If you’re in the real estate investing business long enough, you’re going to end up with a project that goes over budget. And, if you keep at it, you’re going to take on a project that looks great at first but then goes way over budget. It’s going to happen, no matter how well you plan and how much you work to avoid it. The only way to avoid it completely is to quit flipping houses. Since you’re not going to do that, the best thing you can do is be prepared and know what to do when it happens.
Make Sure Your Budget Has Some Wiggle Room
In general, you should start out every flip with the 70% rule in mind. Basically, you want to try to keep all of your spending on a property at or below 70% of its ARV (after-repair value). So, if you think that a property can sell for $400,000, you’ll typically want to set your budget at $280,000. That way, if you stay on budget and the house sells at market value, you’ll make $120,000 in profits.
That’s a lot of profit, and it leaves a lot of room for going over budget. Even if disaster strikes, and you have to spend an extra $100,000, you can still make a $20,000 profit on the house when you sell it. That might sound like a crazy number, but if you’ve kept up with our show, you know that we’ve had flips that looked really good but ended up with six-figure rehab budgets. You never know what’s going to happen until you get in there.
Have Backup Funding Options
Continuing with the same example, let’s say that you actually only need to go $20,000 over budget. You’re still slated to make $100,000 on the flip, so everything should be good…if you have the funding. If you simply do not have and cannot get that extra $20,000, you’re going to be in deep trouble, and you won’t be selling the house at anywhere near $400,000 if your rehab isn’t complete.
That’s why Christina and I maintain working relationships with as many different private investors and lenders as possible. We know that we can’t always go to the same friend to fund our flips, and we know that our investors aren’t always going to want to continue forking over money as our rehab budgets go higher and higher. Having backup funding options is an absolute must if you want to make a profit on a flip that’s over budget.
Plan for the Worst
What if all of your backup funding options are tapped out? If you can’t finish a flip, you need to have a good exit strategy. I recommend selling to another flipper or a wholesaler to recoup as much of your loss as possible. At this point, sitting on the property until you have funding is just going to waste your money, and if the property gets vandalized while it’s vacant, you’ll be looking at an even bigger loss.
Sell It and Learn from Your Mistakes
In an episode of Flip or Flop from season three, Christina and I had a real money pit. Every time we turned around, we had to spend more money, and we finally sold the house for a $3000 loss.
That experience reminded me that the real estate investing business always involves some risks, and you really can’t win them all. That said, it also gave me a good opportunity to look at everything that happened during that rehab project and how I could apply those lessons to flipping houses in the future. That project was an expensive lesson, but what we learned from it will definitely bring in a lot more profits in the future.