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By Lloyd Segal
When flipping properties, you also need to consider repair costs, holding costs, real estate commissions, closing costs, estimated profit, and lost opportunity costs. Let’s analyze each of these costs separately.
Repair costs. The repair costs will likely be your largest cost, so you need to calculate them carefully. If you’re able to inspect the interior, you’ll be able to estimate the repairs and renovations needed to make the house salable. However, if you aren’t able to inspect the interior, use 10% of the purchase price as your estimate of repair costs. In the alternative, multiply the square footage of the house by $7.00. For example, if the property has 1,500 square feet, the estimated repair cost would be $10,500.
Holding costs. It’s going to take you approximately 2-4 months to repair, market, and sell the property. During those months, you’ll incur holding costs (i.e. mortgage payments, taxes, insurance, and utilities). Neophyte flippers frequently forget to include these costs in their budgets. If you’re worried about these costs, you can significantly reduce them by living in the house during this period, which is exactly what many flippers do when they are just starting out. Instead of chalking up your monthly expenses as holding costs, simply consider it rent. Another way to trim your holding costs is to price the house correctly the first time. By offering the best home in its class at the best price, you’ll sell the home faster and lower your holding costs to more than cover the cost of selling the home for a little less.
Real estate commissions. You can assume you’ll pay a 6% commission to your real estate agent for selling the house when you flip it. For that money, the agent will market your property for sale, list it in the Multiple Listing Service and related websites, advertise in local newspapers, receive and submit offers, negotiate with the buyer, and assist you with the timely close of escrow.
Closing costs. You will incur closing costs when it comes time to sell the property. These costs include escrow fees, title insurance, transfer tax, recording fees, and other miscellaneous charges. For a rough estimate of closing costs, figure 2% of the anticipated selling price.
Estimated profit: While we’re at it, let’s factor in profit. You want to make at least a 20-25% profit on each of your flips. In that way, if unexpected expenses do pop-up, you’ll have some margin before you lose money on the deal. (And if you sell the house for more than you expected, or your expenses are lower, you’ll make an even better profit.)
Lost opportunity costs: Opportunity cost is the cost of pursuing one investment choice instead of another. Every investment you make has an opportunity cost. With respect to flipping, lost opportunity cost boils down to making choices between various deals. For example, if you are considering two potential deals and can only make one, which one is likely to generate the greatest return? Which fits best into your workload, your skill set, and the time you have available? If you can spend the same amount of time and money on a property that will generate a 20% return instead of another property that will yield only a 10% return, which would you choose?
Time: Another cost that you may not have considered is your time. Successful flipping takes time. If you buy a property and plan to do some repairs yourself, you will save money on repair costs but you’ll also spending your time. How much is your time worth? If you’ll spend 300 hours repairing and renovating a property and will make $3,000 in profit, your time was worth $10 per hour. If that sounds good to you, great! If it doesn’t, you’ll need to adjust your cost estimates accordingly. For example, if your time is worth $50 per hour, you should factor $15,000 into your budget for those same 300 hours.
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Los Angeles Real Estate Investors Club, LLC