The Big Book Of Real Estate Strategy: Ch2 – Fix And Flip.

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I am absolutely in love with learning and sharing all things real estate. I’m an agent for Jacaranda Real Estate In Harare, Zimbabwe. This blog will be the ultimate resource for all things real estate so subscribe and stay tuned.

Table of Contents

Here is chapter 2 of the big book of real estate strategy an on-going series where I’ll be covering all the popular, unpopular, proven, and experimental strategies and tactics that reside in the real estate landscape.

I’ll be explaining the strategy, breaking down how they are supposed to work, the formulas and principles involved in the strategies, considerations you need to think about, the pros and cons of the strategy, how to start the strategy if you like it and my concluding thoughts on the strategy.

In this post, we’ll be covering one of the foundational strategies of investing in real estate; the fix and flip. Let’s begin.

What Is The Fix And Flip Strategy?

The “fix and flip” is a real estate investment strategy that works on a periodic start and stop course that focuses on earning a practitioner of the strategy immediate income and cash equity from the property invested in and not long-term monthly revenue and asset equity.

Breaking Down The Fix And Flip Strategy?

The strategy at its core is a simple 3 step process that requires the execution of the following actions:

  1. Buy.
  2. Renovate and Repair.
  3. Sell.

1. Buy.

Before you can implement any fixing and flipping, you need to have access to an actual property to fix and flip.  Almost all real estate strategies that involve the ultimate sale of the invested property, depend on or highly benefit from the occurrence of a wedge purchase (wedge deal).

A wedge deal is when from the onset, the home is purchased below its market value and in theory, a wedge purchased property can be bought and immediately resold at a profit. Properties that qualify for fix and flip, are usually but not limited to distressed properties.

The fix and flip strategy is no exception and would greatly benefit from a wedge purchase but is not founded on the requirement of wedge purchases as we’ll cover below.

2. Renovate and Repair – Fix.

The founding action of all fix and flip strategies is the ability to profitably add value to the property invested in through renovations and repairs. A property that is viable for the ix and flip strategy needs to be successfully meet a renovation and repair criteria that not only identifies what works can and needs to be done but also how profitable that work is; in the market.

3. Sell – Flip.

The ultimate conclusion of the fix and flip strategy is the flip; the sale of the property. Once all the necessary renovations and repairs are concluded, the property should be listed on the market at a profit-generating margin that is founded on making the required renovations and repairs and can be bolstered by purchasing the property at a wedge.

The Rules Of Fix And Flip.

The fix and flip strategy works within 2 phases of operations which both have individual requirements that need to be successfully undertaken to maximize the probability of success from using the strategy. These phases are the following:

  1. The Entrance Phase.
  2. The Exit Phase.

Phase 1 – The Entrance.

The entrance stage operates within the timeframe of when you as a practitioner of the fix and flip strategy begin to look for a viable property to use the strategy on and concludes when you make an accepted offer to purchase the property.

The entrance phase is focused on fulfilling an “acquisition” criteria for a property to invest in and will not normally require any financial investment from the part of the practitioner.

The acquisition criteria for phase 1 for a fix and flip property will consist of the following:

  • Finding a viable property.
  • Evaluating the viability of the property.
  • Making an offer on the property.

The main rules for the above criteria are subjective to the real estate market the practitioner is in as well as the practitioners’ requirements but will normally be founded in the following expectations and requirements:

a. For Finding a viable property.

As mentioned above, most “fix and flip” viable properties are distressed properties; properties that are being sold under foreclosure or by an initial money lender. This is usually under the assumption that these properties will be sold at a wedge that increases the renovation and profit margin down the line.

This is no longer a reliable strategy and the reality of finding a fix and flip the viable property is that it is going to involve days of searching property listings for a property that is in the right location, being sold for the right price and is in the right state to be viable for profitable renovations.

Finding properties is often the easiest part, as most properties; including those that are “fix and flip” viable will be presented in the market via an MLS but the next stage is where the most work is during phase 1.

b. For Evaluating the viability of the property.

Because the assumption of distressed properties being undervalued is no longer reliable and was only generally true during the real estate bubble of 2008.

 Now, finding a viable property for this strategy requires more evaluation work that will require a practitioner to be knowledgeable on the market desires of the real estate industry they operate in. This will often require insight into the following:

-Which renovations are and are not profitable?

-What areas have the highest potential of increasing in value? (up and coming neighborhood)

-What would qualify for under and over renovation for properties in a specific neighborhood?

-What is the general value of properties in this neighborhood?

-How much can you spend on the property and on renovations to be in a comfortable profit expectation?

The above insight questions are not the end all be all but do set the tone. When you are evaluating a property for fix and flip, you are essentially creating and following the rules and procedures that leave you in a situation of comfortable prediction where you are as sure as you can be that you can fix this property and sell it at a profit.  

c. For making an offer on the property.

When you make an offer on the property, you are attempting to acquire as much of a wedge as possible to give you more margin to work with, when you are spending money on renovating property as well as allow you to earn more when you sell the home.

