How To Eliminate Risk When House Flipping
When assembling your House Flipping Business Plan, make sure you take the necessary steps to eliminate as much risk as possible.
“The best laid schemes of mice and men often go astray” – Robert Burns, “To A Mouse”
Real estate investing can have an enormous amount of unpredictability. You never know which way the market is going to turn, or what problems could arise when buying, rehabbing or selling a property. To eliminate this unpredictability, you should do the proper research and get rid of as many variables as possible. If you fail to do this, you will be at risk of sinking your venture.
One of the most common reasons that newcomers are scared away from the idea of house flipping is the risk. Many people believe the old saying “the bigger the risk the bigger the reward” is the be-all and end-all of real estate.
For most regular folk, especially beginners in house flipping, risk is a dangerous word, that could mean the loss of your life’s savings, or falling into a deep pit of debt.
Don’t roll the dice on a project. Instead, lay out a house flipping business plan, outlining your risk-free strategy. Leave the risk to the hedge funds and the wealthy that can afford to take a loss on a property.
The 5 Steps To Eliminating Risk | House Flipping Business Plan
While there is always some risk involved, you don’t have to let it control you. Instead, if you know what you’re doing, you can take the proper steps to eliminate most of the risk.
Stick To The 70% Rule
As a real estate investor, one of the most important pieces of information before you buy is the ARV of the property. As you probably already know, the ARV, or “after repair value” is the approximate amount of money that the house will be worth after it is renovated.
The rule of thumb is that you should almost never purchase a home for more than 70% of the ARV. If you do, there’s a good chance that you won’t profit.
A lot of factors go into determining the ARV of a home, like the neighborhood, the town and the size of the property. A beginner’s mistake is to simply see what other homes in the neighborhood have sold for recently. While this is a good start, there may be a factor about your property in particular that you are overlooking. Maybe you saw that the house down the street sold for $300,000, but you missed the fact that that particular home faces a lake and has four bedrooms instead of three.
The best way to get an accurate ARV is by asking a trusted real estate broker in the area. These brokers are familiar with the town and are directly involved with the sale of homes—it’s their job.
Essentially, you want to go with a sure thing. Don’t take a chance on a property that could lead you to crash and burn.
Always Use An Inspector
Sometimes, a property might appear to be perfect. It has strong bones and it’s in a good neighborhood. Maybe it’s a little rough around the edges but nothing to be worried about.
But what if there’s trouble that is hidden within the house? What if the electrical system is outdated, or the plumbing is about to go, or the ventilation system isn’t being filtered properly? That’s where the inspector comes in.
You might even consider hiring a specialist to check for things a carbon monoxide leak or high radon levels.
The only situation where you wouldn’t have to get the property inspected ahead of time is if, within the purchase contract, there is a clause stating that the sale is valid if and only if there are no major problems after the inspection.
Get Estimates From Contractors Before You Buy
Reality TV is often exaggerated and unrealistic, and the many house flipping shows are no exception. Perhaps the most profound example happens before the stars purchase the property. They will quickly walk through the home and determine, to the penny, exactly how much the renovations will cost.
In real life, things aren’t quite this simple. Most house flippers are not themselves contractors, and even if they are, they only specialize in one field. For example, you might be a mason, but you can’t determine the cost of electrical, HVAC, plumbing or septic.
Now you might be thinking, “Of course I’m going to get an estimate. That’s a no brainer. Tell me something I don’t know.”
Most investors will wait until the house is already in their possession before getting these estimates. If you want to eliminate risk, you should get the contractors to take a look at the house before you purchase the home. This way you can find out if there’s an expense that you missed, and properly determine whether or not the property is worth purchasing.
Try To Steer Away From Foreclosure Auctions
If you have enough expendable income to take a loss, foreclosure auctions can be great. However, if you don’t have a lot of money and you want to avoid all the risk you can, try to stay away from them.
When buying a foreclosure from a foreclosure auction, you will not be able to look inside the house, or get it inspected in any way, before buying. Because of this, you will not know the true value of the home or what potential problems it could have,
Instead, consider purchasing a short sale (pre-foreclosure) or an REO property (a property that fails to sell at a foreclosure auction). In both cases, you will be able to look at the interior and get an inspection. Additionally, you might be able to get the same great deal that you would have from a traditional foreclosure.
Leave Wiggle Room In Your Budget
Making a budget is essential to flipping a house. But just because you put together a budget, doesn’t mean it’s a good one. There will always be expenses that you forgot about. There will always be dozens of minute costs that add up and take a chunk out of your profit.
Even if your budget is air tight, and you considered every little detail of the project, as well asked for a number of estimates from different contractors to find the cheapest ones, there are still problems that could arise.
As a house flipper, you should always have, in the back of your head, Murphy’s Law: anything that can go wrong, will go wrong. Just look at what happened to our own John Fossetti in our Nightmare On Elm Street series.
To avoid taking a loss like he did, make sure you leave some extra padding in your budget, just in case. If everything goes as planned and you don’t end up using the money, it simply becomes extra profit to take home.
Let us know how we can help you manage risk in your business by posting in the forum.