As many of you already know, real estate investing can be very exciting. Especially when you get that deal you know is going to sell for a nice profit. Most of you who are new to real estate investing are going to take it one step at a time – certainly the smart (and correct) move in the beginning.
However, once you fully understand all of the benefits of real estate investing, one of which is the potential to grow very quickly using leverage, you may decide to buy as many deals as you can, as fast as you can. If you fit into this profile, pay close attention to what I am saying, so you don’t get burned and potentially lose money.
If you are buying houses to flip, many things can happen that can hurt you and prevent you from doing other deals. Consider the following situation that prompted me to share this with you.
A Painful Flipping Story
Mary and Greg are new to real estate investing, and just completed a weekend flipper training course. They decide that they are going to rehab and flip 3 houses every month. Just in case you are new to this, rehabbing and flipping 3 houses a month is a lot! Start with a single house!
They have excellent credit and good reserves, and use leverage with hard money to finance 2 deals with one lender and 1 with another, all within 30 days. Why did they use 2 lenders? Their first lender was not comfortable with them doing more than 2 deals simultaneously and strongly advised them not to do deal 3. Unfortunately, they took another path. Let’s look at each deal and see what happened.
The rehab begins and they complete it with some subs they know (it was a very light rehab) and put it on the market. No offers yet but they expect one soon. After 60 days, they finally get an offer. It’s also a bit lower than expected but Mary and Greg accept it. The inspection takes place and a list of repairs comes back that includes a roof and a hazardous electric panel that the buyer demands be replaced.
Mary and Greg didn’t notice this when they purchased it from the wholesaler. In fact, they only had 5 minutes to make a decision to buy as there were multiple buyers ready to purchase it if they did not. It was a thin deal to begin with and now with items they agree to fix, plus additional unforeseen closing costs, Mary and Greg get lucky and break even.
Mary and Greg give their contractor a check to get started and after 3 weeks of no work performed, start to wonder what is going on. The check cleared the bank, but their contractor cannot be found – $6,000 gone! They find another contractor (this time a reputable one) and have to start from the beginning. They learn a lot from this experience, and from breaking even on Deal 1, and realize they better make sure this one is market ready.
Mary and Greg have to spend a bit more money than they anticipated, but believe it will pay off for them when they go to market. It does and they end up making $7,500, which is less than half of what they originally expected. The good news is they will not lose money, but will need to use all of this profit for Deal 3.
This turned out to be a very big project with over $40,000 in total scope of work. Unfortunately, this bid came from their first contractor who stole their money and walked off the job. After the new contractor assesses the property, they receive a more accurate bid in the amount of $66,000 – OUCH! Mary and Greg realize they should probably wholesale this deal as is. Unfortunately, there isn’t enough room in the deal to move it and they would have to take a $5,000 loss just to get rid of it. Against their better judgment, they decide to keep working on it. After 6 months of work (and interest payments), and more than 50% over budget, Mary and Greg end up losing over $16,000, for a net loss of $8,500!
In real estate investing, anything can happen. Even with the most experienced investors. However, when you are new in the business, you are exposed to more risk due to the fact that your experience is limited. What I see consistently with new investors is they overpay for real estate deals and they underestimate the true scope of work.
Overpaying for real estate deals, because you are in a competitive situation, is a recipe for disaster. Be patient. There will be other deals that will have better numbers. Also, never put down non-refundable earnest money unless you have done your due diligence.
Your rehab budget should have a minimum 10% buffer in it for unknowns (and the older the property, the higher that percentage should be) and be created by a reputable contractor. Failure to appropriately estimate the true costs of a rehab could cause you to be out of pocket with a significant amount of capital to cover these unforeseen costs. If you have multiple deals going on simultaneously, you could potentially be in a situation where you run out of money!
The point here: start with one property and get some experience before diving in too deep by trying to rehab and flip multiple houses each month.