I recently watched an episode of Flip or Flop? The beautiful Tarek and Christina bought a broken-down house in coastal Palos Verdes, California, gutted it, and put it back on the market for sale at what would be a handsome profit. Everybody who has plied a hammer or a screwdriver (not to mention a nail gun or a power saw) has at least thought about trying their hand at a house renovation and selling it to make money. Tarek and Christina have turned everyone’s dream into a hit TV show. During the episode I watched, Tarek and Christina did some things extremely wrong, but they did some things right, as well. Here’s my take on each:
Wrong!
Cost Overruns: They bought the house and started the project with a general budget in mind. However, as is the case in 99.9% of home renovations, things cost more than they thought. In this episode, for instance, they decided part way through to convert one of the bedrooms into a bathroom – and a very high-end bathroom at that. Some finish pieces, including a pantry door that didn’t exactly work correctly, were added at the spur of the moment. The best renovators follow the following playbook: 1) Know what you are going to do to renovate prior to buying the house; 2) Know how much it costs to do those renovations; and 3) Do what you planned to do, and no more. Ideally, the renovator will know what they want to sell the house for as well as what their renovation costs are and what their profit is before making an offer on the house, as the cost of the house is the “plug number” to make the rest of the equation work. In this regard, they work backward. Creating a renovation budget and sticking to it is essential especially when the for sale housing market is weak, or if the house is in an inferior location because there is no strong market to bail you out when you have overruns.
Time: Tarek and Christina’s renovation took more than 6 months to complete. Granted, it was a down-to-the-studs project, but 6 months plus is a long renovation. The most cost-effective renovations take place lickety-split. In real estate, time is money. If they financed their purchase with a mortgage, then they pay more interest to the bank the longer the project goes on. If they paid cash for the home (the more likely situation in this case), then the cost is Opportunity Cost: what they otherwise could have done with the money they sunk into this house. If they had planned to rent renovated property, then they are losing rental income the longer the renovation goes on.
Right!
Location: Their cost overruns and the time it took them to complete their renovation are mitigated by the high-end location of the property. It is, after all, Palos Verdes, beautiful coastal Southern California. At one point during the episode, Christina remarks that she knows she is overspending on this renovation and making changes they hadn’t planned on, but that Palos Verdes is a high-end market and that the market will support this level of renovation. They understand their ultimate resale market and so they spend accordingly. This isn’t always the case in real estate. A lot of markets are really difficult. Most people have heard the old saw: The three most important things in real estate are location, location, and location. It proved to be true in this episode of Flip or Flop? (I don’t like it when the title of a book or a TV episode ends with a question mark!)
Know Your Contractors: Tarek and Christina knew their general contractor very well. Moreover, the GC knew his business very well. He had a quick answer for each How Much Will This Cost question. Of course, this was a TV show. As a renovator, if you are not doing all of the renovations yourself (i.e., most renovators), you have to have a good relationship with and a very high level of trust in your contractor or contractors. The contractors need to stay dedicated to the job. Maybe you share some of the profits with the contractor? Not a bad way to incentivize them. The contractor will make or break the project and can bail you out if you hit a snag.
IMO
House renovations, if done correctly (that is a really big If!!), can be an excellent source of income or profits. It can be done at any stage during someone’s life. In fact, it is an excellent retirement activity for someone who is handy, or has a good eye, and can stick to a budget. It is not physically strenuous (unless you are doing the work yourself, which is not advised), you can work as you please, and it keeps you mentally occupied. The barriers to entry are minimal – mostly what you need is capital and some experience with buying and selling real estate. Having Home Depot or Lowe’s nearby makes it easy to access the stuff you need to do the renovation. The trick is picking the correct location and sticking to the pre-determined budget.
P.S.: There have been volumes of books as well as seminar programs devoted to the subject of flipping real estate. All of these really boil down to what I have written here in this blog post. Then again, you get what you pay for, so, by all means, do further research if you are thinking about doing a house flip project. Or just contact me.