Beware the money pit…
When considering purchasing a fixer-upper to flip, novice property investors are naturally going to be leery that they will make a huge mistake, and end up buying a money pit of a house. It is good to be wary. Especially without the experience that comes with acquiring more and more investment homes. Whether they be for flipping, or to hold onto and rent out long term, there are some basic mistakes to look out for as you assemble your home buying checklist. And don’t think that a money pit is confined to low end homes either. Even huge mansions can end up being potential money pits. If you’re not convinced, check out this article: http://www.zillow.com/blog/money-pit-home-hits-market-153942/. You’ll get a better idea of how exponentially dangerous large mansions can represent to a novice investor in the process…
Risk vs. reward
Home renovation work is like an art form, and requires the ability to know which buying mistakes to avoid. I have noted in prior articles here on house flipping that “whether it’s an old kitchen or baths that need to be brought into this decade, or an entire whole-house gutting down to the wall studs with complete rehabbing of new electrical and plumbing as starters, fixer upper homes for sale can represent a tremendous opportunity for any investor. You can pick up some cheap fixer uppers that, once you’ve completed renovation, can earn you a tidy profit. Fixer upper houses come in all shapes and sizes, but they all have the same major component: they are waiting for some entrepreneurial person to come along, see the vision in what they can be transformed into, and know where to invest rehab dollars wisely for maximum re-sale value when the house is ultimately flipped.
In my view, the most important aspect of buying a fixer upper is the ability to say “no.” You can never get too emotionally attached to your vision of what a house can be transformed into – and sold for a profit – if you don’t properly crunch your numbers, and stick within your limits. I have seen too many property investors who make the mistake of “falling in love” with a potential flip, only to slowly keep edging their counter-offers up, beyond what they originally felt was their top limit for what they would pay for the property. This is a rookie mistake. Don’t be blind to the emotional pull of it – remember – it’s not your home we’re talking about…it’s a simple business decision. And if it’s not right financially, then you move on to the next best alternative property available to make an offer on.”
Creating discipline for yourself
It’s important to have discipline when searching for, and making offers on fixer-upper house rehab investments. Remember to never get emotionally involved in the decision-making process. Always crunch your numbers – then double check them until you feel totally sure of your financial constraints, as well as what you feel your profit will be on the investment. And always stick to your final number when making an offer – don’t deviate upwards, regardless of the temptation to finish the deal. Remember, there’s always the rule of “next” – and you should move on to the next available property to make an offer on, rather than go in over your head on a potentially bad deal.
Another key mistake to avoid is steering clear of potential investment properties that will throw off huge losses. Unless you are specifically looking to offset other income with losses for tax purposes, it’s best to stick to properties that represent strictly positive cash flows…and the greater the better. Novice investors should be wary of any property rehabilitation project that involves negative cash flows. Second homes and land speculation are prime examples, however even simple “fixer-uppers” can become disastrous for throwing off large sums of negative cash flow (also known as “negative gearing”). Unless you’ve had experience with land development, steer clear of this form of property investment.
In general, be as conservative as possible when numbers crunching for fixer-uppers. Obtain several contractor estimates for the scope of work to be done prior to even making an offer on a rehab project. Without a doubt, investing in negative cash flow real estate should be attempted only by those with deep pockets, looking to shelter other forms of income from the tax man. The losses thrown off by negative cash flows will aid in reducing the bite of their overall tax bill. So, in effect, negative gearing makes sense for them…but not so for the novice investor actively looking for profits from the outset.
Pro forma budgets
In addition, make sure that you run your numbers properly. You’ll need to create a pro forma budget for your house rehab investing project. This is the easy part. Acquisition costs, tentative rehab costs, and carrying costs until you sell it need to tallied up. Be sure to be conservative in all areas, and don’t forget to add 10% as an overage factor when investing in real estate. Then, figure on a realistic market value for the property once it’s all fixed up to determine your net income projection.
I have also warned here before that “if you’re going to redo an entire house, make sure basic amenities are there – or at the very least, provide the essentials to allow a potential buyer to not be left in the dark. Most buyers don’t have foresight and practice in renovating. You supposedly do. In addition, simple items left out can have a major downward psychological effect on any potential buyer.”
Think like your potential buyer thinks
You’ll need to think like the average home buyer does when walking through a home they’re considering buying. Are the basic, standard amenities there? Are there any safety code violations present that haven’t been corrected? You should always have a fresh set of eyes review your project after work is almost completed, just to be sure you haven’t missed anything critical to your ultimate buyer when it comes time to flip the property. In this way you can avoid making any costly house renovation mistakes.
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