How to Start a House Flipping Business
If you’re a fan of home improvement television, chances are you’ve watched a show with a house-flipping premise. The hosts buy a run-down home, fix it up and sell it for a profit. The process, condensed into a one-hour segment, might look like fun.
However, it’s not as simple as it seems on the screen. Renovations can require several helping hands and profit isn’t guaranteed. But despite the challenges, house flipping represents an opportunity to make some extra cash or to start a long-term business as a real estate investor.
More than 48,000 single-family homes and condos were flipped in the U.S. in the second quarter of 2018, according to ATTOM Data Solutions. A home is considered “flipped” if it’s purchased and then sold within 12 months. The home flipping rate was 5.2% of all single family and condo sales in the second quarter, down from 6.6% in the first quarter of 2018.
Although the number of home flips has recently decreased, the competition among real estate investors is still rising, said J. Scott, owner of house flipping business ScottBuilt and resource website 123Flip.com. As house flipping becomes more prominent in pop culture, more real estate investors join the industry.
“Flipping houses is glamorized on TV,” Scott said. “It’s really easy to lose money in this business. If you’re diligent and disciplined and do research upfront, you can protect yourself from that.”
In this guide, we’ll help you get familiar with some of the key aspects of house flipping and the first steps toward running a successful business as a real estate investor.
Figure out your financing.
Before looking for property to buy, you should decide how you’re going to pay for it, Scott said. You should know where the money is coming from before taking steps to close a deal. Real estate investors can find financing from traditional banks, private lenders and partner investors. We’ll dive into your financing options in a later section.
Choose a location.
A general rule for home flippers is to choose the worst house in a nice neighborhood, Scott said. Houses in blue-collar, working-class neighborhoods are also good choices, though you want to make sure there is a higher number of homeowners than renters in the area, he said. You could find that information by searching street names in your county’s tax records. A house may be a rental if the property address and owner’s mailing address do not match. In some cases, the owner may be a business.
You should look for neighborhoods where people have pride in ownership and maintain the upkeep of their home, Scott said. This would be enticing to homebuyers when you’re selling the property. When looking for a house to flip, let your own personal preferences guide the decision and think about where you would like to live, he said.
Write a business plan.
A business plan clarifies the goals for your business and your strategy for reaching them. When applying for financing, a lender or bank may want to see your business plan before approving you as a borrower. Your business plan could include the type of property you want to buy and flip, such as single-story houses that need work or move-in ready homes. You should also specify who you plan to buy property from, including homeowners, landlords or banks that have foreclosed properties. Your business plan could also include how you will generate leads on properties to buy, whether you’ll rely on internet marketing or other real estate listings.
Choose your business entity and insurance policy.
The structure of your business affects your taxes and personal liability. Operating as a partnership or a limited liability company could reduce your responsibility for the business’s debts. Your business entity would also impact the insurance policy for your properties. If you have reduced liability because of your business entity, the insurance company would have to assume more of the risk if something happened to the property. The riskiness of your business would affect the price of your policy, and you’ll likely need different policies throughout the flip – vacant property insurance while the house is empty, a builder’s risk policy once the renovation begins and another vacant property policy or rental property policy after the renovation is complete.
Bring in outside help.
Put together a team of people to assist with the home renovation based on what tasks you don’t plan to take on yourself, Scott said. This could include a real estate agent, a bookkeeper, contractors and an attorney. We’ll take a closer look at who you need on your team in a later section.
Get the right permits.
Before you start the renovation on your property, you may have to obtain permits to perform certain tasks. You might need a permit to do electrical or plumbing work or to replace a roof, Scott said. You should check with your local permit and inspection office to find out what you need and who can obtain permits. Sometimes a licensed contractor is the only person authorized to obtain certain permits, he said.
Financing your house flipping business
Investment property loans are mortgages used to buy, build or improve second homes and investment properties, and they’re typically more difficult to obtain than traditional mortgages. Interest rates are usually higher, too. Why? Lenders view investment property loans as risky — unlike a traditional mortgage on your primary home, it’s easier to cut your losses and walk away from an investment property.
