It's easy for a novice house flipper to underestimate the costs involved in fixing up and flipping a house. This common mistake can lead to a smaller than expected profit, or even a loss, when you sell the house. Doing the math before you make an offer on any property is the only way you can assure yourself that the investment is profitable. Here is a quick rundown on how to calculate the profitability of a flip house.
Final selling price
First, estimate the final selling price you intend to get for the house. You do this by visualizing the house, not in its present less-than-beautiful state, but as it will be when the repairs and upgrades are completed. Compare that vision to all the other similar houses that are currently on the market or have recently sold. The prices that sellers are getting will tell you the maximum price you can ask for your own house. Your Realtor can help you do the research required for this step.
Purchase price
This number is easy to obtain. It's the price the seller wants for his house.
Purchase closing costs
Next, calculate the purchase closing costs. These are all the fees and costs associated with buying the house - appraisal fees, brokers' fees, structural inspection reports, and so on. As a ballpark figure, you can estimate this amount to be half a percent of the purchase price. Note that your down payment isn't part of the purchase closing costs, because you'll get it back when you sell the house.
Carrying costs
Carrying costs are all the expenses associated with owning the property. This can include property taxes, utilities (water, electricity, gas), various types of insurance, etc. The total amount you'll pay in carrying costs depends on how long the renovation period lasts. You may anticipate the repairs to take six months. In addition, the escrow period can consume another two months, for a total of eight months of carrying costs. Estimate monthly costs to be about 45 percent of your monthly mortgage payment.
Fix-up costs
Estimating fix-up costs is challenging for those new to flipping houses, but it's a necessary skill to master. Underestimate your repair costs and you'll cut into the profit margin. To get this number, create a renovation plan in great detail. Picture each room with the improvements you'll make, identifying all repairs and upgrades. Make sure to add the features that buyers in the neighborhood expect in their new homes. Compile estimates for work and materials, and develop a budget and time frame for completion. Then add another 20 percent of the cost and another couple of months to your plan. Home improvements always take longer and cost more than you had planned. Accept this little truth and allow for it.
Sale closing costs
These are all the costs associated with the sale of the property. Among them, the biggest expense will be the Realtor's commission, which is usually 6 percent of the sale price. Add in other fees and charges, and you can expect to pay roughly 7.25 percent of the sale price for closing costs.
Your potential profit
Now, subtract all these costs and expenses from your final selling price. Is this your profit? Not quite. You also have to subtract the capital gains tax. The final number is the profit you should make. Is the number disappointingly low? Then you'll have to find a way to revise the numbers in your favor or else pass up the house as unprofitable.
Although it takes some time and effort to gather all this data, the profit you make on a property (and ultimately your success as a house flipper) depends on your ability to accurately estimate costs and final selling price. Fortunately, calculating the potential profit of a flipped house gets faster with practice.
