Ep 016 - How to Financially Manage a House Flip

Welcome to Be a Smarter Homeowner Podcast, where you'll discover strategies to save money, save time, and be better organized in managing your largest financial asset and biggest expense, your home. Your hosts, John Bodrozik and Beth Dodson, who are co-founders of HomeZada, have been supporting homeowners for over 20 years. They are here to share with you their tips and suggestions, as well as interviews with industry experts, with the goal of helping you become a smarter homeowner. Now here's your hosts, John and Beth. Welcome to another episode of Be a Smarter Homeowner podcast. Today we're going to talk about house flipping. We know that there are a lot of people that are professional house flippers that do it often. But oftentimes there are people that are considering doing a house flip for the very first time. So Beth, how would you like to start off our little episode today?

Well, the first question that I have is, what do we define as a house flip?

A house flip is essentially the concept of buy low, sell high, right? People are basically trying to make money off of buying a home, usually doing a lot of home improvements because there's a lot of home inventory across the country that is just outdated. Most homebuyers probably would prefer to buy a home that's already updated. So there are people basically looking out to saying, can I buy a home that's outdated, do the updates myself, and then once they're updated, then I can sell it. And hopefully the delta between what you bought it for and what you sold it for makes you some discretionary income.

So do you think that most house flippers are, are doing this for a living, or do you think this is additional income that they earn because they do one a year?

I think that there are both. There are definitely ones that are professionally doing this as a full-time job, essentially.

We see them on HGTV.

Absolutely. You know, we've even got some friends in, in your neck of the woods, Maryland, who basically— you've got a real estate agent and a builder that kind of have a little joint venture and they do it together.

That's correct.

For their primary income. But a lot of people will also do it as kind of like a side income, maybe do one house flip a year, maybe 2, and they're looking at it as an additional way of generating income beyond their primary method of generating income.

That's fantastic. And one of the things that I look at when it comes to house flipping is to buy low, location has to be a factor. And so let's talk about location and the factor that it is in terms of flipping because the market's really hot right now and some areas are hot, meaning they're hot and they're expensive and they wouldn't make good flipping homes.

Yes.

So, let's talk a little bit about location and what do you think about that?

Yes. So, the key to flipping is, you know, starting off with a low price, which basically means you got to try and find a home that's going to be priced on the cheaper end. And what I like to to say is you want to buy a home location-wise that's the cheapest price in a neighborhood, right? So you look at maybe a neighborhood of like 200 homes, right? If you can find the one that's the lowest priced in that neighborhood, then you know that that neighborhood will support a higher price point. And there's a reason why that house is priced low, probably because it's outdated and needs work, right? The last thing you want to do is buy a house flip where you're buying a house in a neighborhood that's in the average to the upper end because that neighborhood may not be able to support a higher price point once you do the— once you sort of do the renovation. So it's really trying to find what I call find a great neighborhood, but the essentially the lowest price point home in that potential neighborhood is a huge consideration over targeting location for your flip.

The other thing I'd like to bring up with location as well, and it's a little bit more difficult But buying homes not in your region, but in lower-cost regions. So for instance, we live in California. There are homes you can find in California that you can do and flip. In fact, some of our colleagues and friends have done that here. But what I'm also talking about is other locations. For instance, like in the Midwest. The Midwest is ripe for growth. There's opportunity for first-time homeowners to actually get in these markets because they're lower cost. Tell us a little bit about what you think about outside your current region. What other things could happen as it relates to location?

Great question. I, you know, I think the nature of a flip means you're looking at homes that need updating.

Mm-hmm.

So you're looking at homes that are 20, 30 years old and older, right? And it's got to be in a neighborhood that is probably up and coming, meaning there's a lot of neighborhoods across the country that may have homes that are 20, 30, 40, 50 years old, but they're not like neighborhoods that are hot and people are moving into, right? So you might be the first sort of flipper in a neighborhood. That might be a little bit more risky versus a neighborhood where, you know, 5, 10, 20% of the homes are already being updated. And a lot of people— there's a demand for that neighborhood, meaning it's a great location school-wise, access to, you know, entertainment. But the inventory of homes is still old, and there's a lot of work, and there's a lot of demand of people wanting to move into that neighborhood. That creates a good condition for, you know, making money on a flip.

