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Making Money in Real Estate Investing….and Losing It. The Thin Line Dividing The Two.

Here at ListingSpark we’ve helped our investors make massive profits on their real estate flips.  Unfortunately, on some transactions, we have seen first hand the disappointment of losing money on a deal.  For that reason, we wanted to shed some light on the most common ways a real estate investor can lose money on a flip along with a few tips on how to avoid them. 

  1. Overpaying on the purchase: This one may seem obvious, but the old adage rings true that you make your money when you buy, not when you sell.  Often times a novice investor is over eager to get their first or second deal going so they throw caution to the wind and over pay, hoping they will find a way to make it all back up on the back end.  This can be a recipe for disaster. After months of hard work renovating and bringing a property to market, paying too much on the purchase can lead to the seller (investor) bringing a check to closing rather than cashing one when they go to sell.
    1. How To Avoid
      1. Analyze the comps carefully and understand whether the purchase price is indicative of current fair market value and understand what your ARV (after renovation value) will be. Below are 10 things to look at when determining the right comps are used.
        • In the same neighborhood or in an adjacent neighborhood with very similar values (preferably no more than 2-3 miles away if possible)
        • Similar finishes
        • Similar construction type
        • Same number of stories
        • Close in age of construction
        • Recent (preferably less than 6 months old)
        • Similar square footage
        • Similar bedroom and bathroom count
        • Similar lot size
        • Similar price per sq/ft
      2. Walk away and fight another day:  If the numbers don’t work, you MUST be willing to walk away from a deal.  All seasoned investors will tell you this. They will gladly let someone else overpay for a deal and put their money to use elsewhere.
      3. Get a second set of eyes on the deal: If you are a new investor, find a mentor or someone you trust that knows the business well and have them put eyes on the deal before you pull the trigger.
  2. Contractor Woes: I can’t tell you how many investors have told me horror stories about a deal going south and losing money after they got burned by a contractor.  They either paid the bulk up front and the contractor walked on the job before finishing. Or they paid up front and the quality of work was poor and they had no leverage to get the contractor back to fix the problems because they already have the money.  So now the investor is stuck paying for work twice in order to be able to bring the house to market with the quality that will get the property sold. 
    1. How to Avoid:
      1. Pay out through a draw: You and your contractor(s) should have a contract and be on the same page with both a payment schedule and timeline.  You pay X for the contractor to deliver Y, then they get the next draw for the next stage of work with a mutually agreed on scope and timeline.  This way, if the contractor doesn’t deliver or walks off the job, you still have the remaining funds to finish the project with a different contractor.
      2. Buy your own materials: A great way to manage your expenses and ensure that you don’t go over budget is to purchase your own materials and pay your contractor based off of labor only.  Many times if the contractor is responsible for purchasing and picking up materials, you get hit with a mark up on those materials, increasing your costs.
      3. Work off of referrals: Build relationships with other investors in your area and build a network of contractors and trades based off of referrals.  
      4. Require references: Every contractor should be able to provide a list of references of happy customers who would be willing to vouch for their work.  If they are not willing to provide references….run.
      5. Require a punch list walk prior to final payment: You should NEVER just trust a contractor when they say they are done.  Walk the property with the contractor and go through a final punch list of items that aren’t completed or need finishing work on before you make the last payment.  Once the money is in the bank, are you still going to be a priority?
      6. Cheaper is not always better when analyzing contractor bids: Because time is money, a contractor that is pricier but has a track record of successfully finishing jobs on time and on budget with good quality can actually save you money in the long time.  Cheaper contractors that constantly miss deadlines or have shoddy craftsmanship can actually end up costing you more in carrying costs, loan interest and paying others to fix their work.  
  3. Expect the Unexpected and Budget for it: You are buying distressed properties either directly from a seller or a wholesaler who are motivated to get the house sold and make as much money as possible.  You can’t bank on them telling you everything you need to know about the house. The properties you are looking at will often times come with a lot of deferred maintenance.  That means things like the HVAC, water heater, plumbing, electrical, etc may not have been properly taken care of due to lack of funds from the seller. Some of these things simply can’t be identified through the purchase process so you have to expect surprises. 
    1. How to Avoid:
      1. Pad your budget to cover the unknown.  We recommend tacking on an extra 10% or more on your rehab budget to cover these “surprises”  If you don’t spend it, great, but not having it when you need it can put you in a huge bind.
      2. Get big ticket items checked out. Before you close, check out the big ticket items like the foundation and roof.  These two items alone can kill your profits.
  4. Don’t Over Do It: Far too often investors pump way too much money in to a house and then try to make it all back on the sale.  The problem is, the neighborhood doesn’t support that level of finishes and buyer’s aren’t willing to pay the premium you need to turn a profit.  
    1. How to Avoid:
      1. Look at the other flips in the neighborhood: Find the other successfully sold flips in the neighborhood and reverse engineer your scope of work to match the level of finishes that are supported in that neighborhood. 
      2. Find the balance between cost and quality: You want to deliver a high quality product in order to sell the home quickly for the most money, BUT overspending will kill your profits.  Find sales, close outs, or similar looking products that are less expensive. Remember a $200,000 house does not need carrera marble counters if a level 1 or 2 granite or quartz will yield the same returns. 
  5. Time is Money: So many investors see their profits fly out the window because of a blown timeline and a 12% Interest hard money loan.  Hard money loans can be an awesome resource to fund a deal if you don’t have the funds. But due to the risk and short term nature of flipping, these loans come with high interest payments every month.  If you have either gone over your timeline or miscalculated the estimated days on market for the listing, the monthly interest payments can bite you.
    1. How to Avoid:
      1. Harp on the schedule with your contractors: You should be on site frequently to ensure deadlines are met and you are bringing the property to market as quickly as possible.
      2. Understand while you are working your numbers what the anticipated DOM will be: If you buy a house in October, the comps that sold in July are inherently going to have lower days on market due to seasonality.  This should be properly calculated when you are working the numbers. If you are selling in the “off season”, pad the expected days on market. To account for the extra months you will be holding the property and paying interest.  
      3. Be willing to negotiate: Your listing is the most powerful right after you hit the market.  If you get a solid offer early, understand that it may be worth coming off the price a little to avoid letting the property sit on the market while you have to continue to make interest and carrying cost payments. 

Obviously this topic could be discussed in a book and not just a blog post with all of the things that can go wrong during a flip.  Here at ListingSpark, we pride ourselves in being a great resource for investors. If you have questions and need answers, please reach out.  If we can’t personally help you, I’m sure we can point you in the right direction.

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