An offer is just an offer and can be either turned down by the homeowner or accepted but this part of the criteria only ends when the offer is accepted and the process of financing the property to own it begins.

Phase 2 – The Exit.

The exit stage operates within the timeframe of when you as a practitioner of the fix and flip strategy begin to finance the property that was deemed viable in phase 1 and concludes when you sell the property.

The entrance phase is focused on fulfilling an  “auction” criteria for the property where you are taking the necessary steps needed to increase the value of the property within the range where it will be purchased at a value that generates a profitable net considering all the money put into purchasing and renovating the property.

The auction criteria for phase 2  for a fix and flip property will consist of the following:

  • Funding the purchase of the property.
  • Profitably renovating the property.
  • Selling the property at a profit.

The main rules for the above criteria are subjective to the real estate market the practitioner is in as well as the practitioners’ requirements but will normally be founded in the following expectations and requirements:

a. For funding the purchase of the property.

For the fix and flip strategy, dedicated funding must be available for both the purchase of the property and the renovation fees to fix the property.

purchase costs will include the down payment cost and following mortgage payments until the home is sold as well as any other closing cost like for insurance.

Renovation costs will include all repairs, remodels, and renovations made to the property to increase its value.

b. For profitably renovating the property.

This will usually be the make it or break it stage when undertaking a fix and flip strategy. Renovating the property can be surface level such as repainting certain aspects of the home or redoing the flooring or can be as intensive as complete remodels of the home and putting in new roofing.

Usually, the more renovations that need to be done, the more leverage you will have to get a wedge deal, and the more opportunities you have to add value to the home.

Just remember, not all renovations are made equal and it is very easy to over-invest in the property past a stage where the renovations are adding justifiable value to the concluding sale of the home.

Renovating for flipping requires knowledge of current market desires and trends that will lead to the most profitable renovations. In general, I already wrote a post that covered the most profitable and least profitable renovations you can make on a residential property (HERE).

c. For selling the property at a profit.

The concluding stage of this phase and the fix and flip strategy for this specific property is to put the property on the market and sell it. When this stage is concluded and all the sales cost fees have been paid off you would have profited the balance from the sales price – (purchase price + renovation cost + sales cost).

Thought Process Behind Fix And Flip.

The fix and flip strategy, because of its short-term cycle for both owning the asset and selling the asset is normally stigmatized as the “get rich quick scheme” of real estate investment where many investors would say it’s an entry-level strategic tool that should be used by beginner investors before they get into more long-term buy and hold strategies.

Below, I will list out and detail the considerations that should be thought about when practicing the fix and flip strategy as well as the pros and cons of the strategy to give my conclusion on whether I believe the “fix and flip” is just a real estate entry-level investment strategy.

Considerations – What You Should Know About Fix And Flip.

The following is a detailed list of what a potential practitioner needs to be conscious of when considering applying the Fix and Flip strategy:

  1. The strategy cycle requirements.
  2. Property maintenance and interaction.
  3. Income vs Equity.
  4. Interest Rates, Prepayment penalties, and taxes.
  5. Income Period and Time Value Of Money.

1. Can you afford the strategy cycle requirements?

Fixing and flipping in a strategy that is entirely dependent on start to finish; on the practitioners’ ability to finance the burden of taking the property from purchased on market to fixed off-market to finally sold on the market.

Unlike with other investment strategies that would operate within a long enough time frame to have a tenant in the property who could generate income to lessen the burden – at the cost of all the management requirements needed to successfully run a rental property.

2. Property maintenance and interaction.

The fix and flip strategy is akin to a short but intense sprint for how a practitioner will interact with the property. The practitioner must be prepared to but in a lot of continuous hard work for a short period before they sell the property and have no interaction with it at all.

All the above 6 steps of:

-Find the property.

-Evaluate the property.

-Make an offer on the property.

-Fund the property.

-Renovate the property.

-And sell the property.

Will usually be done within the space of a few months 4-8.

3. Income vs Equity.

The ultimate return for investing in real estate via the fix and flip strategy is purely a financial return through the income generated from flipping the property. The is no equity earned in any tangible asset.

4. Interest rates, Prepayment penalties, and taxes.

Unless the practitioner of the fix and flip strategy can finance the entire strategy from cash (does not need to take up a mortgage or a loan to fund) they will likely be subject to higher than normal interest rates because of the short term nature of the loans.

If the practitioner does take out a mortgage on the property, they will need to pay a prepayment penalty to their lender because they would have repaid the loan far too early. Most mortgages have a clause that states the loan must run for at least 5 years lest a prepayment penalty be included.

Alongside this, the fix and flip strategy often subjects its practitioner to high property sales taxes that are incurred in the same way as prepayment penalties. If you purchase and sell a home within a short timeframe, you are subject to paying taxes on that transaction that would normally be negated or heavily discounted if the property was held for a specific time.