That said, investment property loans are available. We’ll discuss the different types below, but here are a few general requirements to know before you apply:
- Good credit will make things easier. Although you could obtain an investment property loan with a 620 credit score, your cost of borrowing could be high. Remember with generally higher interest rates anyway, a few percentage points could be the difference between making money on your investment or losing it.
- Larger down payments required. If you already own a home, you know that certain mortgages require as little as 3% down or, in some cases, nothing at all. You will typically need at least 15% down for an investment property mortgage, higher if you plan to buy a multi-family unit.
- Cash reserves. Along with a down payment, you probably also provided information about your income and other debts if you already own your home. But lenders of investment property mortgages may also want to see that you have a reserve of cash on hand, in case things go wrong.
Beginner investors may want to consider living in the property while flipping it. A duplex is one way to do this where owners live in one unit and rent out the other(s). Depending on how long you plan to live there, you may even qualify for financing through government programs such as loans backed by the Federal Housing Administration or Department of Veterans Affairs.
Here are some conventional ways to finance investment properties:
House flippers typically have two financing options to purchase property – conventional loans and portfolio loans, Scott said. These are both mortgages, as a mortgage is any loan backed by real estate, though the word mortgage is not typically used in the house-flipping business, Scott said. You could find these loans at your local bank or credit union, although approval may be based on your credit history and reliability as a borrower, he said. The difference between the two is that a conventional mortgage may be backed by government-sponsored companies like Fannie Mae and Freddie Mac while a portfolio loan is one that the bank keeps on its own books.
You could obtain a loan from a hard money lender to finance a house purchase, though these lenders tend to charge high interest rates, Scott said. Private hard money lenders prioritize the value of collateral over creditworthiness, which may be appealing for house flippers with poor credit history. However, not all hard money lenders are legitimate, so it’s best to do your due diligence, Scott said. Friends, family and colleagues could also be a source for private loans, and they may not be concerned with your credit history either, he said.
Many real estate investors bring in a partner to help with the financial aspects of the house-flipping business, Scott said. If you want to handle the property side of the business, you could find a partner with access to money to fund the venture.
Need business funding? Learn more about small business loans here.
Who you need on your team
When Scott first started his house-flipping business, ScottBuilt, in 2008, he had a hand in the whole process, from home purchase to renovation to sale. But he soon decided it would be more efficient to bring in experts to assist in various areas. Scott flips about 30 to 40 homes each year.
“We realized the best way to run the business wasn’t to be hands-on and do the renovations ourselves but surround ourselves with good people,” Scott said.
Here are some of the key players you should have on your house-flipping team:
Real estate agent
Hiring a trusted real estate agent would help you choose the right location to flip a house, Scott said. A real estate agent would be able to evaluate a neighborhood and the resale value of a house, as well as help you buy and sell property.
You may also want a real estate attorney to look over paperwork or contracts, Scott said. If you plan to flip several houses, you may want to work with a title company, which would handle the legal details of each real estate closing, he said.
It could be valuable to work with a financial professional who could navigate the monetary aspects of the business, Scott said. This could include a mortgage broker to assist in securing loans. Someone familiar with the real estate landscape could help your business stay on track.
If you want to renovate a home but can’t or don’t want to be on-site throughout the day, you could hire a general contractor to lead the project, Scott said. Some states require a licensed general contractor to handle residential projects exceeding a certain cost. In North Carolina, for example, a general contractors license is needed for jobs costing more than $30,000, while Georgia requires a license for work exceeding $2,500. The general contractor would hire subcontractors such as carpenters, electricians, plumbers and painters. They would also set the work schedule and manage the crew. However, a general contractor would likely mark up the cost of renovations to cover their own fee. If you have the ability to manage the project yourself, you would save money and would make a higher profit, Scott said.
