As an Investor, you may be forgiven for thinking that I enjoy watching the multitude of popular television programs about people “flipping” houses”. The truth is exactly the opposite.
I cringe when I see the final profit analysis on these shows, picturing unsuspecting watchers deciding that it is easy to make money in real estate. The truth is, these numbers leave out a lot of very real costs and relying on them will almost guarantee a willingness to grossly overpay for houses. Here are some of the largest misrepresentations:
- “Investors” doing the work themselves: Oftentimes, I see what may be an $80K rehab listed as a $20K rehab. The reason? The materials costs $20K. But what of the months of time and long days of back-breaking labor the “Investors” put in? The truth is, the $60K difference should not be counted as profit, unless your time is worth nothing and you enjoy working for free. You actually “bought” yourself a $60K construction job.
- Missing costs: Only recently have I seen some of these shows begin to subtract closing costs from the sale of the property from profit, which is certainly a step in the right direction. But what about closing costs to purchase? What about holding costs such as interest on the money while it is being used (or loss of earned interest if the investor used his or her own money), property taxes, insurance, etc. . . . Money borrowed by Investors for rehab projects generally comes at interest rates in the 10-14% range. Not huge if you’re in and out quickly, but it can add up fast if your rehab takes longer than anticipated, it takes awhile to sell, your buyer takes 2 months to get a loan (very common), and a lot of other “Murphy Factors” interfere with your plan.
- Unanticipated repairs: I don’t believe I ever bought a house where I missed something in my initial assessment. Also, you can expect your Buyer to get a Home Inspection Report and expect that said report will be full of things that are perfectly fine but are made to look scary. Now, you and your Buyer will enter negotiations for how many of these silly “hazards” you will fix. I sold a house built in 1901, and the Inspection Report contained over 80 items, many of which were using new home code as a benchmark. My Buyer promptly asked me to fix them all, and I informed her that as she was not buying a new house, and the price reflected that, I would cancel the sale before doing anything approaching that. We compromised on my fixing maybe 6 of the items, but it still costs money.
Lou Gimbutis is director of education at the Metrolina Real Estate Investors Association, which provides education, mentoring, and networking for real estate investing in the Charlotte region. He can be contacted at [email protected]. For more information, visit www.MetrolinaREIA.org.