As a real estate agent and investor who is actively involved in BiggerPockets, I get the privilege of connecting with a lot of people—especially newer, eager investors looking to get their feet wet. This motivation is great and is truly what will get most people ahead of those who lack it. However, sometimes that motivation can cloud judgment. Unfortunately, I’ve run into a lot of people who were sold a project that was dead in the water to begin with. Because of great marketing, pushy sales, and amazing projected returns, lots of people get sold on this pipe dream. It’s the same story I hear: the project was way over budget, it took too long, and I can’t sell the house for what I was told it was worth—the ARV.
When I sit down and talk with people in this predicament, I work backward to understand where it went wrong. From the start, I usually see the same three issues:
- They bought too high and paid crazy fees to get the property. I’ve seen wholesalers earn a 2.5% commission on a transaction and then charge a 10–20k assignment fee on top of that commission. They also get referred to their “partner” lenders who charge an arm and a leg—3+ points for a client with an 800+ credit score for hard money. I don’t even want to know the interest rate.
- The ARV values are very off. While some ARVs are pretty accurate, most of the time these numbers are extremely inflated. I’ve seen Realtors and wholesalers push “up-and-coming” areas and comp them to locations more than a quarter mile—sometimes half a mile—away to boost ARV. This is one of the most dangerous things you can do as a flipper, especially in up-and-coming areas.
- Rehab costs are drastically underestimated. I’ve walked into properties that need close to $150–200k of rehab that wholesalers and agents marketed as needing only $50–100k. Recently someone told me a full gut rehab on a South Philly home would only cost $100k. Nowadays, $100k maybe gives you a solid budget for mostly cosmetic rehabs—maybe a full gut is possible for those who are incredibly experienced and have hourly workers busy on other job sites. A cosmetic rehab—new kitchen, flooring, bathroom, recessed lighting, and minor plumbing/electrical—costs me close to $30–35k for a 2-bed/1-bath apartment, and that’s considered cheap for many! When you’re buying a full rowhome, gutting it, installing new framing, changing the layout, adding bathrooms, replacing windows, running brand-new plumbing and electrical, new roof, dry-locking the basement, etc.—trust me, that does not cost $100k!
The most important part when analyzing a flip is to always overestimate your rehab budget and underestimate your after-repair value. Doing the inverse just to make a deal pencil is the worst thing you can do and will ultimately lead to disaster. Also, as a newer investor, you have to consider that there will be mistakes and hiccups along the road. That’s why you overestimate rehab and underestimate ARV—because, God forbid something happens, you can absorb that loss.
To combat the three issues above, you have to do the following:
- Buy as low as you can. You make money when you buy the property, not when you sell it, and the lower you can buy, the better off you’ll be. Of course, when you’re buying a long-term rental and plan on holding it for many years, $10,000–$15,000 won’t make a big difference in the long run. However, if you’re planning a flip, then every penny matters. Know your fees and what people are charging you to buy the property. If the wholesaler/agent is already making a commission, understand why they’re making money on top of that as well. That said, I have seen instances where wholesalers make a pretty penny but, because the deal is so good initially, even after paying a very large assignment fee the deal is still a slam dunk. In those cases, it’s absolutely OK to pay the wholesaler—they should be compensated for finding such a great deal and bringing it to you. Understand your lender fees as much as possible as well; know how many points you are paying and shop that rate!
- When looking at after-repair values, make sure to look as close to your property as possible and try to compare apples to apples. Don’t chase comps in completely different locations or different property types. Also, if your ARV comps are flips, understand that as someone who is new to this, you might not have as much experience in what the neighborhood expects—color palettes, fixtures, finishes—which also influences value. So if you see a lot of comps selling between $400,000–$425,000, use $400,000 (if not a little less) as your base when running numbers. If your property sells for more—great, you earned a bigger profit. But if you ran numbers on the high end and didn’t achieve as nice a renovation due to experience or other factors, you can find yourself in a predicament.
- Always, always, always overestimate your rehab cost—especially as a newer investor—and if you’re not sure, have someone else look at the property with you: perhaps an experienced agent with construction experience, a mentor, or somebody who has spent money on similar projects. Almost always you will be over budget and delayed on your project—even most experienced investors run into this on every single job. When you overestimate rehab costs and use conservative after-repair values, you insure yourself against mistakes and help ensure a profit.
Good luck to all new investors, and always ask for a second opinion before pulling the trigger on a transaction!