If you don’t hire a general contractor to manage the renovation, you would have to select individual contractors to get the job done. You would need contractors to sign several documents, including W-9 forms for the IRS, independent contractor agreements, which could include performance expectations and payment schedule, and insurance agreements.
You may need contractors or subcontractors to cover these basic tasks:
- Sheetrock repair
- Flooring installation
- Electrical work
- Pressure washing
- Gutter cleaning
Hiring contractors rather than doing the rehab work yourself allow you to focus on other aspects of the business, such as marketing, or to spend time at another job if you’re flipping houses part time.
Making a profit
Scott suggests real estate investors look for a minimum return of $15,000, or at least 10% of the sale price. To calculate your profit, take the resale value of the house, which is the final value after renovations, and subtract the purchase price of the house and rehab costs, including labor and materials, Scott said. Then subtract fixed costs, which include home inspection fees, commissions and other closing costs associated with buying and selling a house. Your fixed costs could total 10 to 20% of the resale value of each home, Scott said, and you risk losing money if you don’t factor them into your budget.
Benefits and challenges
Flipping houses can be a big financial risk, Scott said, but there’s also a chance for you to build a successful business. Here are a few pros and cons to weigh:
Flexibility in your schedule. House flipping doesn’t have to be a full-time commitment. You can manage projects on weekends and continue working your regular weekday job. But if you do jump in full time, you have the power to create your own schedule.
Income potential. In a reliable market, you stand to make a decent income from flipping houses. You could make $60,000 to $70,000 per deal in a good market if you successfully manage each project, Scott said.
High tax burden. If you keep a full-time job and run your house-flipping business on the side, you’ll have to pay self-employment taxes on top of your standard income tax. Because you’re not living in the house being renovated, mortgage-related deductions are not available. Whether you make a profit or a sustain a loss would determine whether the IRS views your activity as a business or a hobby, which would affect how much of your income you would be able to deduct. You may need professional tax advice to make sure you’re paying the right amount.
Difficulty finding properties. There’s a growing amount of competition in the industry, which makes it difficult to find properties that are well-suited for flipping. While anybody can buy property, it’s challenging to find houses at a low enough price point that allows you to add value and sell it for a profit. With so many investors in the market, there’s less room to buy low and sell high.
Is the house flipping business right for you?
Flipping homes, of course, is not as easy as it looks on TV, said Ilyce Glink, founder and CEO of financial wellness website Best Money Moves and author of “100 Questions Every First-Time Home Buyer Should Ask.” New real estate investors need to be aware of the history of their market – if there were a number of foreclosures, for example – as well as the potential to make sales in the area.
“You have to be thoughtful of [the market] you are buying out of, and what you are selling into,” Glink said. “You’re going to want to understand how long it’s going to take you to list and sell that property once it’s done.”
You should be prepared for surprises as well, Glink said. A home inspector should be able to point out structural problems or signs of decay before you get started on a renovation, but you may run into issues once construction begins.
“When you’re renovating an old house, it generally has problems hidden behind the walls,” Glink said.
Considering the number of variables that impact a house flip, you should think about all possible outcomes for a project ahead of time. Ask yourself what you would do if you were unable to sell the property and had to rent it out, or if you don’t recoup your full investment in the property, Glink said.
“You really have to look at all the scenarios of what could happen and figure out how you’re going to manage,” Glink said.
Oftentimes, newcomers who are not educated in the business make things more difficult for veteran home flippers, Scott said.
New investors will sometimes overpay for property, not realizing the value, which makes it hard for others to compete with lower offers in the same neighborhoods or communities, he said. Those new investors may later realize they paid too much for the house.
Before putting any money into the business, you should research the real estate industry in your area. Local real estate investment associations can provide a wealth of knowledge, Scott said. Meeting people in the investment community would provide a way for you to ask questions get a clear idea of whether or not you’re ready to move forward.
“Figure out if it’s something you might want to do,” Scott said. “Talking to other investors who are doing it is a great way to make that decision.”