Fix-And-Flip Due Diligence Checklist

Pro Tips from Maggie Polisano, Co-Founder, CamaPlan LLC

So, you want to flip a house. Congratulations! Fix-and-flip deals can be fun, exciting, and profitable . . . unless you don’t do your homework and fail to prepare for the unexpected.

Due diligence is the whole ballgame in real estate investment. Fix-and-flip deals are notorious for going south and wiping out even the smartest would-be investors. But successful fix-and-flip investors consult with a bevy of experts and third-party advisors before they sign on the dotted line.

Maggie Polisano, experienced real estate investor and Principal and Co-Founder of CamaPlan LLC, a self-directed IRA administrator and custodian, weighed in on the ten “checkpoints” that should be on the “due diligence checklist” of every aspiring fix-and-flip investor.  Here’s what she recommends:

Checkpoint #1. Start with Purchase Costs

Buying a house usually costs more than just the purchase price. Make sure to tally up the fees and closing costs you will be responsible for as a buyer. Try to estimate:

  • Wholesale fees.
  • Broker fees and commissions.
  • Inspection fees.
  • Appraisal fees.
  • Survey fees.
  • Attorney fees.
  • Escrow fees.
  • Title insurance.
  • Title search fees.

Also, do the same due diligence with regard to comparison with comparable sales to price a finished flip in Checkpoint #4.  Make sure your starting point in this deal – purchase of the home – is as advantageous as possible, so that you’re not paying more than you need to get into the flip.

Checkpoint #2. Accurate Estimate the Rehab Costs

The first thing you need to know, in addition to purchase price and comparable purchases (see Checkpoint #4below) is how much the “fix” will cost. Experienced flippers might assign a house a three-tier rubric for the rehab: ‘light’, ‘medium’, and ‘gut’– then, based on materials contactor and labor costs,make a quick assessment of the rehab cost per square foot.  For example, $20 per square foot for light, $60 per square* foot for medium, to get a fix on investment costs over and above acquisition cost

*NOTE:  Don’t just copy those numbers. Costs will vary by market, and supply and demand might cause the cost of materials and labor to fluctuate.

Don’t just rely on a visual inspection of the “showpiece” rooms or interior/exterior examinations. Look for unseen problems in the crawl spaces, basement, attic, or other hidden crevices. You’re looking for signs of:

  • Mold
  • Water intrusion
  • Pest infestation
  • Structural compromise
  • Bad insulation
  • Asbestos
  • Aluminum wiring
  • Asbestos issues

Some hidden problems may be common to a region, say, cracked foundations in northeast Texas or moisture problems in sub-tropical regions of the south.If the infrastructure (plumbing, electrical, etc.) is out of date and needs to be upgraded for code purposes, you need to know that. Make sure to check out:

  • All Mechanical Systems. Water heaters, HVAC, interior and exterior plumbing.
  • Kitchens and Bathrooms. Plumbing, electrical, subfloors.
  • Doors, Windows, Walls, Ceilings. Does anything need to be repainted, restored, or replaced?
  • Flooring. Needs to be replaced or restored?
  • Exterior. Roof, soffits, siding, brick, patio, garage, decks, sidewalks.

Get the right people to do the inspections.  Get recommendations and vet your professionals.  A little extra money on a thorough inspection can save you loads of heartache and cash in the long run.

“If you’re a beginner and can’t identify these issues for yourself, you can start by investing with experienced flippers, which you can do with a self-directed IRA,” Polisano recommends. There is an industry of professional flippers, usually focused regionally or on certain types of property, such as affordable or multi-family housing, who partner with investors to expand their businesses.  “Then, as you gain more experience and want to take on more of the project – and the profits – work directly with contractors and inspectors you’ve grown to know and trust as an investor,” she advises.

Once you get your first few flips under your belt, you’ll get the hang of it and be able to estimate rehabs like a pro.

What about the finish-outs? “Remember, youaren’t going to live in this house,” Polisano said. “Youmight love cultured marble countertops, but if no other house on the block has that level of finish-out, it might be overkill. The target demographic might not be able to afford it, so you may not get the ROI you think you will get out of that finish-out.”  This is where knowing your market and comparable selling prices (see #3 below) come in.

Smart house flippers take their rehab estimate and then add 10%-20% for “the unexpected.” Rehabs have a way of running over budget, and you don’t want to be caught flat-footed by an optimistic estimate.

Checkpoint #3. Look for Recent Comparable Sales

This checkpoint is to try and identify what the house will sell for once the rehab is complete. You do this by performing the same kind of “comparable sales” analysis a REALTOR or appraiser might do — see what similar houses have sold for within the last two months.

“You want to look at what comparable houses have sold for, not currently listed for,” Polisano pointed out. “You have no way of knowing if someone in your neighborhood has delusions of grandeur and overpriced their listing. To find out what houses are actually going for, see what the houses actually sold for.”

But don’t stop there.  Find out why comparable homes sold for different prices.  A finished basement or upgraded kitchen (things you may also be doing to your flip) may account for the higher prices among your comparable sales.  Measure your projected flip against comparable conditions among your comparable sale units, too.  You can pay a REALTOR or an appraiser to do this for you, or you may be able to do it yourself using MLS listings or an up-to-date listing site like Redfin.

If you do it yourself, look for comparable sales that are:

  • Recent Sales. The more recent, the better. Try a 90-day lookback. Six months is pushing it.
  • Nearby. The same neighborhood or subdivision is ideal. The closer, the better.
  • Similar. If you want to flip a 3-bed/2-bath, look for other 3/2s. If the comparable properties are different (lot size), you may have to calculate adjustments.  If the comparable properties have a different level of finish-out, you may also have to adjust.

