House under construction
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If someone tells you they are flipping houses, it means that they are buying a property — possibly distressed — at a low price, making repairs and updates, and putting that home back on the market at a substantially higher price. Television shows like “Rehab Addict,” “Flip or Flop,” and “Property Brothers” make it appear as though anyone with a plan can flip a house. The fact that profits from house flipping were at a 10-year high in 2016 makes it tempting for newbies to consider getting into the business.

Why 2016 was such a good year

In 2016, flipping rose 3.1 percent to the highest level since 2006, and flips represented 5.7 percent of all single-family homes and condominiums sold, according to ATTOM Data Solutions.

Low interest rates, coupled with low inventory and high demand for first-time homes creates the ideal scenario for house flippers. Another factor adding to the trend: Many homebuilders have slowed their efforts to build starter homes, in part because of a shortage of skilled labor. Instead of building a home that will net a modest profit, builders having been focusing on constructing multi-family and high-end houses. Yet recent demand for single-family homes has been much higher than supply.

The reality of flipping houses

Despite the recent popularity of house flipping, spurred in part by how easy it looks on television, many people lose money flipping houses. One analysis found that as many as 3 out of 10 flips in the third quarter of 2016 may have resulted in a loss. What flippers sometimes forget to factor in are all the expenses incurred, including the costs associated with carrying the house until it sells.

Flippers who have been in the business for years say that, in order to make a decent profit, a house must sell for 30 percent over what it cost to buy and remodel. A basic breakdown looks like this:

  • You purchase a distressed property for $200,000, with 20 percent down ($40,000), leaving you a balance of $160,000.
  • Your carrying cost for six months, including monthly mortgage payments at 4 percent interest, property taxes, home insurance and utilities runs nearly $6,800.
  • You make $30,000 in repairs and upgrades to the home.
  • You sell the home for $275,000.
  • You pay the standard 6 percent real estate fee to market and sell the home, or $16,500.
  • You pay seller’s closing costs of approximately $3,000.

In total, not counting the value of your time, you have roughly $96,000 into the property, including the down payment, carrying costs, repairs and upgrades, realtor fees and closing costs. Once you subtract the $160,000 balance on the home (which may be less, depending upon how long you have held the mortgage) and the money invested, you end up with about $19,000 — not a great profit.

What you need

If you are undaunted by the idea of house flipping, you need three things to get started:

  • An excellent credit score. Unless you are paying cash for a property, repairs and carrying costs, you will need a mortgage lender. Lenders have not only tightened their requirements, but also view house flipping as high-risk investment, so they will want you to have superb credit.
  • Plenty of cash on hand. You need to put at least 20 percent down on a new mortgage or you will be forced to pay private mortgage insurance, an added expense to your carrying costs.
  • Knowledge of the market. Make sure you know the housing market in any area in which you are considering a flip. Houses in some neighborhoods will sell within days, while others, due to reputation, poor schools, or other factors outside of your control, will linger on the market for months. The longer a home is on the market, the more bargain hunters begin to circle.