Buy a house, put in a few improvements, and then sell it for a much higher price. Do it again and again. It sounds so simple, but here are a few pointers to keep in mind if you want to succeed with house flipping:
Experience: If your experience in real estate is performing repairs on your home during weekends, then you do not have the required experience. Ideally, you should have experience in both residential construction and real estate sales. Experience as a general contractor will help you to determine the amount of time and costs to improve a potential flip, while experience in real estate sales will help you to locate a property, determine the market characteristics, and eventually sell the property. Both are extremely important because you want to maximize your profit by investing your time and money in the right house and the smartest improvements. If you do not have this experience then you need to spend the time to learn as much as possible before purchasing a flip to minimize costly errors.
Know your costs and potential selling price: Before purchasing a property you need to estimate your cost of purchasing the property, the necessary improvements, and carrying costs such as real estate taxes, loan payments, utilities, and insurance. Just as important is the estimated selling price. If you underestimate your costs, overestimate the selling price, or underestimate the time to improve and sell the property, then your chance of profit will be greatly decreased. The formula is simple, but not always easy to accomplish; profit = the selling price minus all costs. With this in mind you want to make sure that you leave enough wiggle room to make a profit in case your estimates are off.
Capital: If you don’t have the necessary capital to purchase a fixer upper, make improvements, and pay the carrying costs, then you need to either obtain a loan or partner with someone who has the necessary capital. Make sure that you have a cushion just in case your estimates are wrong.
Time and opportunity cost: Let’s say that you are a contractor and are looking to flip a house. Make sure that you estimate that you will make more money on the time spent with your flip than during your regular construction activities. The same goes for anyone else trying to invest their time and money in a flip.
Start small: If just starting out then make sure that your first slip does not have the potential to decapitate you financially. Just think back to what happened to many house flippers about a decade ago.
Taxes: Most likely your profit will be taxed at ordinary income tax rates and possibly self-employment taxes vs. long-term capital gains rates. This is due to the fact that you are usually considered to be a dealer with the intent to buy, improve, and sell a home in a short time frame.
Alternatives: An alternative and close cousin to house flipping is to rehab a rental property, rent it out, and hold it for the long term. It is not as exciting as house flipping, but it can be very worthwhile, while also carrying less risk.
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