Hidden Costs when Flipping an Investment Property
Flipping a home in Alberta involves buying a property that needs upgrading, renovating it, and selling it quickly for a profit. While flipping houses can be profitable, it's important to consider the potential hidden costs involved. I’ve known investment property owners who have had to halt projects due to such high expenses they weren’t expecting. Here are some things to consider when preparing your budget and plan.
Purchasing Costs: The purchase price is the obvious cost, but there are other expenses associated with acquiring a property, such as legal fees and home inspection. However, a lot of these flip properties will sell unconditional - meaning no inspection/ financing condition. In this market, be prepared to compete for this type of property!
It's generally recommended to have a conservative savings cushion that covers at least 20-30% of the total project cost, including the purchase price, renovations, holding costs, and financing expenses. Making sure you buy with enough margin to take some risks. The 70% rule states investors should pay no more than 70% of a property's after-repair value (ARV) minus the cost of the repairs necessary to renovate the home.
TIP — Do your research to know the standard value of homes in the area you plan to flip. You will have a higher chance for success if you buy in a good community with prior high resale activity. It is also good to remember there is GST on Realtor Commissions so be prepared when calculating selling costs. When purchasing the property, you will not pay realtor fees.
Renovation Costs: Renovations are a crucial part of flipping a home, and costs can escalate quickly. In addition to the actual materials and labor, there may be unexpected repairs or issues that arise during the process. It's important to have a contingency fund to cover these unforeseen expenses.
Some costs you might not think of:
1. Hardware and Fixtures: upgrading door handles, drawer pulls, faucets, light fixtures, and other hardware throughout the house can give a fresh and updated look.
2. Trim and Molding: Replacing or adding decorative trim and molding can elevate the visual appeal. Crown molding, baseboards, and window trim can add character and a finished look to rooms.
3. Paint and Finishes: A fresh coat of paint can transform a space.
4. Switch and Outlet Plates: replacing with new, coordinated ones can make a significant difference in the overall appearance of a room.
5. Grout and Caulking: refreshing or replacing grout in tile work and applying fresh caulking around sinks, tubs, and showers can improve the cleanliness and prevent water damage and mold growth.
6. Air Vents and Registers: cleaning, painting, or replacing air vents and registers can enhance the overall look and air quality of a space.
7. Closet & Storage Systems: upgrading closet systems with organizers and storage solutions can maximize storage space and add functionality.
8. Windows & Treatments: installing new windows, blinds or window treatments can improve privacy, control natural light, enhance the overall ambiance & reduce future utilities.
9. Upgrading Smoke & CO detectors: is essential for a safe environment.
10. Electrical Wiring Upgrades: in the 1960s and 1970s, aluminum wiring was commonly used. Over time, this wiring can develop loose connections, which may lead to overheating, electrical arcing, and potentially fire hazards. It is common practice now for copper wiring to replace all old wiring. This can be invasive and expensive, make sure you have a good inspection done before buying the property to decide what you want to do.
11. Cleaning out the Chimney: over time, creosote, a highly flammable substance, can build up inside the chimney. Cleaning the chimney removes the creosote and reduces the likelihood of a fire hazard, as well as reduces odour issues and increases air flow.
12. Manufacturing Delays: windows can take 10-12 weeks or more for them to come in, make sure you have this written out in contract and also check into warranties from the distributors.
Make sure your layouts are conducive to what modern buyers want today to help you reduce costs. The more you can stay with the bones already in place the better. It also helps if you like and have skill in working on DIY projects, as getting a contractor for every little thing is expensive.
Careful with High Quotes & Poor Quality: Make sure you get a minimum of 3-4 quotes before deciding on a contractor. Their prices can vary substantially. Contractors have varying experience and skills, take your time finding who you can trust. Work off referralsinyour networks if possible. It is also good practice to not give a deposit in advance because I have heard many property owners being ripped off, when they don’t show up. A lot of flippers with experience will renovate the property themselves to save on renovation costs.
TIP — Don’t get cheap on your Electrician. This can be the leading reason your property is safe or dangerous to live in for future owners. Make sure they have their own insurance.
Holding Costs: Flipping a home takes time, and during that period, you'll incur holding costs. These can include mortgage payments, property taxes, property insurance & utilities (you may want to leave water on for a contractor toilet). If the property doesn't sell as quickly as anticipated, these costs can significantly impact your profit margin.
TIP — Look into Commercial Insurance where you can switch properties on and off when you sell, so that the plan is always active.
Maintenance: There will be constant upkeep while the property is getting ready for sale. Some expenses include: snow removal & landscaping, furnace cleaning & new filters after drywall renos, as well as vandalism & potential theft.
Financing Costs: If you need to borrow money to purchase and renovate the property, you'll likely incur financing costs such as interest payments, loan origination fees, and closing costs. These costs can vary depending on the terms of your financing arrangement.
TIP — Not all Mortgage Brokers will lend on a flip, so check in advance.
Having a Contingency Fund is crucial. Set aside around 10-20% of your total budget, to cover unexpected expenses that may arise during the flipping process.
Legal and Permit Costs: Depending on the extent of the renovations, you may need to obtain permits and adhere to building codes. This could involve additional costs for permits, inspections, and ensuring compliance with local regulations. Some examples where you will need permits: electrical, plumbing, load bearing walls, and basement developments.
Market Volatility: The real estate market can be unpredictable, and fluctuations in property values can impact your potential profit. If the market declines during the time you're working on the flip or when you're ready to sell, it could affect your ability to sell at a desired price. It's important to carefully assess all potential costs and create a detailed budget before undertaking a house flipping project. Accounting for these hidden costs will help you make informed decisions and ensure a realistic profit margin. Consulting with professionals such as real estate agents, contractors, and financial advisors can provide valuable insights and help you estimate these costs more accurately.
It is also important to be realistic in your endeavors. You can make money flipping properties, but you can also lose money, it is the risk you take.
Starting on January 1, 2023, CRA states the new deeming rule applies to flipped property to ensure that profits are subject to full income inclusion. Under the new rule, profits from the sale of a flipped property are deemed to be business income and need to be declared accordingly.
If you would like to discuss your next project, send me an email at firstname.lastname@example.org