It is important to know the pros and cons of flipping a property before you begin. It is a riskier type of investment, and as is the case with most risky investments, the rewards can be great if everything goes according to plan, or it can become a horrible mistake if the plan goes awry. Here are some things to consider.
Pros of Flipping a Property
Flipping a property can reap very generous rewards. Here are some of the advantages.
Make a Quick Profit
The main reason people enter into a real estate flip is with the hope of making money quickly. If done correctly, a real estate flip can provide very large profits, often upwards of the annual U.S. median salary.
These returns can be achieved in a very short period of time, and in many cases in only a matter of months.
Learn About Construction
Through repairing, renovating or remodeling a property, you will gain insight into aspects of construction.
You will start to understand the costs of materials and various plumbing and electrical repairs. You will learn how to spot big issues such as structural problems and environmental hazards like mold and asbestos.
You'll also learn to budget for unexpected costs such as:
- Building permits
- Delays in construction or delivery of materials
- Contractor disputes
- Holding costs if the property doesn't sell as quickly as you expected
This construction experience will help you make more money on future projects because you’ll know how to best budget a deal.
Understand the Local Market
You should always do your market research before actually purchasing the property. You should talk to Realtors in the area, browse 'for sale' ads and look at houses that have recently sold.
This should give you a good idea of what people are looking for in the area. A modern design may be popular in one part of the country, while a traditional design is a winner in another.
This is why you must always do your research and target your renovation to your local market.
Develop Buyer Insights
Once you put your first flipped property up for sale, you will gain even greater insight into what buyers in the area are looking for. Take notes on what they like and don’t like so you can make the necessary adjustments in your next, and hopefully even more successful, flip.
Learn About Real Estate
Flipping a property will help increase your knowledge of the real estate industry in general. If you are buying your first short sale or foreclosure, you will learn the ins and outs of the process as well as various financing and refinancing options available to you.
Increase Your Network
While undertaking a flip, you will create many new contacts in the industry, including:
- Building inspectors
- Insurance brokers and other investors
These contacts can come in handy for future investments or when working on your own personal property.
Another advantage of a real estate flip is being able to see the potential in a property that few others can see. Knowing that you have the vision to create value in a home is a source of great personal pride, along with the ability to achieve financial returns that are far superior to most other investments available to the average person.
Cons of Flipping a Property
Along with the advantages of flipping a property, there are also risks involved. Here are the drawbacks of flipping a property.
Risk of Loss
The main problem with flipping a property is when a flip becomes a flop and you lose money. There are many factors that can contribute to this loss including:
- Unanticipated Expenses: This includes everything from building permits and contractor delays to renovations and materials you had not budgeted for. These expenses quickly add up and eat into any potential profit. You may also be forced to offer seller concessions to your buyer, and these concessions can also eat into your bottom line.
- Tax Increases: Once you have completed renovations on the property, the city may increase your property taxes. This will affect you if you have difficulty finding a buyer and have to pay the taxes yourself, or it can impact buyers who may rethink purchasing the property because of the higher tax bill.
- Capital Gains Tax: Any profit that you make on an investment property may be subject to capital gains taxes, and depending on whether you owned the property for less than or more than one year, your capital gains rate will vary.
You will also have the ability to do a 1031-Exchange and postpone the taxes owed to a future point in time.
The longer you own the property, the more money you are losing.
Even after renovations are completed on the property, you will have to pay the mortgage (assuming you have a mortgage on the property), taxes, and insurance on the property for as long as you own it.
You may also have additional maintenance costs such as yard care or snow removal. And the longer the property sits on the market, the greater the likelihood that you will have to reduce the price, which will eat into any anticipated profit.
Stress is also a drawback of a real estate flip. Causes of stress can include:
- Finding the right property
- Properly anticipating the costs involved
- Dealing with contractors, Realtors, and local ordinances
- Trying to meet your deadlines
- Finding a potential buyer
Knowing the pros and cons of a flip will help you make an informed investment.