Note that housing prices change with market conditions! If the market has upward momentum, you may be pleasantly surprised at what your flip sells for! But if the market takes a turn for the worse, your flip could be in trouble — another reason to get the rehab done as quickly as possible.

Speaking of time … don’t just look at what the comps sold for. Look at how long it took them to sell. Take the “average days on market” (ADOM) number and add it to your “holding time” (see Checkpoint #5). You need your holding costs in Checkpoint #6 to account not just for how long it will take to rehab, but how long it may take to sell.

Checkpoint #4. Calculate Financing Costs

Many house flippers borrow money to execute their flips, often from a private or hard-money lender. This also costs money. (“You can also find this money with self-directed IRA investors,” says Polisano, “who are active lenders to the fix and flip market.”)  Talk to your lender or prospective lender and get cost estimates for:

  • Interest. Just get the annual percentage rate (APR) for now — you will need it in Checkpoint #8.
  • Loan Origination Points.
  • Any Other Loan Fees.
Checkpoint #5. Calculate the Holding Time

Now that you have an estimate of how much the rehab will cost, you need to figure out how long it will take. Time is very much money in a fix-and-flip deal, as we will see in Checkpoint #6.  If you’re new to fix-and-flip deals, talk to contractors. Could the work be done in three months? Six months? Twelve? More? Get an idea of the best-case and worst-case scenarios.

Checkpoint #6. Calculate Holding Costs

Time is money in house-flipping. Checkpoints #1, #2 and #4 give you an estimate of how much it will costs to get into the flip.  But we have to add to that an estimate of how much time it will take to complete the flip (Checkpoint #5). There will be expenses for every month you carry this deal.

Estimate how much you will pay per month for:

  • Loan principal and interest repayments.
  • Insurance. NOTE — “vacant-house” insurance is more expensive.
  • Property taxes.
  • Utilities.
  • HOA fees.
  • Security and alarms. (Vacant houses are targets for squatters and burglars.)

Now you know your monthly holding costs … multiply this by the holding time. Once you have this figure, consider adding 10%-20% to that figure like you did for the rehab costs to account for unforeseen delays.  Add this to the cost of getting into the flip (Checkpoints #1, #2 and #4).

Checkpoint #7. Calculate Sale Costs

Just like it costs money to buy a house, it costs money to sell a house. In order to complete the costs of getting both into AND out of the flip, consult with REALTORs and title agents, and come up with estimates for:

  • Broker commissions and fees.
  • Staging the house.
  • Listing photography (good photos sell houses).
  • Appraisal fees.
  • Home warranties.
  • Termite inspections.
  • Seller closing costs.
  • Title insurance.
  • Transfer taxes.
  • HOA transfer fees.

Note that different houses might face different marketing challenges, which will affect the sale costs.

Checkpoint #8. Determine your Target Offer Price

Now you have a bunch of figures — a list of costs for the entire deal (Checkpoints #1, #2, #4, #6, and #7), as well as an estimate of what the house will sell for (#3).Add up the costs, then subtract them from the estimated sale price. You should be looking at an approximate potential profit margin for this fixer-upper house.  Make sure your target price is not only profitable enough for the time and effort you will put into the deal, but also leaves room for negotiation, especially if you’re facing a buyer’s market.  That will be your strike price.

Checkpoint #9. If the Asking Price for the Fix and Flip is Higher Than the Target, Determine If There is Room for Negotiation

Of course, the seller might be asking more than your strike price — possibly a lot more. If so, it’s time to determine if there is room for negotiation. How motivated is the seller? Are you bidding against other investors or potential buyers? Are you willing to slim down your profit margin?

“The deal only works if you can agree on a price,” Polisano said, “so figure out how far apart you are and if the gap can be bridged.”

Checkpoint #10. Check the Legality of your Plan

But before you do anything, this checkpoint could easily come a lot earlier on the list, but it’s at the end because it is someone unrelated to the other checkpoints. And yet it’s kind of the most important — is your rehab plan even legal?

Are there easements or covenants on the title that will prevent the kind of work you want to do? Is there a zoning issue with your plan? Will the city give you a permit? Is there an HOA that has veto power over your plan, or a nosy neighbor who loves to push the NIMBY (not-in-my-backyard) button?  Many cities and towns are re-zoning to allow rental units to be added on to a property.  But rules can change and navigating permitting and approval processes in some areas can be formidable.

“Talk to attorneys, title examiners, surveyors, HOA reps … everyone you have to,” Polisano said. “If your plan is flawed, you want to find that out before you close, not after.”  Move deliberately, and assemble a team of experts you can rely on, from title specialists, to inspectors, contractors and real estate agents.

—————————————————————————————————

As you can see, there is much to consider when attempting a fix-and-flip investment. If you’re new, don’t try to go it alone. Even the pros rely on a robust team of experts to successfully close the deal.

CamaPlan LLC is a custodian and administrator of self-directed IRA, 401(k), Health Savings, and Education Savings accounts.  Located in Ambler, PA, and serving a nationwide client base, CamaPlan accounts enable investors to allocate capital from their tax-exempt or tax-deferred retirement accounts to real estate, private lending, venture, precious metals and other alternative assets.  Self-directed retirements accounts from CamaPlan provide investors with maximum control over the direction their retirement savings for wealth accumulation, preservation and legacy provision. Learn more at www.camaplan.com.