Making a quick profit is part of the American way of doing business. And what could be easier than buying a somewhat run-down property, facilitating the purchase with debt, putting on a new coat of paint, and flipping it for a profit?
Of course, there are other ways to make a profit in real estate, such as working the rental market. But fixing up and flipping houses has somewhat of a fascinating appeal, because it combines the emotionally charged dream of owning your own home with American capitalism.
House flipping is certainly a valid strategy for making a fairly short-term profit, but there are substantial risks. If you're thinking about entering the flipping business to make a few dollars for yourself, understand that you do need some cash for the down payment, experience in construction and or repair work, and patience to pull off a successful fix-and-flip.
If you are properly prepared and conscious about the risks involved, you will have much better chances of successfully flipping your investment project:
1.You'll need cash
Don't fall for the hype about "no down payments." Most lenders want you to be able to put up some cash in order to demonstrate your value as a creditworthy client.
During the housing boom of 2004-2007, many borrowers got loans they couldn't afford. Easy credit might be tempting, but the real estate crisis certainly has shown how devastating poor underwriting standards can be.
Unless you can come up with some cash to finance the equity portion of a project, you shouldn't think about being a flipper at all.
2. It is not as easy as it sounds
The way flipping is often characterized -- people simply buy houses, fix them up, and sell them for a profit -- suggests that nearly everyone can do it. That is clearly not the case.
First of all, you need knowledge of the local real estate market you want to invest in, and you need a solid understanding of how real estate is valued so you can determine how much you should offer for a renovation project to begin with.
Real estate is often valued at multiples of annual rent though there are other valuation methods as well. Different houses have different characteristics (zoning, sizes, locations, building materials, and so on), and it can be quite difficult to come up with accurate numbers to make accurate comparisons.
Second, you need a proper understanding of how much any repairs or remodeling jobs will cost you, and it requires at least a little bit of knowledge about construction to determine which improvements are feasible. A good source for determining the repair costs is the cost guide from Homeadvisor.
Unless you've done some repairs yourself and have some knowledge about building structures, you should probably avoid house flipping.
3. It's risky
Flipping houses is like running a business and involves a decent amount of risk: There's no guarantee of a sure exit and no guarantee of a set price at which you'll sell the property.
Don't give in to the hype about using "other people's money," which is a theme that real estate seminars and boot camps popularize. You're running a business. And if your remodeled property doesn't sell, you will be on the hook for it.
The Foolish bottom line
Fixing up houses and flipping them for a profit can look like an appealing way to make some quick money, especially given the way it's portrayed in house flipping seminars. But don't fool yourself: You rarely will buy a house, throw on some new paint, and immediately sell it for a gigantic profit.
Understand that you're running a business, and you'll be on the hook for mortgage payments if your project doesn't sell right away. Many potential flippers have overly optimistic expectations when it comes to house flipping.
Also make sure you have a solid grip on your local real estate economics (house prices, renovation costs, expected selling prices after improvements, marketing and selling costs, and the like) and that you're liquid enough to come up with some cash for the down payment by yourself.