Pros and Cons of Flipping a Property
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.
- Potential to 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.
- Gain Experience- Flipping a property can further your education in a variety of areas:
- 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. This construction experience will help you make more money on future projects because you’ll know how to best budget a deal.
- 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 the winner in another. This is why you must always do your research and target your renovation to your local market.
- 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.
- Unanticipated Costs- You will learn to budget for unexpected costs such as building permits, construction delays, delays in delivery of materials, contractor disputes, and holding costs when you are unable to sell the property as quickly as you had hoped.
- Real Estate in General- 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 Realtors, attorneys, contractors, building inspectors, insurance brokers, and other investors. These contacts can come in handy for a future investment, so you must always remain professional during your dealings with these individuals.
- Personal Pride in Having a Vision That Very Few Can See- 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.
- Losing Money Instead of Making a Profit- The main problem with flipping a property is when a flip becomes a flop and you lose money. There are many factors which can contribute to this loss including:
- Unanticipated Expenses- This includes everything from building permits, contractor delays, material delays, permit delays, and renovations and materials you had not budgeted for. These expenses quickly add up and eat into any potential profit. In a soft market, you may also be forced to offer seller concessions to your buyer, and these concessions can also eat into your bottom line.
- Higher Taxes- 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.
- Losing Your Profit to Taxes- This may be something you learn the hard way come April 15. 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. However, you will also have the ability to do a 1031-Exchange and postpone the taxes owed to a future point in time.
- Holding Costs- 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. These costs take a large chunk out of the budget, and the longer you own the property, the more money you are losing. You will also have additional maintenance costs as the yard will still need to be cleaned, the grass will need to be cut, and depending on where you live, the snow may need to be plowed.
- Difficulty Selling- You are losing money every day you are unable to find a buyer for your property. Because you must pay the holding costs on the property, the longer it takes to find a buyer, the more money you are losing. In addition, 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- Stress is also the main drawback of a real estate flip. From finding the right property, properly anticipating the costs involved, dealing with contractors, Realtors and the town, trying to meet your deadlines and finding a potential buyer, stress is your constant companion when flipping a property.
Knowing the pros and cons of a flip will help you make an informed investment.