5. Income Period and Time Value Of Money.

The fix and flip strategy concludes in a comparatively “single” and immediate payout after the strategy. Concerning Time Value of Money, the fix and flip strategy has a very high positive value because the money is earned sooner rather than later but there is no periodic income or potential gain from future appreciation and the negation of costs from selling early.

Evaluating The Fix And Flip Strategy – Pros and Cons.

Table.

Pros Of Fix and Flip.Cons Of Fix and Flip.
Time Value of Money – immediate equity.Stressful.
Immediate and potentially high ROI.Cash and time-intensive.
No long-term property management costs.Very low margin and buffer for failure.
Leads to the knowledge of multiple avenues of real estate.High closing costs.
Fast access to more deals.No long-term income or asset appreciation.

Pros Of Fix and Flip.

1. Time Value of Money – immediate equity.

Most other real estate investment strategies only make it viable to sell the property in multiple years into the future. Though the income from this future sale will likely be at a higher price than the immediate sale, that amount needs to be discounted for its time value as money now is more valuable later because it is not negatively influenced by inflation and allows for the capitalization of opportunities now.

2. Immediate and potentially high ROI.

The fix and flip strategy is based on the focus of earning high returns in a short time. When done successfully, the profit margins from the flips can be massive; equal to annual salaries of many middle-class professions but earned with a fraction of the time (a few months).

3. No long-term property management costs.

Once the “fix and flip” course has been run, the property is sold and no longer the responsibility of the practitioner. Managing a property is a lot of work that is time-consuming and costly.

There are no mortgage loans to deal with, repairs or renovations to continue, tenants to manage and deal with, property managers to interact with and property management laws to follow.

4. Leads to the knowledge of multiple avenues of real estate.

A single run of the fix and flip strategy requires a practitioner to become familiar and well versed with multiple avenues of real estate; from location and analysis to construction and renovation and management and sale.

The experience that can be earned in such a short time is invaluable to all future investments in real estate whether they be through another run of “fix and flip” or other strategies.

5. Fast access to more deals.

Because you can potentially earn large amounts of income in a short time from one single fix and flip run; it is a fast way to enter multiple long-term real estate investments in a safer position.  

Cons Of Fix and Flip.

1. Stressful.

There are a lot of variables that need to be successfully researched and coordinated back to back. Finding a viable property, researching the market, negotiating the purchase, coordinating the renovations, and making the sale; all need to be done within the relatively short timeframe of a few months.

2. Cash and time-intensive.

The fix and flip practitioner is wholly liable to all the costs and recurring payments that need to be made for the property between the time of purchase to the time of sale. If the practitioner is not able to self finance the strategy, they will have to go into debt to fund the multiple avenues of costs for the property.

The down payment, mortgage payments, interest rates on loans for renovating the property, insurance, and tax are all fees the will need to be paid regularly when executing the fix and flip strategy.  

3. Very low margin and buffer for failure.

Because success, when practicing the fix and flip strategy is dependent on one conclusion – the sale of the property; anything that hinders and affects a profitable sale risks ruining the entire strategy. And from the start, everything affects the potential sale of the property.

A practitioner needs to partake in the following operations that will affect whether or not the property is sold profitably:

  • Was the property properly evaluated to be viable?
  • Was the property purchased at an adequate wedge?
  • What are the post-purchase costs of owning the property?
  • Are the renovations being done, value-adding renovations?
  • Are the renovations within budget?
  • Are properties being bought where the property is?
  • What are the post-sales costs of selling the property?

All of the above questions directly influence the profitability of the property and must be considered and positive.

4. High closing costs.

Because of the short-term cycle of the fix and flip strategy, practitioners are usually penalized with high closing costs through taxes, prepayment penalties, and realtor fees.

5. No long-term income or asset appreciation.

One big reason why the fix and flip and general quick flip strategies are not desired by most real estate investors is that they don’t lead the long-term revenue and security opportunities of owning real estate long-term.

The fix and flip strategy is a short-term ownership strategy and doesn’t allow a practitioner to benefit from rental income, property appreciation, asset security, and long-term holding for sale.

Conclusion – What Type Of Strategy Is Fixing And Flipping?

The Fix and Flip strategy is very lucrative, likely being able to boast the most efficient income ratio between time and ROI; though this is at the cost of high-risk operations and an extremely stressful period.

Viable, fix, and flip properties need to tick an extensive list of requirements that makes this strategy; though it is a short-term strategy, it is likely difficult to repeat continuously throughout the year.

The benefits of the strategy are both lucrative for early and experienced investors, the fact that the strategy is intensive in requirements and operations makes it flawed for a reliable year in progression but as a strategy that is occasionally used alongside a slower more stable strategy; is where I believe fixing and flipping is most useful.

When the strategy is coupled with something slower, the practitioner is not forced to always be rushing to find the next big deal; which could lead to costly mistakes being made. When coupled, the practitioner can work within more secure boundaries and only act when the full criteria are met.

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I am absolutely in love with learning and sharing all things real estate. I’m an agent for Jacaranda Real Estate In Harare, Zimbabwe. This blog will be the ultimate resource for all things real estate so subscribe and stay tuned.