Buying a rundown property, rehabbing it and selling it for a profit about the purchase and rehab costs has long been a standard tool of the experienced real estate investor. Profits on a properly planned rehab deal can be spectacular. Especially when you have all the elements in place to perform rehabs in a smoothly running manner.
In the past several years, many would be investors have been attracted to this marketplace, primarily because of shows like Flip This House, Flip That House, Property Ladder and others. And of course, the bookstore shelves are filled with a variety of books that teach you how to rehab a house.
The TV shows are very exciting because in every instance, they show the rehabbers making a spectacular profit no matter what unexpected problems crop up during the rehab process. And that gets naive investors very excited and prone to believe they can do this without any education. After all, it is so easy to make 20K, 30K or more even when mistakes are made.
Let’s look at a real scenario in a real market. We will break it down into its components.
We purchased a fixer upper fo 43K. We estimated it needed 20K in repair work and would be work 100K when finished.
Lets start with the purchase costs. First the financing. We went to a hard money lender. The costs were 4 points plus 13.75% interest for 6 months, renewable for another 6 months at no additional points. They financed 100% of the purchase price plus 100% of the rehab costs. That represents a loan of $63,000.
Closing costs were 4 points to the lender and other closing fees totaling around $2500 (including one year prepaid property insurance), for a total acquistion cost of about $5000 in fees. The $43K was paid to the seller and the other 20K was put into a draw account that we could access as we hit specific milestones in the project.
Holding costs - Every month, we had to make an interest only payment to the hard money lender of approximately $700/mo. There were costs for electricity, water and sewer during the ownership period of about $100/mo. There was also the cost of money borrowed against a credit card to pay the contractors in between draws. For the total renovation time - about 2 months - this ran about $500.
Rehab costs - Total rehab costs ran $22K - $2K more than was calculated in the loan. So that came out of our pockets.
Selling costs - The selling costs include time on market to sell, real estate commission (at 6%) and closing fees - including property taxes.
The total time the property was owned was 7 months before the sale to the end buyer was finalized. It sold for 97K.
Lets run down the expenses and profits.
| Sale price | $98,000 |
| Purchase Price | ($43,000) |
| Purchase Closing Costs | ($5000) |
| Holding fees | ($6100) |
| Total Rehab Costs | ($22000) |
| Sale Closing Costs | ($7800) |
| Total Pre-Tax Profit | $14,100 |
All in all, not a bad profit for finding and managing a small rehab project. But it is a far cry from the $35,000 that would have been reported on one of the Flip This House type of TV shows because they never include all these extra costs. I guess financial reality makes for too much complexity for the viewing audience.
So, is it worth a new investor’s time and energy to learn how to do rehabs? Absolutely. Can a new investor, or even an experienced investor, get burned when doing a rehab? Absolutely.
Numbers are absolutely critical when you make a rehab purchase. Be sure you understand all your numbers and make sure there is enough of a cushion there to ensure a profit when you finally close with the person who buys your house. Do this, get good at it, and you can make a very serious income year after year in any real estate market.
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