We regularly work with investor clients to buy and hold income properties. It’s a proven strategy to build wealth over time by having tenants pay your mortgage down while market appreciation builds even more equity in the home.
While most of our investor clients are thinking mid to long-term for their purchases, we also work with some clients who like short-term purchase and sales. Flipping real estate can be exciting and very lucrative if it is done right, but there are significant transaction costs in buying and selling.
On the purchase side, the land transfer tax is the biggest transaction cost that buyers incur and if it is in Toronto, it is doubled due to the Toronto Municipal Land Transfer Tax.
On the sale side, real estate agent commissions are the biggest transaction cost, typically at around 5% of the sale price. We always work hard to make sure our clients receive value commensurate with those costs and one of the best ways to do that is for us to be involved from start to finish in a flip project.
Broadly speaking, the biggest benefit our clients receives when they work with us on flipping real estate is our experience in the market and seeing what works and what doesn’t.
- We’ve seen sellers trying to make $200K on a property in three months after just putting in new floors and painting the walls.
- We’ve seen dilapidated properties go on the market, sell and then come back on the market a year later as stunning homes that cause bidding wars.
Mostly though, we’ve seen sellers make mistakes and fail to make much money on flipping a property.
While there are a number of factors that impact the profitability of a flip (buy-renovate-sell) project, the most crucial is your purchase budget. Specifically, having a big enough budget.
Here’s why.
The cheaper the place, the more people can afford it.
There is an old axiom in real estate which states you make money in real estate when you buy, not when you sell.
If you overpay for a property, it is quite difficult to make up for that overpayment with your sale price.
The biggest factor that leads to a buyer overpaying for a property is competition. The more people who want a home, the more it likely sells for at the end of the day.
The lower priced a home is, the more competition there is from other would-be house flippers.
With every $100K up you go in purchase price, there are fewer people who can afford the purchase, carrying costs and transaction costs (land transfer tax for example) of the home.
While we’re currently in a market with very few homes for sale, our experience has been that homes in GTA that are listed as “handyman specials” and marketed to flippers show the result of competition at different price points.
On the lower end of the price scale, homes that were listed between $700K to $900K sold for, on average, 107% of the asking price. It’s reasonable to assume that implies a fair bit of competition from flippers who could afford the home. Even if some were interested in the home for their own use rather than a flip, the lower price point still resulted in more competition.
In contrast, if we look at homes that were listed a bit higher, between $900K to $1.1 million, we see they sold on average for 99% of the asking price.
Paying less than list price sounds a lot better than paying more than list price, don’t you think?
Percentages stay the same but the dollar value goes way up.
The second reason higher purchase prices are better for flip properties has to do with return on investment in dollar terms.
We often talk about ROI in percentages, which makes sense when you are trying to compare apples to apples. At the end of the day though, our clients want to make a certain amount of money. If you received a 14% return on investment, that sounds pretty appealing, but it is how much that turns out to be in actual dollars that determines if you want to do it or not.
Consider two scenarios that returned similar profits in terms of percentage ROI.
In the first scenario, we found a good flip option for $750,000. With land transfer taxes and 10% of your purchase price set as a budget for renovations, you put about $100K into it, so your total investment was around $850K. If we sold for 33% more than your purchase price, you’d sell for almost $1M and clear a profit after commissions of around $121,000. That’s about 14% return on your $847,000 investment.
In the second scenario, we found a more expensive property that was also a good flip option and we bought it for $1.125M. Your land transfer taxes and a 10% renovation budget brings your total investment to about $1.275M. We sell for the same 33% more than your purchase price and that means a sale price of $1.496M, which allows you to clear $178K in profit after commissions. That is also about a 14% return on your investment.
Two options, both using similar assumptions and both returning about 14% ROI. The lower priced property nets you $121,000 in profit and the higher priced property about $178,000. That’s $57,000 more in actual dollars.
If it took six months for the flip and you were the only one involved in funding the purchase and renovation and you also oversaw the renovations, the first option sees you make you make about $20,000 per month before tax. That’s $5K a week, or about $680 a day if you’re there all the time.
The second option sees you clear almost $30K per month, which is $7,500 a week, or just under a thousand bucks a day.
Obviously the above calculations are just examples and how much you buy, spend and sell for makes the results very different, but if you’re using the same percentage assumptions about costs and returns, then the higher the purchase price, the more you are rewarded for your investment of time and money.
When you’re looking at a flip property, you need to think beyond simply the ROI, because you want to make reasonably decent money if you do a flip project. It has to be worth your time and at the lower price points, it becomes pretty easy to find yourself working hard to make not much actual money, regardless of what the percentage looks like!
Renovations cost a bit more with higher budget purchases
Finally, let’s go over something that seems pretty counter intuitive. We view the fact that renovations cost more with higher budget purchases as a positive reason to buy more expensive properties.
We say that’s a positive because they only cost a bit more than they would with a lower budget home, yet the benefit can be a lot more.
The reality in real estate is that more expensive homes are often not much bigger than cheaper homes. The location of a home has a huge impact on the price of real estate and we have shown many $2M plus homes that are not bigger than $1M homes in other, less desirable areas.
When you renovate a home that has a lower price point, there is a limit to how much additional value you will add to the home. If you spend $100K on a $800K home in a not great area, that home is not going to get you an additional $100K in appreciation on top of your work and sell for $1M. It may not even sell for $900K. Put simply, people will love the home, but they won’t be willing to pay that much for the home in that area.
In contrast, if you spend $150K on a $1.3M home, you might very well be able to get $1.6M for it and realize a $150K profit on top of your expenses. You put more money into the property, but the upside on the renovation is increased on higher priced properties.
When you can realize much greater returns on renovations with only slightly higher renovation expenses, you see that higher priced homes offer much better opportunity to make more actual dollars.
As it became obvious to us that higher purchase prices often result in higher margins and higher actual dollars of profit, we developed an investment structure that allows individual clients of ours to combine funds and see better returns together. In many cases, we partner with the clients as well.
If you are interested in investing in real estate and wants to make more money on a flip by combining your investment with other like-minded investors, then we’d love to help make it happen. The first step is getting in touch with us so we can sit down and talk about how it works. Talk soon.
