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How Much Risk Is Too Much in House Flipping?

By Kristi Waterworth – Dec 1, 2021 at 10:00AM

Key Points

  • House flipping can expose you to major risk if the property itself has serious, undisclosed problems.
  • Other risks for sellers have to do with how much -- or how little -- they do to their project.
  • Ultimately, a well-done flip can always become a rental unit, minimizing the risk in any market.

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No matter what kind of real estate you're investing in, there's going to be some sort of risk involved. But what about house flipping? How much risk is too much?

House flipping in any market is an imperfect -- and potentially risky -- business. Once you crack open a house, well, almost anything can happen. Even with an inspection (which you absolutely should have), you can uncover old problems that were never properly repaired, run into cost overruns when material shortages catch you off guard, or even discover that you've got a house you can't make a profit on.

In the real estate industry, we all know everything can be sold -- but "for how much?" is the question. When flipping houses, it's really important to understand the market your house is located in, as well as who future potential buyers will be. Unlike other kinds of assets, a house is something everybody actually needs, but it's far more difficult to liquidate than, say, a stock portfolio. The amount of risk you're willing to take has to be based on the hyperlocal market and slice of time in which your project sits.

A person marks lumber for a cut during a house remodel.

Image source: Getty Images.

Flipping in today's market

For most flippers active right now, the only real risk they face is blowing their budgets, because there are still massive nationwide housing shortages. October's existing-home sales report from the National Association of Realtors showed that the number of unsold existing homes (which is the classification a flip falls under) continues to decrease. Year over year, inventory dropped 12% to just 2.4 months worth of housing.

At the same time, existing-home sales rose 0.8% from September to October 2021, despite there not being enough inventory for a wide range of buyers, it would seem. On top of that, the few homes that are available are selling for more -- prices are up 13.1% year over year, to a median price of $353,900 nationwide.

In today's market, flipping (provided you do a quality job and address any structural and mechanical issues rather than just slap a coat of paint on a house and call it good) is almost without risk. That's not to say that you can't get stuck with a house, but it would certainly be unusual in this particular market.

Situations that create excessive risk

As a flipper, it's important to know your market down to the city block. Check out any houses you can, see what they look like inside and out, and really get to know what people expect from the neighborhood. The two biggest mistakes I've seen people make when flipping are overbuilding and underbuilding, and both are very easy to do.

If your flip house is in a neighborhood that demands excellence, respond appropriately. Spend the extra money on the right trappings, and your buyer will show up and your house will appraise the right way. If your neighborhood requires more affordable housing, use simple but durable materials that will last a long time but don't necessarily cost a lot. That means forgoing the marble counters in a neighborhood full of Formica. There's no sin in Formica -- there's a lot of that stuff still in excellent shape (and in use!) left from the 1960s.

The other big mistake I've seen in house flipping is one that HGTV almost primes people with little construction experience to make: You can't just dress up a house and call it good. You have to lead with the unsexy stuff: the structural defects, roof, HVAC, plumbing, etc. Once all of that's right, then you can paint the walls, sand the wood floors, and put in new light fixtures.

When you can't sell your flip house

If you create a house that's not only attractive, but sound, you will have almost no risk because your very worst-case scenario is that you now have a long-term rental. According to the U.S. Census Bureau, as of the third quarter, 2021 rental vacancy rates are as low as they've ever been, at a national average of 5.8%, 0.6% lower than the previous low in Q3 2020. On top of that, the median rent for vacant units was $1,203.

Of course, rental vacancies and rental rates will vary widely based on where your house is located, down to the neighborhood. But if you plan your flip so you can still come out OK if you have to rent it, you'll have an exit strategy that will ensure you aren't really risking anything. As real estate continues to appreciate, the benefits increase too: Your flip's value will grow, you'll get steady rental income, you'll have some pretty neat tax deductions, and when you're ready, you can try to sell it again, if you've decided you'd still like to unload it.

Flips are wonderful when done properly because they are generally such low-risk investments by their very nature. People always need housing, and in a tight market like this one, people need housing more than ever, both as purchases and as rentals. Your options are nearly limitless, as long as your property makes sense for the neighborhood and buyer (or renter) you hope to bring in.

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