08 Jan The One Assumption That Every Amateur Flipper Makes
I’m not pointing fingers because I’ve done this in my younger days. What is it, you ask? It is assuming that just because you bought a fixer-upper means that you’re guaranteed to make money on the flip.
I’ve seen so many aspiring house flippers make this faulty assumption. Heed the lessons below. Learn from the mistakes of others.
A newbie house flipper found an off-market twin home. He worked out a deal with the seller to guarantee the seller $10,000 in proceeds at the closing. The seller, who was behind on his mortgage payments, said that his mortgage balance was around $130,000. The flipper assumed that he would therefore be paying around $142,000 for the property ($130,000 to pay off the loan + $10,000 to the seller + $2,000 in closing costs). Despite warnings to conduct a thorough title search first and then to close quickly to prevent the mortgage balance from climbing higher, the flipper took his time to complete the sale. The flipper was also warned before the closing that the After Repair Value (ARV) was around $240,000. The flipper ended up paying $166,000 total for the property. The flipper then overimproved the house. Their total basis in the house with renovation costs and financing charges grew to $264,000. After many weeks, the flipper excitedly listed the house for sale at $280,000. The market responded to the house being overpriced by, well, ensuring that the house did not receive any offers. The flipper lost money on the deal.
Lessons:
– Just because you buy an off-market house does not mean you found a good deal.
– Just because the seller is facing foreclosure does not mean it is automatically a good deal.
– Just because you completely renovated a house does not mean that someone will pay more than the house is worth.
– You shouldn’t choose your asking price by simply picking a number higher than your total basis in the property.
A brand new investor came across a total wreck of a house being offered off-market. The seller had purchased the house for $15,000 several years earlier, and they wanted three times that amount. Despite the fact that homeless people were squatting on the premises, and that a busy highway overpass ran directly by the property, and that the property bordered a commercial area instead of a traditional residential neighborhood, the investor bought the house. They underestimated the cost of renovations and overestimated the time it would take to fix up the property. The investor ran out of money several times during the project, causing them to cut corners and stop work for long periods of time. After three years, they finally completed their work. The investor had no idea how much they had spent on the property. So they can’t know if they lost money or made money. Of course, if they place a value on their time, they most certainly lost.
Lessons:
– Just because you buy a major wreck does not automatically mean it will turn into a major profit, or any profit at all.
– Do not buy residential flip projects right near major highways or in predominantly commercial areas.
– Do not buy something that will require more time and money than you can commit.
– If you are a rookie house flipper, buy a light fixer-upper that may only need simple things like paint and carpet.
An aspiring flipper who knew just enough about subject-to transactions to be dangerous found a person facing foreclosure. The flipper wrote a $20,000 check to the seller on the spot to have them sign a quit-claim deed. The flipper did not conduct a title search, did not know the ARV, did not consult his business partners, and did not bring in a contractor to prepare an estimate. When questioned by his irate business partners, the flipper replied that even if they made a $5,000 profit it would be worth it. The business partners decided to part ways with the wayward flipper, and they deeded the house to him. The flipper encountered numerous problems with the house and was unable to sell it. After a couple of years of trying to sell, they rented it for an amount that produced a negative monthly cash flow.
Lessons:
– Just because you take over a defaulted mortgage loan that appears to represent 100% financing does not mean you will automatically make money.
– Failure to perform due diligence comes with a cost, and that cost may be significant.
– Consult with your partner(s) before committing to a purchase decision.
Don’t assume that you will make money simply because you bought a house that needs some work. Optimism alone will not make you money; you need some healthy skepticism when evaluating a potential deal. It’s okay to make mistakes, yet avoid making catastrophic mistakes.
Tai DeSa is a graduate of The Wharton School of the University of Pennsylvania. He became a full-time real estate investor in 2004 after serving in the U.S. Navy. Tai has made colossal mistakes in investing (and learned some things along the way). He has helped hundreds of homeowners avoid foreclosure through successful short sales. Check out Tai’s books on Amazon.com. Tai may be available for coaching and speaking engagements on a variety of real estate topics. Send an email to tai@investandtransform.com.
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