Now, Let's talk about how you find those. Obviously, you can go on to local sites to find those. What do you, what do you think about like auction sites?

Yeah, so foreclosure sites. Yeah, I mean, foreclosures are a great place to find. It's basically people who got in over their head and need to sell and get out. Obviously, that's even lowering your price point, right? But then obviously, you have to think about why is the house in foreclosure? And how much work are you going to put into the house? So, we're going to get into, I know, probably a little bit into this podcast about the home improvement side of the flip. But it's really, this gets back into knowing your market and knowing your location, right? A lot of flippers will spend a lot of time and effort trying to size up that location to try to decide where is the best place to sort of engage in that flip. And then, once you've sort of determined that location, Then it's basically constantly sticking on the, you know, real estate portal sites, foreclosure sites to see what homes are going on the market that are going to fit your financial criteria.

Yeah. And so now that we've talked about briefly buying low-cost homes and then eventually selling them for a higher price to earn additional income, let's talk about what's involved in a flip.

Yeah. I'd say there's 2 things that are involved in the flip. One is the financial aspects, and maybe we can get to that second. But the other part is the physical aspects, right?

Sure.

Which is you're buying a home that needs work. So let's say you've bought the home, now you actually have to go do the work. And it really gets into maybe you get lucky and the flip only needs a lot of cosmetic things, but maybe you actually have decided to take on a little bit more risk and you bought a house that it needs a lot more structural things. It needs new roofs, it needs new siding, The amount of home improvements and the scale of them are significantly greater than just, you know, replacing carpets and painting rooms and sort of the cosmetic things. So it's really having a good understanding of the construction and remodeling process. A lot of, you know, contractors, real estate agents, people who are sort of ingrained in that in their experience get involved in the flipping process. Maybe you're an avid DIY person and you're just, used to doing it yourself, that kind of becomes a good segue into, okay, I understand the process of doing home improvement projects. But candidly, I'll give the reverse advice, right? If home improvement is not your thing, then trying to make money on a flip is probably not a direction that you want to go in because there's so much going to be involved in determining what to demolition, what to put in, how to go about putting all those improvements in place.

And let's face it, if you don't have any experience doing home improvements, you absolutely have to hire out contracts, contractors to get that done. And that may end up costing you more for the house. And you may end up not making any money on the house.

Without a doubt. You know, if, if you're hiring a contractor to do everything right, your cost to do those remodel projects are going to go up, right? Which is how can I do the remodel projects, but my cost to invest in those remodels is low. That usually means you've got some skills to be able to do part of the remodel yourself. Maybe it's as simple as you're capable of doing the demolition yourself, right? Or maybe you're capable of doing the flooring and the painting, and you're going to hire specific trades to do the plumbing and the electrical and some, you know, cabinet or cabinetry work. So the more you can do your own, the lower your cost is to do the home improvement, which means the more likelihood that that you're going to be able to make more money on the flip because you're not spending as much money on doing those home improvements.

So you— so we talked briefly about the structure and how to get those improvements done in order to make money. Let's talk about the financial aspects and the financial issues when you need to consider a house flip.

Great question. I'd say there's probably 6 or 7 key financial aspects in the whole sequence of essentially having a successful flip. Right? The first one is you've got to figure out what your purchase price is of the house, right? Are you going to be able to find a house that's $300,000, $400,000, $500,000, whatever that number is? And how are you going to buy it? Do you have the cash already or are you going to have to finance it? Right? And if you're going to finance it, then it gets into, you know, what is your financial cost in terms of paying off that sort of mortgage?

Mm-hmm.

Then the second key piece is having a plan to know how much you're going to have to invest in the house before you decide to buy it. Right? So, you're going to go check out this house and you're going to go, oh, this needs a new kitchen. This needs a new bathroom. I need to do all that stuff. You need to have that sort of financial plan over the home improvement investments that you're going to do. A third component is how long is it going to take you to do this?

Sure.

