If you’re considering jumping into investing, it’s probably due in no small part to the fact that it can be incredibly profitable. You’ve studied, learned from experts, and gotten a taste of the kind of money you can make.
But even experienced investors experience profit loss on flips from time to time. And many more inexperienced investors do too. So, if you’re new, or gearing up for your first deal, how can ensure that you’re able to get the most profit? Or, put differently, what are the most major threats to a profitable deal, so you know how to avoid them?
For this article I’ve asked some established investors or real estate professionals to share their answers.
Threat #1: Choosing the wrong property.
Some properties are just bad investments. It’s that simple.
Purchasing one of these is the first major threat to a profitable deal. If you’re new, you may be tempted to take the first deal that comes along or jump on the first flip you have an opportunity to buy, but this would be a mistake.
You need to let the numbers inform you, just like you will on the 10th or 100th flip. Wade, a Realtor and Investor has been in the industry for over a decade, running Mitchell Property Group. He warns, “The biggest mistake investors make is choosing the wrong property to flip. Some houses are just terrible flip properties no matter how seasoned you are. Underestimating repairs and all holding costs is the second biggest mistake followed closely by overestimating the after-repair value.”
If you’re inexperienced or still learning the ropes, it takes help from a mentor, or a close scrutiny of the property in order to evaluate if it’s going to be a problem property or not. And as Wade says, the second biggest threat to a profitable deal is similar.
Threat #2: Buying too high.
When you buy a property too high, you’re losing ground (or profit) that’s impossible to make up. “Money is always made in the “buy” of a property not the “sell”,” says Dara, who’s been featured on HGTV and co-runs Properties ATL, “no matter what unforeseen defects or issues a flip property may have, if you buy it low enough and properly calculate your resale value, your profit should be healthy.”
In other words, even if you don’t estimate repairs correctly and end up spending more on rehab than you thought you would, you still have a chance at making up some ground in the sale… if you bought the home at the correct price.
Threat #3: Miscalculating the ARV.
The third major threat to a profitable deal is miscalculating a property’s after-repair value. Buying a property with high hopes of being able to sell it for $300,000, but finding that in reality, its value is only $250,000 is a major kill to your profit.
Heath is a solo investor who founded Elevated Home Buyers. He warns, “the single biggest profit killers are buying too high and missing your ARV. Many times, I've missed renovation budgets or timelines but those typically won't ruin an investment unless coupled with either paying too much or miscalculating what the house will be worth when finished.”
So, as you’re beginning to see, these mistakes often go hand in hand. And when they do, they can turn profitable flips into major time and money sucks.
Threat #4: Underestimating repairs.
As you’ve heard multiple times already, this often goes hand in hand with miscalculating the ARV or buying too high. In other words, it’s possible to buy a home that, on paper, looks like a good deal. But if you knew the work it would require on the other end, looks like a horrible one.
The scary thing is, it’s common for anyone, let alone an inexperienced investor with no construction background, to miss things like major foundation needs, problems hidden behind the walls, etc. It’s something that even the most experienced contractors can run into, and in some sense, there’s not a ton you can do about.
You need to do your due diligence of course, and it always helps to learn as much as you can in order to prevent this from happening. But when you thoroughly inspect a home, feel you have a good grasp of it, and then realize that there has been a major mouse infestation costing you thousands (that you couldn’t see until you began demo), the only thing you can do is put aside a little extra cash as padding.
Threat #5: Trying to work with “non-motivated” sellers.
This is a slightly less common one you’ll hear. You could argue it somehow fits as a subcategory under “buying too high”, but it’s different in that it focuses on the source of your leads or income. The reality is, if your branding, marketing, and business is only drawing homeowners who, in reality are better fits for real estate agents, then you’re always going to get driven up in price.
That’s the experience that Blaine had, as he got started in real estate investment. In fact, he unintentionally ended up getting requests from so many non-motivated sellers that he ended up getting his real estate license in order to be able to help both motivated and unmotivated sellers at his business Awesome Wholesaler. He advises new investors, “A non-motivated seller will always kill a dealing. Therefore, your marketing needs to get you in front of homeowners with the right motivation. If you’re marketing wrong (say, for example, sending postcards to people with 100 percent equity in their property), you’ll get a lot of calls from non-motivated sellers wanting to know what you would give them for their house.”
Seasoned investors would recognize this of course, and probably end up referring the homeowner to a recommended Realtor, wishing them well. But if you’re new, it would be tempting to negotiate and secure your first deal, fearing that there may not be another for some time.
Wisdom requires that you recognize when a seller is motivated and when they are not. And if they aren’t, be able to either help them list their home on the MLS and benefit that way or wish them well and point them in the right direction. And if you end up finding that the bulk of people you’re hearing from are non-motivated and looking for full value, then go back and inspect the source of those leads and see what needs to be fixed.
Learn now, to avoid profit loss later.
If you’re just getting started, here are some steps you might consider taking to help you avoid the threats we just talked about…
- Shadow or learn from an established local investor. I’ve talked to many investors who learned this way or recommend it as a good way to get started. See if you’re able to either pay them or do some free work in order to learn the ropes from them and accompany them on a flip.
- Get really good at the numbers you need to know and practice them. There are certain numbers you need to know. You can pick sample homes on the market and practice running those numbers (neighborhood value, what homes are currently selling for, etc.) and make sure you have a good grasp on them before setting out to land your first deal.
- Go into a deal with a mentor. This could be someone online, who helps you with the deal for a share of the profit. Do the deal with them, so you have a second set of eyes watching you while getting to learn at the same time.
- Learn the most common things to look for in a property, or partner with a quality contractor who’s going to help you spot potential problem spots on a flip.
Like I said, there are certain things you simply won’t be able to avoid. There are certain things that contribute to profit loss that you can’t control. That’s life.
But for the ones that you can (and there are many), make sure you learn from pros who have gone before you so you can avoid getting burned.