I am often asked by brand new real estate investors how much money can be made by flipping houses. Over the last decade, a number of television shows have shown both new and seasoned investors making huge profits on house flips. Some of the shows are realistic, but others seem to be somewhat contrived.
I remember watching one show that showed the purchase price, the rehabbing costs, and then the price sold. That leads the viewer into thinking the remaining difference is the profit. But what the show left out were all of the other costs, such as closing fees, Realtor expenses, taxes, insurance, utilities, and maintenance. Only by taking those costs into consideration can we get a more realistic view of just how profitable a flip will be.
One thing to keep in mind is that each area of the country has different house prices, expenses, and market demand for houses. It’s not reasonable to expect the profit from a flip in Florida would be the same as it is in New Jersey, or Iowa, or California. Expenses such as taxes, insurance, utilities, and closing costs will vary from state to state. Also, in the areas where houses are lower priced, investors are much more likely to use cash, rather than mortgages or hard money loans to purchase investment properties. Because of the fees associated with financing, whenever one can use all cash for a purchase, they can maximize the profit potential of the flip.
I teach investors to think of real estate investing as a business. One undertakes a business with a preconceived idea of how much money they would like to earn, and then establishes the business in such a way as to make those earnings feasible. We want to approach house flipping in much the same way.
One should also remember that flipping is an investment, and as such will have risks just like any other investment. You must decide in advance how much profit is worth the risks you are assuming for your cash outlay. One way to minimize risk is to use all cash rather than financing, and always buy a house that you could rent if the sales market were to quickly go soft. So, for example, I would shy away from flipping a pool house, because if it doesn’t sell, with high insurance costs, I don’t want to rent a house with a pool.
It is vital that you rehab your flips as quickly as possible, because every day that the property remains unsold will eat up your profit in taxes, insurance, utilities, and maintenance. Purchase all of your materials and schedule your service providers in advance so that you can begin the work immediately upon closing and minimize the time you own the property and maximize your profits.
An important investment decision is whether to strive for a large cash profit versus a high return on investment.(ROI). The ROI is calculated as a percentage return on the money that comes out of one’s pocket. You should always generate a higher ROI by using financing because you will use far less of your own cash. However, financing a flip will markedly reduce your actual profit dollars.
A recent example of a house that I flipped here in my house state of Florida will demonstrate the actual profit, as well as the typical expenses of a flip:
In 2015, I purchased a foreclosure with cash for $86,000. The purchase closing costs were about $1100. Repairs and other expenses totaled approximately $13,600. Closing costs on the sale, including real estate commission paid to the buyer’s broker, were nearly $6300. Taxes and insurance totaled about $1300.
The house sold for $133,000. The net profit was just slightly under $25,000 after just four months of work. The ROI is calculated as follows. First, we add the total costs:
$86,000 sales price
1 100 purchase closing costs
13,600 repairs/expenses
6300 selling closing costs
1300 Taxes and insurance
———-
$108,300 Total spent
Next, we subtract the $108,300 total spent from the $133,000 sales price. The net profit comes to $24,700. Then we divide $24,700 by $108,300, which equals .228, or 22.8%. So 22.8% is the Return on Investment.
But had I financed this flip on a conventional mortgage with 20% down, I would have spent another $3000 or so on front end closing costs and paid almost $2000 in interest payments for the time I owned the property. Thus, my net profit would have been reduced by $5000 to approximately $19,700. However, when we calculate the ROI, we find that it would have been greater than the ROI garnered by using all cash on the transaction. Here is how we calculate the ROI:
$17,200 20% down payment on the loan
4,100 purchase closing costs
13,600 repairs/expenses
6,300 selling closing costs
1,300 taxes and insurance
2,000 interest on mortgage during the loan period
————
$44,500 total spent
Since we financed only 80% of the purchase price, the initial mortgage was $68,800. Assuming we would pay down about $500 in principal over the four months the house was owned, the remaining mortgage of approximately $68,300 is then subtracted from the $133,000 sales price, to get $64,700. Next, subtract the $44,500 spent from $64,700 and the net profit made is approximately $20,200.
So you can see the actual dollars earned will be less by financing the flip. However, to calculate the ROI, we divide the net profit of $20,200 by $44,500, and we get .45 or 45%. So when we finance the flip, our return on investment is more than double the return on cash.
Thus, investors need to decide if they want to strive for the greater profit, or the greater ROI on their flips. By using all of one’s cash, it limits the flips to just one at a time, but will return a greater profit than by financing the acquisition.
Remember, flipping houses does involve some risk, so make sure before you sign on the dotted line at the closing table that the amount you stand to profit will be worth the risks being undertaken. Whether it’s using cash or financing, flips are still a great way for investors to profit!
About the Author:
Ethan Roberts is a real estate writer, editor and investor. He’s a frequent contributor to InvestorPlace.com, and his work has been featured on Money.msn.com and Reuters.com. He’s also written for SeekingAlpha.com and MarketGreenhouse.com, and was one of five contributing editors to TheTycoonReport.com. He’s been investing in real estate since 1995 and has been a Realtor since 1998. He also teaches classes on investing in residential real estate.
