It's time! You've either acquired your first property through a tax lien, or you're doing an old-fashioned fix and flip. And… The property needs some work. The key to a successful fix and flip is knowing what rehab projects will add to the property's value without breaking the budget. A common mistake that many new real estate investors make is going overboard on the rehab. New granite countertops, a full bathroom remodel, some new floors, the works. Before you dive headfirst into your rehab, take a look at these do's and don'ts.
The Do's of a Fix & Flip
1. Know the Local Market
When rehabilitating a property, it's essential to look at other local rental listings to see the status quo. Does every listing show overly shiny granite countertops? If so, it may be smart to factor them into your budget. However, you'll probably find that many listings boast simple updates. Knowing the market can help you decide what renovations are necessary for your property to sell and which ones are overkill. Using a search tool like Zillow can help you get an idea of other similar properties.
You'll have an easier time with your fix-and-flip endeavor when you know the basics of the local real estate market. Current market trends will clue you into the types of features local buyers expect. For example, are home values currently rising or falling? How long are properties sitting on the market before selling? In a seller's market, you can typically get away with more straightforward improvements; in a buyer's market, you might have to include more upscale extras to fetch the price you need.
2. Analyze the Numbers
To make a profit, you'll need to know accurate numbers. Comparing the resell value to the purchase price and factoring in the anticipated rehab costs will help you get off to a good start. Knowing these numbers can help you determine your budget as well. If you purchased a property for $50,000, and it has a resell value of $90,000, it's safe to say you could put $20,000 worth of renovations in and still make a good profit on your investment. Whatever the margins are, it's important to know what you're working with to ensure a successful flip.
When you buy a property intending to flip it, you know its current market value. After analyzing the local market and comparable properties, or comps, you should have a clear goal to shoot for in terms of what you'd like to list it for when you're done. To get from point A to point B, figure out which repairs and renovations are needed to bring the property in line with similar ones. The result will be the property's after repair value, or ARV.
Determine the ARV for any property with this simple formula:
Purchase Price + Value of Repairs/Renovations = After Repair Value
This formula won't do you any good if you don't base your information on realistic comps. The comps you use should be for properties sold in the local area within the last three months. Find comps that match your property as closely as possible in terms of the following:
- Age – Comps should have been built within 5 to 10 years of the property that you're flipping.
- Bedrooms and Bathrooms – Stick with comps with the same number of bedrooms and bathrooms as the subject property.
- Square Footage – Choose comps that have roughly the same amount of interior square footage as your property.
- Finishes – Consider the quality of finishes like flooring, fixtures, appliances, and the like, and select comps with a similar quality level in those areas.
- Amenities – Consider any special amenities that the subject property has; ideally, comps should include similar amenities.
- Lot Size – The lot's size should be taken into account, too; comparing the subject property with one that sits on a much larger or smaller lot will produce inaccurate results.
- Curb Appeal – Likewise, the landscaping and overall curb appeal of the subject property should be similar to those of any comps that are used.
Create a spreadsheet to compare the subject property to the top three to five comps that you have found. Identify the home that sold for the highest amount, and then see what it has that the subject property lacks. Perhaps the comp has better finishes, for instance, or maybe it offers an attached garage while the subject property has no garage at all. This information will clue you into the types of repairs that you should make to get the price that you want.
3. Create a Budget, and Stick to It!
Once you have estimated the numbers, it's time to create a budget. Take a look at the needed renovations and what they cost. Will these repairs exceed your budget? If so, the property may not be worth the investment. On the other hand, if the numbers work, create your budget and stick to it. We recommend including a little extra room in your financial plan for unexpected repairs. While we all want to assume the best-case scenario, sometimes things come up. Including this extra cushion can keep you from exceeding your budget.
Creating a budget for your fix-and-flip property won't do much good unless it's based on timely and accurate information. That's why it's crucial to have a clear idea of how much it will cost to make the upgrades, repairs, or renovations needed to increase the property's market value to the desired amount.
Start by having a basic understanding of the ballpark cost of various types of home improvement projects. Some examples include:
- Adding a Home Addition – $21,000 to $70,000
- Rewiring a Home – $4,000 to $20,000
- Installing New Plumbing – $500 to $2,000
- Exterior Remodel – $5,000 to $15,000
- Kitchen Remodel – $4,500 to $50,000
- Bathroom Remodel – $6,000 to $35,000
- Basement Remodel – $11,000 to $30,000
- New Roof – $5,500 to $10,500
Next, contact local contractors for quotes. That way, you will know the exact cost of whatever rehab work needs to be done. Make sure that the quote includes the price of whatever new items you will need. Add a cushion of 15% to 20% for contingencies. As with any home improvement project, things happen, and unexpected costs often arise. It's better to have more than you need than to fall short and potentially lose out on additional profits.
At this point, you should be comfortable that the cost of performing the upgrades or repairs will increase the market value of the home to an acceptable level. Your knowledge of the local housing market should reassure that the property will be sold at the desired price when the work has been done.
Of course, it is also important to keep timing in mind. Market conditions can change quickly, so make sure to have a realistic timeframe in mind for when the work can be finished. Sometimes the work can drag on for months and months, for example. In that case, you could end up listing the property under entirely different market conditions – and that could be a recipe for disaster if, say, the market has switched from a seller's market to a buyer's market in the meantime.
Finally, the most critical point of all: Stick to your budget no matter what.
If you hit a bump in the road and learn that a repair or renovation will cost way more than anticipated, it is better to back out and cut your losses than to end up in the red. Even with your cushion in place, it is always possible to end up with a property that will simply cost too much to repair to the point of profitability. Therefore, always be prepared to cut and run, knowing that there are still other opportunities to explore.
Rule of Thumb, Don't Go Overboard!
The easiest thing to do as a new investor is to get caught up in perfecting your first flip. Many new investors go overboard by adding all of the bells and whistles with the rehab, but it isn't always necessary. Knowing the local market, analyzing your numbers, and sticking to your rehab budget is a surefire way to know what renovations will help you, and what will hurt you.
Remember: No matter how many upgrades you make, the local housing market caps the maximum value that you can hope to get for your property. Therefore, the wiser strategy is upgrading the property to the point that it is in line with similar properties – not to the point where it is conspicuous. Most of the time, you can get away with performing simple yet effective repairs and renovations. Installing new carpet, freshening up the paint, patching holes, and swapping out some fixtures is often all that's needed. When it comes to fixing and flipping a house effectively, there's a fine line to walk; over time, though, you'll get better and better at knowing what to do, allowing your property investment prowess to improve accordingly.
