This is primarily addressed to the newbie. I welcome further input from other experienced professionals.
It can be a great way to turn a quick profit- you buy a house at below-market value, you put some work into bringing it up to market value, you sell it, you put cash in your pocket. Simple, right?
Yes. Deceptively so.
Rehabbing and flipping SFR's can be very profitable, indeed. It can also be fraught with danger. So, here's a nickel's worth of free advice from a former Realtor, long-time contractor, experienced fix-and-flip guy and current loan broker working within that niche:
1. Remember the 2nd oldest rule in real estate: You don't make money when you sell, you make money when you buy. So when analyzing whether a property is a good opportunity, start with the ARV and work backwards to arrive at the purchase price.
Let's take a rough thumbnail as an example:
You figure the selling range (and it's ALWAYS a range, folks. Always.) is 175,000 to 200,000. You want to minimize your holding costs, so you decide to price it at 180,000 knowing that it will ultimately sell for 175,000. (Note: common mistake is to market the property at the TOP of the range, which not only eats up your profits in holding costs, but serves only to help sell the similar house down that street that has an asking price of 189,900)
So, ARV is $175,000
Rehab cost is $15,000
You estimate closing and holding costs to be 20,000
This means your break even point is a purchase price of $140,000. Different people have a different threshold for what type of return they're willing to accept, but personally I wouldn't go much over $90,000.
I see people make three mistakes when they buy a property:
A) Lack of patience. Don't be so anxious to make a deal that you make a bad one. If you have to make 50 offers to get one that fits your strategy, fine. Decide what you must have as a net profit from a deal and discipline yourself to stick to it.
B) Intimidation by real estate agents and sellers. I don't care what they tell you. I don't care if the walls are insulated to R-100. I don't care that the garage has 3-phase power. I don't care if it's got granite counter-tops. And I REALLY don't care if they're offended by my low offer (you'll be surprised how often a flat rejection of your offer will result in a call 2 months down the road to ask if you're interested in re-making a similar offer!) Never trust the listing agent or seller's opinion of ARV. Don't ever, ever, ever, ever be bullied into a purchase price that doesn't suit your investment needs.
C) Over-estimating the ARV of the property. Buy low, sell high is a good philosophy in the stock market. For quick turnaround of SFR's though, the rule is buy low, sell low.
2. Beware the high rehab budget.
This is an extremely common mistake, and I see it all the time. If the ARV is 175,000 and you've figured a rehab budget of 65,000 something is wrong. Either,
A) You're trying to make the house into something YOU want to live in. You must be brutally honest in figuring how much return you get for each dollar spent on repairs and upgrades. You simply do not add $10,000 to the value by spending $10,000 on granite counter-tops and high-priced flooring. If the market demands, for the price range you're in, that the home have granite tops then by all means put them in. But you must understand that only brings the property to our original ARV range of 175-200,000. It does not ever raise the value to $210,000!
B) You're looking at a money-pit. Paint. Carpet. Light fixtures. Light carpentry. A new roof, perhaps. Minor plumbing repairs. Minor electrical repairs and upgrades. Patching walls. Getting rid of of pet odors (cat urine smells like money to a rehabber) That's it.
If you're looking at a property that needs to be rewired, re-plumbed, gutted down to the studs, or has foundation or framing issues... be very, very cautious. Get qualified contractors to inspect it. It's all too easy to dig into structural issues or major repairs and find that there were hidden problems. Cost overruns will eat you alive.
Remember: The rehab budget is directly proportional to your risk.
3. Begin looking for buyers immediately. This gets easier after you've done a few, but depending on the condition of the property, go ahead and show it to prospective buyers. Share with them your list of repairs. Let them pick their own color of paint and carpet (within reason) if they'll make an offer with good earnest money. I'd suggest figuring a real estate agent's commission into the deal from the beginning. You may not like it, but selling property is what they do. (Well, the good ones anyway.)
You can't get paid til there's a closing.
There can't be a closing til there's an offer.
There can't be an offer til there's a qualified buyer.
There can't be a qualified buyer til there's been showings.
Be smart, disciplined, patient and humble enough to learn and you, too can reap tremendous profits from real estate.