Because if it's going to take you 6, 7 months, then you're paying 6 or 7 months' worth of a mortgage if you had to finance that, right? So, there's the how-long piece. Then it's also the— before you've even decided what house to buy, you're trying to also figure out how much you think you're going to be able to sell it for before you decide to buy it, right? So I bought it for $300,000. I'm going to put $100,000 into it. Can I sell it for $400,000, $450,000, etc.? Having that sort of aspect of it. And then it's really kind of determining your tax situation as well, right? Right? Because let's face it, you know, death and taxes, we can't escape all of those things. So you got to have a sort of financial plan as it relates to understanding your tax implications of doing the flip as well.

And, you know, bringing up taxes, because when you buy a house and you improve it and you sell it, there is what we refer to as a capital gain. Yes, on that property. And for some people, they are okay paying those capital gains. For other people, and especially if they want to do 1 or 2 homes a year and they want to use these funds for other expenses that they may have in their life or other income. However, as a professional flipper, they can take these capital gains and then transfer it to yet a new home to flip, and that becomes their financing for that home. Moving forward. I don't— I'm making a statement here, so I don't know if there's a question in this, but do you have anything to elaborate on that?

So yes, absolutely. Determining capital gains is a huge component of— it's not just, um, you know, what you bought the house for versus what you sold, the difference between the two. It's really what you bought the house for plus all of the home improvements that you've made. So, that's called the tax basis in your house. So, having great documentation over what you bought the house for, how much did you invest, those 2 things become the tax basis. And then, you want to do the delta between that and your selling price, that becomes your capital gain. And there are different tax laws around 1039 exchanges and other factors over if you did have a great flip that you made a lot of money, you could put that cap, you may be able to defer the capital gains because you're going to do the next flip, right? really conferring with your tax attorney or tax accountant to determine, you know, is this just going to be a one-time thing or are you going to potentially do, you know, multiple flips may lead to what is your tax strategy, you know, depending on whether you're going to do a one-timer or you're going to do multiple flips is going to impact that strategy.

That's a great point. So, One of the questions I always ask too is, does house flipping ever turn into a rental property?

Yes, a lot of people will, um, do the flip— or sorry, they'll buy the house, they'll do the home improvements, and maybe they're doing the financial analysis of saying, instead of me turning around and selling this for $25,000, $30,000 in profit, maybe I should hold on to this house and create rental income. Right? Because you may be able to not— maybe, maybe you don't make the $25K to $50K right up front, but you're like, hey, if I can get a renter in and they're going to pay me $2,000 to $3,000 a month in rent, I can hold on to this house and the rental income is going to pay for my ongoing financing on the mortgage and the property tax and the other aspects. And that becomes a way of generating additional income. So this gets into the, are you buying it purely to flip it right away? Again, that has to do with market conditions, right? If you're living in a neighborhood where a lot of people want to get in, but a lot of people don't want to do the updates and they're willing to pay a premium, then maybe you actually do the flip and you sell it right away. But maybe during that process, maybe the market changes a little bit, right? And it's not so hot anymore, but it's hot enough to basically say, I'm going to turn this into a rental property. And you make a year or 2's worth of rent on it. And then you turn around and selling it.

Yeah.

And you kind of get what I call the double win, which is ongoing rental income and then being able to sell it, you know, in a few years.

Yeah, that is, it's a good strategy and it's a good option should the financial math not work out initially. Now, we talked briefly about whether to do the work yourself or to hire a contractor. What type of projects do you think make a difference on whether a house is sellable or more valuable?

So I think it breaks down into 2 to 3 categories. One is purely the, what I call the structure and bones of the house, right? It's the roof, it's the siding, it's the HVAC, it's the equipment, it's all those things around the base, the foundation of the home, all those things. Those things have to be in place. And this goes back to the A home that needs a new roof or needs new HVAC equipment is going to have a lower price point because buyers are going to say this, this house needs a lot of work. So as a flipper, you're going to be able to get that house relatively cheap, but the cost to improve it is going to be higher because you're going to have to put on a new roof and put on a new HVAC system. A second category is what I call lifestyle, which is the bones of the house is great. You know, it's the—

Sure.

The roof and the HVAC still has a good life, But the layout sucks or the, you know, the kitchen appliances are just old, right? It's 20, 30 years old, it's out of date. The rest of the neighborhood's got kind of a hipper feel and you've got sort of things that are really old. You're gonna have to do those lifestyle things of new kitchens and bathrooms, which tend to be what I call the money rooms.

Yeah.

