As we invest to make money, new real estate investors often ask me, how much will I profit from selling my home? Actually, the profit of selling homes depends on different factors. In this article I’ll discuss how a few major factors affect the return you’ll receive on a given deal.
Specifically, I’ll cover each of the following topics:
- Major Factors Affecting Home Sale Profits
- Profits from Wholesaling Deals
- Profits from Fix-and-Flip Deals
- Additional Considerations
Major Factors Affecting Home Sale Profits
As stated above, several major factors will dictate how much you profit from a given home sale. And, while I’ll discuss additional, strategy-specific factors below, I want to first outline these three major ones:
- Purchase price: It may seem obvious, but investors need to understand that, how much they actually purchase a home for serves as the primary driver of profit. No amount of subsequent improvements can add enough value to overcome too high of a purchase price. For example, if you analyze a particular property, and determine that, with $50,000 in repairs it will have an after-rehab value of $250,000, you’ve set your purchase price ceiling. In other words, if you pay $200,000 or more for this specific home, you’ve already erased any potential profit from the deal.
- Holding period: Next, the time you hold a property will significantly affect your profit. When investors pursue a long-term buy-and-hold strategy, they reap the benefits of property appreciation. While the market may fluctuate slightly in the short-term, over the long-term, property values increase, meaning that – if you have a tenant covering your expenses – the longer you hold a property, the more profit you’ll receive when you ultimately sell (due to both appreciation and loan amortization).
- Work put into the property: If you buy a dump of a property in a foreclosure sale to rehab, but you don’t actually do any renovations, it’ll remain a dump of a property. For this reason, house flippers assess a deal’s merits based on the after-rehab value, as this rehab work serves as the value-adding force behind a deal. If you put work into a property, the value will increase at a rate greater than market appreciation, which gives investors a measure of control. If you don’t put any work into a property in need of it, you’ve ceded control to the whims of the market.
Profits from Wholesaling Deals
Now that I’ve discussed the broad factors influencing profits on property sales, in general, I want to talk about how specific strategies affect profits. First, I’ll cover wholesaling.
In a wholesaling deal, the investor typically doesn’t even actually purchase a property. Instead, he or she finds a deal, puts it under contract, and then assigns this contract to a third-party (likely a house flipper) for a fee or percentage of the purchase price. And, in doing so, wholesalers inherently assign the contract for the property “as-is,” that is, without any improvements.
While deal- and market-specific factors will influence exact numbers, in my experience, I’ve seen the typical wholesale deal result in a profit around $2,000 to $5,000 (though sometimes as high as $20,000). Put simply, as the wholesaler doesn’t actually purchase the property, these deals have significantly less risk than fix-and-flips. But, the other side of that coin means that they also have far less reward.
For wholesalers, low risk, no maintenance requirements, and no holding costs represent the primary advantages to a deal. But, lower returns constitute the associated disadvantage of this strategy.
Considering the above, the profit target for a wholesale deal should be simply a return on the investor’s A) time finding the deal, and B) marketing costs associated with finding a third-party assignee for the contract.
Profits from Fix-and-Flip Deals
Next, I’ll talk about a higher-risk and higher-reward investing strategy for investors seeking larger profit margins – fix-and-flip deals. With a fix-and-flip strategy, investors broadly pursue the following three steps:
- Purchase an undervalued property: This property will likely require a significant amount of repair work – the reason for the below-market purchase price.
- Renovate the property: Within a designated deal budget, renovate a property to A) add value relative to the local market, and B) make the post-rehab property appealing to potential buyers.
- Sell the property: If the deal has been properly analyzed and the budget adhered to, a flipper will sell the property for more than the sum of the original purchase price, the renovation costs, and associated holding costs, with the difference representing the profit.
As investors assume significantly more risk in this sort of deal, they also command far higher returns than a wholesaler would. Once again, exact numbers vary by deal and market, but I’ve seen average profits across hundreds of flips at around $35,000 per deal.
These higher profits represent a clear advantage to a fix-and-flip strategy. But, this higher profit goes hand-in-hand with much greater risk. Specifically, investors face rehab-, resale-, and loan-related risks by purchasing a home to rehab and resell at a greater price. However, this final risk pertaining to debt can be eliminated if investors have the cash to self-finance a deal (though this also exposes investors to the risk inherent to tying up so much cash in a single deal).
As a general rule of thumb, I argue that house flippers should strive for a profit target of 10% net profit margin after sale, that is, a 10% return on cash invested considering all expenses. If investors analyze a prospective deal and come up with a lower projected return, they should absolutely reject it and consider another deal. As stated, too much risk exists in house flipping to not receive a high return on a deal.
Regardless of what strategy real estate investors ultimately choose, they need to consider three final factors in their pursuit of profit:
- Capital gains taxes: Uncle Sam wants his cut of all income, and this means that the IRS imposes capital gains taxes on home sales. While the time an investor holds an investment property will dictate whether this tax falls under the short-term or more beneficial long-term rates, there will be a tax on any gains, and failing to account for this reality means that investors may realize a profit anywhere from 15% to 37% less than initially projected.
NOTE: Real estate investors can defer capital gains taxes on property sales with a Section 1031 like-kind exchange, but specific requirements exist. Investors should speak with a tax professional to determine if this approach makes sense for their unique situation.
- Closing costs: Like capital gains taxes, new investors often fail to include closing – or transaction – costs in their profit calculation. Recording fees, realtor commissions, and other sale-related costs can significantly cut into a deal’s profitability if not accounted for by the investor. Using a closing cost calculator or software like the Investor’s Edge software that can provide investors the fidelity they need to accurately and confidently estimate these costs.
- Contingency: As any experienced real estate investor will tell you, no deal goes exactly as planned. By including a contingency – or reserve – line item in a deal’s budget, you can provide yourself the buffer to ensure that, whenever the unexpected inevitably comes up, you still can profit on a deal.
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