you move forward with the investment. In order to prevent underestimating on a project, you need to know the material and labor costs for specific tasks for your specific market. If you are not familiar with these numbers, you need to call on your team for help. This means, sitting down with your general contractor or calling to get bids on every task before you purchase the property.
3) Not Capturing the Full Scope
One of the first documents that you will create for any rehab, will be the scope of work. The scope of work will tell you all of the activities that need to be completed on this specific project. This document will allow you to create your Schedule, Material List, Budget and give your subcontractors apples to apples bid sheets.
Your scope of work will initially begin to be assembled during your initial meeting and will be completed when your "Home Inspection" period is complete. When you are creating this scope of work, make sure you spend as much time as necessary making it accurate and utilize all the resources you have for input until you are comfortable making these decisions by yourself. It is very easy to miss certain pieces of a project and not forecasting them into your costs for your projections. This will cause you to have to take on unexpected costs during the rehab that could have been forecasted prior to the project starting, allowing you to offer a lower price or to never go under contract. By understanding all of the costs going into a project, you can better determine if this is a project that fits your minimum profit requirements.
4) Hiring the Wrong Contractors
Another popular reason that house flippers fail is their inability to hire / find good subcontractors. I will be the first to tell you that this is no easy task and it is a process. However there are certain things you can do to cut down on the learning curve and find better contractors quicker. As you know there are hundreds of contractors to choose from, but you need to vet and have systems as to who fits your requirements to determine if they even can "try out" for your business. The reason it is difficult to find contractors that fit your model is because you are on the search for contractors who do good quality work for a reasonable price. There are typically two types of contractors that you will work with on any given contract:
1) GENERAL CONTRACTOR (notice the caps) - They will handle 50-75% of the scope of the work as well as manage all the subcontractors on the project.
1A) General Contractor - They will handle 50-75% of the project but they will not be in control of managing the subcontractors.
2) Subcontractors - Contractors who specialize in a specific division. For example, you may hire an electrical contractor to handle all of your electrical work on the property, depending on the scope.
What type of contractors you hire will depend on how much involvement you would like to have on your projects and the infrastructure you have in place to complete a project. As you begin to scale you may consider some key employees to streamline the rehab process, such as a Project Manager and/or your own construction crew. Depending on your experience level and comfort level with construction will depict which contractor route you move forward with.
Here are a few tips for selecting the right contractor for the job:
Use Your Network - Who better to start your search with than people who may already be in the industry? (investors, agents, brokers). If you do not have a local network yet, check online or at your local REIA
Interview the Prospects - Interview a few chosen candidates. Make sure you check references, go visit there past projects and see first hand if you should work with them or not.
Be Specific - This is where you scope of work comes in to place. Make sure that you are giving apples - apples estimates so you can have a good understanding of the pricing discrepancies.
5) Taking on a Larger Project Than You Can Handle
When it comes to flipping properties, you have to be realistic with your skillset and experience. If you are just starting off, you may not want to get into a project that involves extensive mechanical work or foundational repair. Investors often times move forward with a project that is to extensive for them due to lack of inventory and get themselves caught in a rehab that they can't manage.
Here are a few tips for property rehab selection:
Know Your Limits - If you are just starting out in this business have a good understanding of your knowledge and experience. Have a set criteria as to what properties you are actively looking for and stick to the criteria. These properties may be harder to find but be patient.
Have A Great Team - Your team can make up for your lack of experience. Find a team that has a lot of experience and is willing to work with you.
There is no better way to go over a budget then to over spend on the finishes on a project. Each project, neighborhood, property value and location calls for a specific level of finishes. Often times investors tend to fall in love with the property during a rehab and begin making repairs that are unnecessary or using a higher level finish than necessary.
For example, 90% of the homes in the neighborhood have laminate counter-tops. The average resale value of the properties in your neighborhood at $140,000. The property you are rehabbing has a resale value of $145,000. Should you put laminate counter-tops in? or spend the extra $2,500 for granite counter-tops?
If the neighborhood calls for laminate countertops, then you put laminate countertops in the property. We always say, do not over complicate things, establish a plan and execute the plan.
7) Spending Rehab Money in the Wrong Areas
Going into a rehab, you need to know what needs to be done and what areas of improvement are going to increase the value of the property that you are rehabbing. Generally there are areas of the house that are going to attract buyers and add more money to the resale value of the property. These rehab choices will also add a level of comfort for your end buyer when it comes time to sell
Here are some areas of the rehab where you get the best return:
Kitchens
Bathrooms
Mechanicals
Roof Repair
Interior Paint
Front Door (Paint or New)
Garage Doors
Layout
Flooring
Decks
Areas you may decide to hold off on:
Garage
Basement
Added Amenities
Driveways
Trim
Exterior Paint
Final Thoughts
We hope that you have a good understanding of certain things that may cause you to lose money during a rehab. With that being said, we are still huge fans of fix and flips, especially in our current market. They are a great way to add cash flow into your business and increase your buying power in the future - if you can execute them properly.
In the comment section below, let us know some tips you may have for avoiding mistakes during a house flipping rehab.
HS Property Funds
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(315)516-8023
www.hspropertyfunds.com