Right? Which is remodeling those kinds of things. Usually, it ends up also blowing out a wall or 2 and kind of creating an open floor plan. A lot of people and homes were built 20, 30, 40 years ago without open floor plans. People love the whole concept of entertaining in their home, open floor plans. That's kind of the second category. And then, the third category is really what I call a lot of the cosmetics that could be done inside and outside the home, right? It could be the whole house just needs new carpeting, it's old carpeting, it just needs a fresh paint inside and outside, or it's landscaping projects to kind of clean those things up.

Sure.

Or it's meeting what I call the demands of the marketplace, right? Meaning a lot of flippers will understand the dynamics over what are the other homes in the neighborhood, what kind of amenities do they have, do they have swimming pools, do they have outdoor kitchens and patios?

Sure.

And if you bought a home that doesn't have that, maybe that's part of the flip process is to get that home to sort of be on par amenity-wise with the other homes in that neighborhood.

That's, that's really important because we talk about home improvements on previous podcasts. And yes, kitchens and bathrooms are money rooms, mostly because people use them a lot. But they're also those areas where people can really shine a property on. You can really make it look beautiful. And obviously you need those rooms to function in a house in today's day and age. So in addition to that, a lot of times we've talked about if you're a contractor, you may be a professional flipper. If you are a homeowner but understand improvements, you may be a flipper. If you're a real estate agent, you may want to choose to be a flipper. Do you think it's easier for a real estate agent to be a flipper?

I do, because they understand the neighborhood conditions probably better than somebody who doesn't do this full time. Right. Because if you're a real estate agent, you know the neighborhood of 200 homes, you know which street has homes that are updated, which homes still need work. You probably know the market trends over, is this a hot neighborhood that people are trying to get into? So, understanding the local market conditions and making that financial decision over which house to decide to flip is such a huge key aspect over whether it's going to be successful or not. And people who are real estate agents are naturally knowledgeable about that. Now, that's not to say that You may not be a real estate agent, but real estate is your passion, right? And you know all your neighbors and you, you've gone to their homes, you know, neighborhood Fourth of July parties, and you're going to the open houses because you're just super passionate about real estate. You could not be— you could still not be in the real estate industry, but super knowledgeable about the neighborhood to understand whether it's financially going to be viable for you to engage into a flip or not.

Yeah, so we're basically saying it's easy for— probably easy for real estate agents, contractors who have the skills, and people with passion about real estate to become a flipper. But we're also saying if you are interested in doing this, test it out, but also do the math to make sure it pans out. One of the things, um, I'm going to bring up because This is also helpful. What about going into business with multiple people? So maybe 4 people buy a house, they know it's gonna flip, and then they all do the work together or work with contractors when part of the work and then flip it. What do you think about that?

A great idea. 2 things to think about. One is the financial contribution, right? Which is the— if you're going to get multiple people in on the flip, is it all equal contribution over who's going to buy it, who's going to spend the money, come up with the cash to do the investment? How are you going to split the profits? So it's how— it's all about having the financial plan and, and having a financial plan that's, you know, everybody's in agreement with. And then the second part is who's going to do the work?

Yeah.

Right? Which is, um, some people may want to passively participate of like, yeah, I'll chip in, you know, I'm an investor, I'm an investor, I'm going to do— I'll chip in $20 grand, but I'm not going to choose the house to flip. I'm not going to be involved in any of the remodel project itself, and I'm not going to be involved in the selling part, right? So it's the passive participation versus active participation. And is it active in terms of doing work? And let's just face it, it's like, how are you going to divvy up the investment and how are you going to divvy up the profits? You really want to be able to do that with people that you know and trust and you're going to have a good relationship with.

No, that's great. And then On that same, that same stage, when you eventually sell the house, we've talked about this with realtors when we've interviewed them on our podcast as well as in our company. Do you think that staging a home is beneficial to selling a flip?

I do. I think that a home that's got no furniture in it, a lot of people, consumers have a tough time visualizing how it's going to work. Right now, I don't think you need to stage the entire house, but staging enough of the house to have furniture in an orientation can actually accentuate and give people the visualization over how they're going to actually live in that house. So I'm a big fan of staging, but not overdoing it, you know what I mean?

Yeah.

