House Flipping Expenses
Be Sure You Add Up All the Costs Before You Buy That Flipper House
When you buy a house to resell it, the plan is obviously to sell it for more than you paid. The difference between the purchase price and selling price is considered your gross profit.
Of course, you don’t get to put all the gross profit in your pocket. Part of it reimburses you for a wide variety of expenses you incur during the project. After paying your expenses out of the gross profit, anything left over is net profit, which you get to keep for your time and trouble (less income taxes).
If your gross profit doesn’t cover all the project’s expenses, then you have a net loss. In effect, you’ve taken money out of your pocket for the privilege of the experience.
Though you can deduct it for income taxes, it still hurts when you lose money on a deal. To help you avoid that trap, make sure you take all possible expenses into account before you make that buying decision.
House flipping expenses fall into four broad categories – purchase expenses, carrying expenses, repair and improvement costs, and selling expenses. The last two categories tend to be the most problematic.
Purchase Expenses
Purchase expenses vary from one transaction to the next depending on the purchase terms and your financing. The most significant are usually loan fees (points, underwriting fees, and document charges). But since lenders are required to provide you with a good-faith estimate of closing costs, you’ll generally have a good idea what these expenses total before you’re locked into the purchase.
Some costs that may not be reflected in the good-faith estimate, however, could include fees for home inspection services.
By the way, when adding up your anticipated costs, don’t include the down payment as part of the expenses. The down payment is part of the purchase price. What you’re trying to add up are all your expected expenses over and above the purchase price.
Carrying Expenses
While you own the house, you’ll be making mortgage payments, and paying for property taxes and insurance. Only part of these expenditures will actually be expenses, though.
For example, you may pay for an entire year’s worth of insurance up front, and be making escrow payments to your lender for renewing the policy next year. But you’ll get a partial refund of the premium and leftover escrow payments if you sell in less than a year. So if your insurance premium is $480, you’ll figure your ultimate expense at about $40 a month. Prorate property taxes similarly.
Your loan payments may be interest only, in which case 100% of the payment is an expense. If part of your payment includes principal, however, that is not an expense. You’re lender can provide you with a loan amortization table breaking down the difference between the two.
You final calculation of carrying expenses will thus include the interest expenses until you pay off the mortgage at sale, and the taxes and insurance due for the period of time you own the house. This could pencil out around $1,000 to $2,000 per month depending on the size of your loan.
What throws off most new investor’s calculations is how many months you expect to own the property. If your carrying costs are $2,000 a month, and you end up owning it six months instead of four, you suddenly have $4,000 in unanticipated costs nibbling away at your net profit.
Repair and Improvement Expenses
These may seem the easiest to calculate accurately up front, but reality is another matter.
Home inspectors will point up apparent repair needs, but they can’t spot some defects that are internal to the structure (and they include a disclaimer in their reports to that effect). As you start into your rehab, you may encounter some of these unexpected problems with their associated unplanned expenses.
While you may accurately estimate the cost of painting, obvious repairs, and planned upgrades, something will always come up that you didn’t notice or think about. When it becomes clear to you that you have to do something about it if you hope to sell the house quickly for your target price, you have another unexpected expense.
Prudent investors include extra money in their projected budgets to take care of these hidden or unexpected expenses.
Selling Expenses
One area where new investors can underestimate selling costs is lowballing real estate commissions in order to make the project pencil out. The truth is you need agents showing your property, and they’re not going to do it if there’s not money in it for them.
You’ll also have typical closing costs such as document fees, escrow fees, title insurance fees, and so forth. These can be 1% to 2% of the selling price.
Your buyers may also negotiate concessions out of you such as paying their points or contributing to their closing costs. These may be worth the cost, but you can only factor those costs in at the time of the offer.
Most new investors also overlook marketing expenses. Even if you have an agent marketing your property, most agents are not as motivated to move your house as you are. To avoid holding onto the house an extra month or two waiting for a buyer to show up, you’ll probably be pouring some of your own money into advertisements, print collateral, staging, and open houses.
For evaluating your potential project’s feasibility, you should use 9% to 10% of the selling price as an estimate for selling expenses. However much you can beat that estimate in the end is extra profit in your pocket.
Also be wary of fine print in your loan docs that may include a prepayment penalty. If you can't get a loan without this penalty, be sure you add that cost to your estimate above.
Final Estimate
Take the purchase price of the house, add your total budgeted expenses, and the result is the selling price you need just to break even. If it’s clear you can sell the house for more than that, then you have to decide if the potential profit is worth the time and risk. If the answer is “yes,” pounce on it.
Related Articles:
Financing is Key to House Flipping
Actual House Flipping Project Costs (Spreadsheet)
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