Why property flips are likely to flop

Why property flips are likely to flop

Have you ever thought of tarting up an old property to on-sell and make a quick profit?

Of course this concept is often taught at property seminars and has recently been popularised by reality television shows like The Block.

But can you really make a living flipping properties?

If you’re after a quick buck I’m sorry to disappoint you; while buying a run-down property at a good price, improving it and selling it for a profit sounds good in theory, in reality most property flips flop!

Let me explain why…

Flips in theory – double or nothing

Proponents of this strategy and those who sell courses teaching how to do this will tell you that the key to a successful flip is knowing the types of improvement you should make to the property to maximise your bottom line.

They suggest that you should at least double your renovation outlay, aiming for about $2 for every $1 spent on cosmetic improvements.

In order to achieve such lofty profits you are usually taught to undertake a heap of due diligence, researching:

1. Local property values and the growth history of the actual building to be improved.

2. Ceiling prices – what is the highest property price achieved in the area? Obviously if nothing has sold for over $500,000 and you need to achieve $600,000 to make the flip worthwhile, you could end up in hot water.

3. Costs and potential profit margins – is there anything in it?

This is the (sometimes literally) million-dollar question.

You need to have an idea of how much the renovations will set you back, the quality and reliability of local tradespeople (as this will impact your timeframes and end budget) and how much the local market is prepared to pay for a home improved to the standard you have in mind.

4. The market itself – you need to become a local real estate expert understanding your target market, who is your potential buyer, what they expect and what they’re prepared to pay.

5. The target property – “flippers” tend to go for properties being sold by highly motivated vendors. The theory is to buy at the lowest possible price – clearly something very difficult to do in today’s sellers market.

So can flips work?

While this strategy might make a few experienced punters money, in my opinion it’s the wrong strategy to adopt because:

1. To improve a property’s value by $2 for every $1 you spend on it you need to do much more than the simple cosmetic renovations – the type that are in the scope of most DIY-ers.

It usually involved structural renovations that cost more, take more time, require permits and involve a different level of expertise.

And even if you can undertake this type of work…

2. Most of your profits will be eaten up in costs.

Once you look at the table below you’ll see that in a typical flip project your associated costs could easily add an extra 50% to your renovation budget of $75,000 when purchasing a property for $400,000 and trying to flip it after renovation for $550,000.

Associated buying expenses

Estimated cost based on $400,000 property purchased

Legal fees

Varies, but can be around $1,500

Stamp duty

$20,000 (but varies state to state)

Mortgage costs – application fees, banks fees & settlement/exit fees

Varies according to lender but could be about $500

Property valuation fees

Depends on lender – usually between $0 to $300

Building & pest inspections

Around $600

Lender’s Mortgage Insurance (if loan more than 80% LVR)

$2,500

TOTAL (estimated) buying costs

$27,400 (estimate)

Renovation costs & selling expenses

Based on final sale price estimate of $550,000

Renovation cost

$75,000

Legal selling expenses

$900

Selling agent’s commission & advertising

$15,125 (based on 2.5% of final sale price + GST)

Loan exit fees & charges

Varies according to lender but could be about $500

Rates etc during holding period

$1,500

Interest on funds for 6 months (time to renovate, sell and settle)

$15,000

TOTAL (estimated) selling costs

$108,025 (estimate)

Now sometimes renovation flips do work…

But when they do it’s likely that you’ve fortuitously caught the right stage of property cycle and values have moved in your favour.

The problem is that most experts, let alone part-time investors, have real trouble pinpointing where we are in the cycle until it’s already moved on to the next phase!

You must also be cautious with asset selection; one false move could trip up your flip.

That’s because budgets and timeframes are at serious risk of a blowout should you purchase a property that, at first glance, looks like it’s in need of a few cosmetic enhancements, but actually turns out to be a structural money pit.

The main way you profit from flips is to update a property without getting into costly repairs or extensions, like replacing roofs or restumping.

These “invisible” works don’t seem to add much value, as purchasers want to see the “bang for buck” and only tend to pay you top dollar for a tangible wow factor.  

 his means that a preliminary pest and building inspection is an absolute must, along with properly qualifying the level of work required by consulting builders and tradespeople.

Then of course there are other considerations:

  1. Are you going to project manage? Do you have the necessary time and skills to coordinate trades in the right order and a timely manner?
  2. Do you have a contingency fund should things go pear shaped?
  3. Will you need to go through lengthy processes to obtain council approval for structural works?
  4. If you buy a property managed in an apartment complex you’ll need approval from the owner’s corporation? 
  5. Can you afford to hold the property in case it doesn’t sell according to plan?
  6. What about the selling costs? Real estate agent, advertising and legal fees, as well as early discharge fees on loans over the property will all eat into your profit margin.

Sexy versus stable

While donning a project manager’s hardhat can be a romantic notion, there’s much to be said for a more “steady as she goes” approach.

The risks of overcapitalising on a flip and coming out with nothing but a headache at the end is very real; as is the potential to complete your project only to be faced with a market that’s cooled its heels.

After investing through numerous property cycles, I am now convinced that you create sustainable wealth by accumulating and growing your asset base over time rather than by trading, renovating or developing for a quick profit.

Boring? Perhaps.

Tried and tested? Most definitely!

As I’ve shown above, losing substantial chunks of your investment profit with flips is a real concern when you factor in all the buying and selling costs, as well as interest and holding costs as well as loan establishment fees.

Remember, you don’t have a tenant in there helping to pay the mortgage while you’re undertaking improvements.

And of course if there is any profit left over, the taxman will take his share.

Rather than dabbling in the high-risk flip type of project I would recommend investors buy, renovate and hold on to their properties.

You see, rather than selling you can release your newly manufactured equity by refinancing your property.

By doing so, you will not only retain all of your post-renovation profit, but you’ve retained that great newly renovated investment property, which should attract a wider range of tenants, command a higher rent and give you the benefit of depreciation allowances.

That’s what smart renovators do!

Michael Yardney is a director of Metropole Property Strategists, a company which creates wealth for its clients through independent, unbiased property advice and advocacy.

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