And doing it in what I call the money rooms. You may not need, you know, a bed in every single bedroom. You probably want a bed and maybe some furniture in the master bedroom. You know, the living room and the dining room and the kitchen and those kinds of rooms are important for people to visualize how they're going to end up living and lifestyle in that particular house.

Which also adds to cost when you're ready to sell the house, because staging a house can be done professionally and it generally does cost additional money. So it's something that people need to consider if they are going to flip a house and if they are going to stage it, that they need to add this to the bottom line and plan for it.

Without a doubt, you said the key word, which is plan. Whether you're an experienced flipper or whether you're considering doing this for the first time, I can't stress enough about how to create a plan before you do anything throughout the entire process. You know, spend time understanding the market, spend time understanding the homes in the market, spend time deciding which home you might decide to Buy, spend time figuring out how you're going to do the home improvement projects, spend time thinking about how long it's going to take, spend time thinking about how you're going to market the home when you're going to sell it, spend time thinking about your tax implications. All of that has to be planned out. As you can tell, I'm a huge proponent of planning because the last thing you want to do is jump into a flip because you found like this really cool thing, but you haven't planned out all these other things. And then it becomes the unexpected becomes— Problems. And then it's the, uh, the last thing you want to do is be underwater on your flip. Yeah, right. You had the financial expectation that you were going to make $30,000, $40,000, $50,000, $60,000, $100,000, and now all of a sudden you can't get out of it and you're stuck with it and it costs you a lot more than you thought. Then you're in a worse financial situation than you were when you started.

So it makes sense. What you're basically saying is FOMO is not good when you want to do a house flip. It really does require you to evaluate the finances, the location, the opportunity with the growth of the property. Also to interview specific contractors, build relationships with contractors if you're going to make this an ongoing experience, and then understand your investment strategy both on the front end and also on the back end once the home is sold. So I totally 100% agree with you on that because a lot of people get into this and they do have FOMO, fear of missing out.

For those, fear of missing out, for those people who may not know the acronym of FOMO, you know, I just gotta do it.

I see all these HGTV shows and they make it look so easy, but they are professional, um, house flippers and they also have budgets behind them on places like HGTV. So not all is as Yes.

And not only is it planned, you better have a system in place to track all of your documents and paperwork because you're just going to have an inordinate amount of stuff to keep track of. It's everything from your mortgage, your selling costs, your inspection reports that you got when you bought the house, to creating budgets for all of the remodel projects, to storing all the, you know, product manuals and warranties and all the things that you put in because there's going to be a warranty associated with it. There's all the documents over how you're going to sell it. You're going to have to have all these documents to meet with your tax accountants. You really need kind of a system in place.

Yes.

Because if you're going to wing it again, you may— you might be good at the physical aspects of doing the home improvement. But if you don't have the financial and paperwork aspects of it, that's going to get you in hot water as well. So not only is it planning the physical, but it's also planning the financial and paperwork aspects of it.

Yeah, that's really good. So Any last takeaways? Because I think we've talked a lot about planning and what people could go through being in the flipping business or hobby. I hope it's a business in that sense that you're making money from it. But is there any last thoughts that you have for our audience?

I'd say for people who are passionate around DIY, and, you know, they've done it to their own house where they're sort of considering and doing it, you know, their first flip for the, you know, the first time doing it, I'd recommend trying to talk to people who've already done it. Oh, that's great, right? It's the whole concept of, um, I'm sure there's lots of sites online where you can read stories about, you know, people going through flipping processes. Maybe you're gonna, you know, meet a real estate agent or a contractor in the neighborhood that's done flipping. You know, literally go out to coffee, have, have a discussion with them. You're going to learn a lot. I'm a big believer in asking for advice from other people when you don't— haven't done something yourself. So asking that kind of advice is going to give you even greater tips and tricks than even what we've shared today here.

That's fantastic. So for us here, Beth and John, we want to thank you for joining us today. We wanted to talk about house flipping because we know it's a hot topic for a lot of people passionate about real estate. But thank you again for joining us on this episode of Be a Smarter Homeowner Podcast. If you found this valuable, please share this with your colleagues, friends, and family. And by all means, rate us on the major podcast platforms. And we hope to see you again on our next episode of Be a Smarter Homeowner Podcast.

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