Four Reasons You Won’t Make Money Flipping Houses

Four Reasons You Won’t Make Money Flipping Houses

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Jon Gorey
Jun 19, 2018
(Image credit: Natalie Jeffcott)

Who among us hasn't entertained visions of buying a distressed house, fixing it up, and selling it for a handsome profit? HGTV shows make it look downright easy—and fun, too. But even veterans of these shows and big-pocketed pros sometimes struggle to make money flipping houses—or, at least, enough to make it worth the stress and hassle.

Not convinced? Let's imagine we buy a tired old house for $300,000, invest $50,000 in repairs and improvements, and resell it for $400,000, for a profit of $50,000. Sounds pretty great, right? Well, in the name of bubble bursting, let's see how the sharp edges of reality can poke holes in our flipping fantasy.

Reason No. 1: Commissions

Any time you sell a house, you're starting out at a loss, because you're going to pay an average of 5% to 6% in realtor commissions. Even if you're a realtor yourself, you'll typically need to pay at least the buyer agent's commission of 2.5% to 3%. But for most people, that means you need a home to appreciate in value by at least 5% just to break even.

Using the nationwide average of a 5.26% commission, we'll pay $21,040 in realtor fees to sell our $400,000 home — a figure that doesn't even include marketing or staging. That whittles our profits down to $28,960.

Reason No. 2: Time Isn't on Your Side

Remodeling shows on HGTV are edited to condense a long, complicated process down to a single episode. The truth is that any remodeling project takes time — and usually a lot more of it than you think. Contractor Tom Silva of PBS's This Old House has said you should expect a full kitchen renovation to take two to six months. And whatever budget and timeline you decide on, "It's going to take you longer and it's going to cost you more," Silva told me in January. That's because unexpected problems or design changes almost always come up during a big remodel.

And that's if you can even get a contractor. We're in the midst of a skilled labor shortage, and in busy markets, good construction pros are booked up for months; it can take weeks just to get a callback or a quote. And without the benefit of a national TV audience, your contractor is a lot less likely to work overtime to finish the job on your timeline if complications arise.

But the longer you hold onto a property, the longer you're paying overhead costs like insurance, property taxes, and utility bills. Assuming you're able to complete the work and sell the home in six months — which is probably optimistic — you'll still be on the hook for half a year's worth of property taxes, insurance, and utilities. At the average effective rate of 1.15%, taxes alone on a $300,000 property would amount to $1,725 after six months; add homeowners insurance plus electric, gas, and water bills, and our profit dwindles further.

Reason No. 3: Taxes

When ordinary people sell a home, they don't generally have to worry about paying taxes on the profit, even if it's pretty substantial. If you sell a home that you've lived in for two of the past five years, you'll owe no taxes on up to $250,000 in profit ($500,000 if you're married filing jointly).

If you flip a house within a year, though, any profit will be considered a short-term capital gain, which is taxed as regular income—at rates as high as 37%, depending on your other income. Sell in year two, and the profits are subject to the more forgiving long-term capital gains rate, which ranges from 0% to 20%.

Let's say that, after commissions and carrying costs, we're left with $25,000 in profit. If we earn more than $38,700 a year at our day job, that's going to be taxed at a rate of at least 22%. Our profit is now trimmed to $19,500. And we haven't even factored in stuff like closing costs, which also run into the thousands.

Reason No. 4: Everyone Else Is Doing It, Too

Still, while it's not even half the profit we first envisioned, $19,500 would be a welcome windfall for most of us. The trouble is, that payday comes with so much risk. It takes a huge investment of capital, time, and energy to buy and rehab a house.

There's very little margin for error—and there's the very real possibility that you're unable to sell the home for what you hoped. You could be left with a house you can't sell, and carrying costs that continue to pile up month after month.

That might seem unlikely in today's hot real estate market—when even an utterly unremarkable Bay Area bungalow can sell for hundreds of thousands of dollars over its asking price.

But consider this: Americans flipped more than 207,000 homes in 2017—the most since 2006. Professional house flippers say competition is stiffer than ever, and that it's a lot harder to make money than it was in the aftermath of the housing crisis.

More to the point, a lot of those house flippers in 2006 were about to face financial ruin: By 2009, home values had plunged from their mid-2000s peaks, leaving millions of homeowners—and house-flippers—facing foreclosure. In fact, new research suggests that house-flippers may have played an outsized role in bringing about the housing crisis.

If sales slow down or prices start to slide in the months while you're pouring money into a property, you could end up selling into a much different environment than you bought the house in. The bottom can fall out of the housing market faster than you can say 2008.

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