A fix and flip type of real estate investing. Its pros and cons. Calculating ROI for fix and flip.
Before we jump into the discussion of the fix and flip type of real estate business model let's discuss the types of real estate income. This is important to understand as the fix and flip type of real estate investment is very different from rental investments.
Types of real estate income:
a one-time profit that occurs when we sell something (when selling an apartment or land).
constant passive income - the creation of an asset that periodically or continuously makes a profit. Renting out your property for monthly income is an example of such income.
The fix and flip type of real estate investing is an interesting way of real estate investment as it is somewhere in between. You do buy a property, renovate it, and sell. Thus, you recognize a one-time profit. However, if you do it frequently enough, it can provide constant income. The big difference is that this is truly passive income as it requires a lot of management and control.
The idea behind this way of investment is the following:
Invest (Purchase) → Renovate→ Sell → Reinvest
Any investment strategy is about finding or building a potential that will generate returns. In this strategy, the potential is created in the form of added value such as finishing the premises, which increases the sales value. Income is about 15-20% of the original purchase price. To accelerate the implementation of this strategy, you can attract sponsor or investor money for the purchase of an object.
The Pros and Cons of a fix and flip real estate investing
Ease of project implementation, the main task is to find a repair team
A lot of time and labor is involved. May need to hire and manage subcontractor
Low risks of losing money, because the apartment has already been built
A large initial investment is required equal to the cost of the entire object
The apartment can be bought with a mortgage and further sale with income
Success factors of a fix and flip real estate investing
Let us examine several success factors in the implementation of the fix and flip real estate investment scheme.
1. Purchase at the lowest price.
The first success factor in this strategy is the purchase at the lowest price. The ideal condition would be if the price is lower than the market price in the area. You may work with developers and search for special deals. If you are buying properties from the owners, look at distressed markets or people who need to sell quickly. Very often, people will agree to sell cheaper if they need to sell quickly due to family emergencies, the need to move to a different place, etc.
2. Search for an area with steady demand.
The second factor of success is the search for an area in which there is a steady demand for housing under construction. This is very important when selling an apartment, otherwise, the time of your cycle between the purchase of the first property and reinvesting to the next will increase. Also, longer selling times will increase costs associated with borrowing money from lenders.
Apartments under construction near various transport hubs are in active demand: subway stations, railway stations connecting the city and the region. Buyers of finished apartments near transport hubs are workers. For them, the speed of getting to and from work is important.
3. Minimize your costs.
The third factor in the success of the strategy is to minimize the cost of renovation and finishing. To search for a construction crew, you can use various services online, Yellowpages, or other business directories.
So, the maximum profit from the implementation of the strategy for the purchase and renovation of real estate will be when the purchase price was minimal (due to discounts and promotions) and the cost of repairs was reduced by searching for teams from services.
4. Speed and price of sale of the property.
The final point will be the sale of the apartment. The sale price is most influenced by the cost of similar apartments in the area and the level of demand. If there is a growing demand for real estate in the area, then it can be sold in 2-3 months. In this case, the income from the sale will be on average ~ 15-20%. This strategy allows you to make a one-time profit, not passive income. To speed up the sale of an apartment, you can contact various real estate companies, which are redeemed at a price 10-15% lower than the market price. The next investment method allows you to create passive income.
How to calculate the rate of return on investment for a non-rental property? Rate of return on investment for fix-and-flip real estate investment.
The calculation of the rate of return on investment for the below types of real estate investments is straightforward since we just need to remove the rental income from the equation.
Buy to renovate and flip
Buy to hold
Buy to split the property and sell in parts
Buy at pre-construction phase to sell later
The ROI formula will be similar to the one we used before:
ROI = (Gross Income - Costs) / Investment
The trick here is to properly calculate the price you can sell the property for and the costs.
For example, in a fix and flip scenario, you need to have a good sense of the price you will be able to sell the property for after renovations as well as the costs for renovations.
For our calculations, we will use the following case. You bought a house for $550,000. To buy the house you provided a downpayment of $50,000. For the remaining $500,000 you obtained a private short-term loan (3 months at a 10% annual interest rate). You would usually expect the interest rates to be higher for short-term terms. You expect to sell the property at $610,00 after renovations.
Maximum possible income from the property
($630,000 - $550,000)
Mortgage payments ($50,000 * 10% * 3 / 12)
Cost of materials for renovation
Labor cost (160 hours at $35)
Real Estate Agent Fee at Sale (2.5%)
Title Transfer Tax at Purchase
Home Inspection Fees
Since the fix and flip type of investment is rather short in nature you would usually include all incurred costs in addition to the downpayment in the initial investments.
Our total costs from the above table amount to $44,900. The return on investment will be:
ROI = $15,100 / ($50,000 + $44,900) = 16%
However, please note, that the return of 16% is only for the 3 months of work. Let's say it takes extra 3 months to find, buy, and then sell the property and get the money in your bank account. This means you can technically do another property flip this year. If you manage to get as good of an investment opportunity, your rate of return will be double at 32% for the year. If you are really good at making all your available money constantly work for you and reinvest both the original investment you had plus the profit, the rate would be actually even higher. This is due to the compounding effect. The first time you make 16% on $50,000 + $44,900. The second time, if you invest everything you have, you make 16% on $50,000 + $44,900 + $15,100. Thus your actual rate of return for the year may go as high as:
(1.16 * 1.16) - 1 = 34.6%
If you are able to fix and flip the homes faster (e.g., every 4 months) you would achieve an even higher annual rate of return on your real estate investments. So, the speed of flipping your properties is important in this model of real estate investment.
In summary, the fix and flip type of real estate investment require a lot of management and knowledge about the current state of the real estate market, costs of renovations, and their impact on the value of the property. An additional layer of complexity is added due to the need to manage contractors who will be doing the renovations. Finding a good crew of people who will do the renovations as quickly and efficiently as possible is key. However, when done right, this type of investment may provide for an increased return on investment.