House flipping is something every real estate investor has thought about trying at one point or another. It offers a chance for huge returns over a short period of time, but it can also prove to be costly if you don’t know what you’re doing when doing a house flip.
In addition to picking the right property, one of the most important skills is to accurately estimate repair costs on the front end so you maximize profits on the back end. While this is an acquired skill that you’ll become better at over time, it’s imperative that you learn about how to estimate rehab costs before entering into your first deal.
There is no perfect science to estimating repair costs. There are, however, some different rules and techniques you can use to ensure you get more accurate estimates.
Here are some specific things to think about:
You can’t estimate repair and rehab costs if you don’t know what needs to be fixed. Before investing in a fixer-upper, you must start by taking inventory of the home’s condition and evaluating the problem areas.
When investing in a house flip, you want something with good bones. Think twice about investing in a house that has problems with the structure, roof, and/or foundation. Other expensive problems include issues related to electrical, plumbing, and HVAC.
Ideally, a house flip simply needs cosmetic work. Things like drywall, flooring, countertops, appliances, paint, finishes, and landscaping are all cost-effective fixes.
Because real estate deals often come and go within days, you don’t always have a ton of time to figure out an exact cost right away. This is when it’s helpful to use rules of thumb. House flipper Justin Williams likes to attribute a rough estimate based on square footage.
“The ‘$20 per sq. ft.’ rule is a guideline we use to give us a pretty good idea of what it is going to cost us to fix up a house,” Williams explains. “In a nutshell, this rule comes from our experience that most houses requiring a full ‘standard’ cosmetic rehab will cost around $20 per square foot.”
Depending on the market you live in, this figure may be lower or higher. You’ll have to figure out the rules in your area so that you can make quick judgment calls.
While a price per square foot rule of thumb is good for getting a nice round number, you’ll want to come up with a more accurate estimate if you’re really thinking about buying a flip house.
In order to cover yourself and avoid seriously under or over estimating, it’s best to itemize out each repair and come up with an average cost.
“First, compile the total list of materials needed, and record a high and low price estimate for each. Once that’s done, add both columns of numbers to get the total cost for both high and low,” real estate investor Ethan Roberts says. “Then add the two totals, and then divide by two to get the average cost.”
You’ll also need to understand labor costs and what contractors charge for their time. When you start establishing relationships with contractors and providing them with lots of work, you’ll find that their rates come down.
In a house flip, it’s not the repairs you’re aware of that you have to worry about. It’s the hidden costs that you haven’t accounted for that will do you in.
“If you’re new to real estate and this is your first deal, then appoint an experienced inspector, handyman, or contractor to do the job,” investor Abhi Golhar suggests. “This will save you from the other costs that you didn’t expect. These professional inspections of your fixer-upper along with a structural inspection can cost you about $200. Which, in the grand scheme of things, is nothing compared to the cost of the damage that could be lurking in the foundation or the roof if you’re not careful!”
In addition to calculating rehab costs, be prepared for carrying costs. These are the expenses that you incur during the repair. If you’re financing the deal, it includes interest and payments. If you’re paying in cash, you’ll still incur property taxes and other expenses the longer you own the house. Take these into account, since they affect your budget.
It’s always important to have contingency plans in place in case things don’t go according to plan. In any house flip, it’s a good idea to create “tiers” for your rehab.
First tier repairs are things that you absolutely must fix in order to flip this house. This includes things like flooring, paint, and plumbing leaks. Second tier repairs include key cosmetic elements like new countertops and updated cabinet hardware. Third tier repairs may include things like re-sodding the backyard, staining the deck, or installing a designer light fixture in the kitchen.
First tier repairs must be taken care of. Ideally, you’ll also get to most of the second tier repairs. Third tier repairs are only handled with surplus money in the budget.
If you aren’t careful, you’ll get so caught up in the excitement of rehabbing a house flip that you actually do too much. Make sure you’re doing everything with the market value of the home in mind, otherwise you’ll price yourself out of the neighborhood and experience diminishing returns.
At Green Residential, we work with real estate investors from all walks of life. Whether you need a property manager to help you stay on top of your portfolio of rental properties, or an experienced team of real estate experts to guide you through the process of buying and selling – we can help.
Contact us today and we’ll be happy to get you moving in the right direction.
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