Strategy basics for real estate’s flipping model

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BY KOSTA KIOLEOGLOU

There are several strategies when it comes to real estate and property investments. One of the most popular strategies used around the world is the “Flipping Model”.

Flipping (also called wholesale real estate investing) is a type of real estate investment strategy in which an investor purchases a property not to use, but with the intention of selling it for a profit. The word ‘intention’ is key because it is a wish to make profits and not a fact that the project will produce guaranteed profits. People tend to forget the key element of investing, and that is simply the risk reward trade off which dominates any investment strategy around the world.

The truth is that flipping sounds very easy. Buy a property, keep it for a while, maybe make a few ‘cosmetic fixes’, put it back on the market and make a huge profit. That profit is typically derived from price appreciation resulting from a hot real estate market in which prices are rising rapidly or from capital improvements made to the property – or both. Usually, the faster you can sell a “Buy & Flip property, the better off you are going to be and the higher the rate of return you will experience. Much in house-flipping depends on the real-estate market, which we all know is cyclical. During a boom, flippers have the upper hand and can almost name their price in some areas. During slow period, many of these fixed-up homes can sit on the market for months.

The logistics can get pretty complicated. There are a lot of critical decisions to make. Location is maybe one of the most important factors that will determine the success of your project. Where should you buy? If you purchase a house in an up-coming neighborhood, you’re banking on the neighborhood increasing in value. If you decide to buy in a new development, you’ll want to attract higher-end home buyers who want the luxury features and space offered in the suburbs.

If all goes well, you could make a nice profit. If something goes wrong, faulty budgeting, timing issues, a market   trend   change, etc, you could be stuck with a house you can’t get rid of. The next step is deciding what type of property you want to purchase. If you go for a fixer-upper, you’re committing to improving the home, which takes time and money. If you buy a foreclosed property in an auction or from a bank, you could get a bargain on a vastly underpriced house. Remember, if the previous owners couldn’t pay the mortgage, they probably couldn’t pay for the upkeep, either and that could hide several renovation costs.

Fixer-uppers and foreclosures are what most people think of when flipping comes to mind, but it is possible to flip a house without doing any work on it at all. During real-estate boom periods, flippers can buy new construction homes, hold on to them for a few months, and then sell them at a profit.  Now there’s a trend toward trying to flip houses in new, high-end developments in outlying suburbs. If commercial and retail development spring up, it could bring in droves of residents. The situation is not always perfect and when the conditions change this kind of flipping becomes pretty risky

Secrets of flipping

House flipping is more like a basic investing lesson: Buy low, sell high. You want to find a property that is undervalued or is just in bad enough shape that you can invest minimal time and money in it before selling it. There are people who have made careers out of buying distressed properties and quickly turning them around for a profit. However, in a real-estate bust, things aren’t quite so easy.

The first piece of advice that most flipping experts give: Make a budget. While finding the perfect place and knowing your skill set is important, budgeting is where new flippers most often fail.

So, where does one start? First check your financial situation and if you need to get financing then make sure you can get a good deal. When a market is booming getting a house loan – or property mortgage usually is supposed to be an easy procedure. In Kenya though, the available finance options do not look so lucrative. The cost of money is very high, while getting a loan approval sounds almost like a miracle. Calculating properly the cost of money is vital for the sustainability and viability of your project depends on proper and very careful calculations.

Good news is that during a booming market, the period of time that you will have to hold on the property is less, the costs sometimes can be affordable. When the market is flat, however, obtaining a mortgage for an investment property is more difficult. Sky-high interest rates empty investors’ wallets when a property sits on the market for several months or years. As a result, cash plays a much bigger role in getting that flip started. The bigger the down payment you can afford, the lower the interest rate. And, of course, it helps to have cash around for fixing up the flip.

Budgeting

Before you proceed with any investment, you need to have a good business plan, and remember, budgeting is key. If you’re simply planning to buy a new-construction home, budgeting can be simple. It’s exactly like buying a home you actually plan to live in. The basic expenses you need to cover are the mortgage (if you need one), insurance, taxes, real-estate agent and lawyer’s fees, and that’s about it. There are other factors to consider such as the investment period. Example, in a softening market, the supply of houses is much greater than demand, so you may own that property for longer than you plan to.

If your project is to work on a fixer-upper, the budget starts to grow when you consider the renovations you’ll need to make. You can never estimate 100% on the total costs for the renovation. According to most experts, you should add 20% to your estimate for the final cost. If you overestimate you will get better returns, if you underestimate, your project might not make sense at all. Structural improvements like plumbing, electrical, insulation, pest control, are typically the most important improvements a flipper can make. New hardwood floors and coat of paint may get buyers in the door, but a termite problem or walls full of moisture can kill a deal quickly. If your technical skills are lacking here, you’ll have to figure in the cost of labor, too. Personal work has also to be calculated.

Most real-estate professionals advise fixing up the kitchen and bathrooms for the best return on your investment, as these are two of the most important areas of a house. In addition to the structural changes, this can include new cabinetry, counters, hardware, sinks, backsplashes, appliances, floors and lighting. Kitchen upgrades can be expensive, but they make a big impression. A property that is in good structural shape and just needs updated paint and carpets obviously should be your first option to keep your possible money exposure low.

Another aspect to consider is curbing appeal on the outside of the house. You might need to paint, land-scape and fix up the driveway, which adds to the budget. If you’ve bought in a pricey neighborhood, mowing the lawn and repairing the fence may not be enough. In up-and-coming neighborhoods, you might have to budget for security measures. You need to focus to your initial plan. It is very easy to keep popping money in a property but you need to make sure that you are adding value without over exaggerating.

Location

Spend as much time as possible for research. Make sure you really investigate the area, drive around during the day and at night, check recent sale prices and find out if any other flippers are sitting on empty properties. Try to find the market trend in the area. You need to understand correctly the supply and demand of the area. If you’ve decided to flip a new home, your options are somewhat limited to what’s being built there. If you’re determined to buy a house in foreclosure, you need to find the correct source of available properties via the banks, auctioneers or newspaper, website adverts etc.

Budgets can balloon quickly on fixer-uppers. If you decide to invest in one, you need a high tolerance for risk and an exit strategy. Depending on your goals and the extent of the renovations, fixer-uppers can take a few months or years to turn around. While up-coming neighborhoods can explode overnight, there will also be fluctuations in crime rates, local business booms and school improvements, all of which can affect your property’s value. Patience is key when waiting for a neighborhood to take off.    

REV Valuer – Tegova
Civil Engineer Msc/DBM
Managing Partner Avakon Ltd