(CLICK ON THE TITLE TO WATCH THE VIDEO)
Where the money comes from and goes, costs for debt and equity along with an explanation of many of the inefficiencies in the market.
Realities of The Multibillion-Dollar Home Flipping Industry
By: Bruce Bartlett
Hi everybody, Bruce Bartlett with FlipGreat, coming to you today with a presentation in regard to the financial realities of the multibillion-dollar flip industry where the money goes, where a lot of the inefficiencies are. If you have ever been curious as to how this business really works because what they show you on TV is not anything like the business at all, then take a look and I hope it’s helpful.
The realities of the multibillion-dollar home flipping industry, I should say the inefficiencies of that industry. Why listen to me on this? Well, I used to be managing partners Sequoia Real Estate Partners where I ran investment funds for a Single-Family Homes over flipped. I was boots on the ground. I handled all aspects, acquisition, renovation, sale, design, you name it. So, I know little bit about this. I was featured in the Wall Street Journal, the Los Angeles Business Journal, Fox Business. I have been quoted in a few publications and every single year I am invited to the nation’s largest industry conference on Single-Family Home Investment to speak on a couple panels.
I have a 100% success rate. Every single project we ever did, the investors have had a complete return of capital and some fairly healthy profits as well, so we’re batting a thousand. So, this way the industry works, there is a bank, they have a busted-up house, they sell to some flippers, they buy it with all cash, they fix it up and they sell it to this wonderful family, right? Not exactly.
First of all, they have to buy it at 10-35% discount for this to work. Why that range? Well, it depends on the neighborhood and what type of condition it’s in. Rule of thumb is pretty much a flipper is not going to buy it, not at least a 20% discount, typically more like 25%, otherwise the numbers just don’t work, and the house is usually in fairly bad shape. If all it needs paint and carpet, this is not a flip.
Now on that transaction, all of these people have to get paid lenders, real estate brokers, escrow and title, County of Los Angeles because we’re in Los Angeles County, and don’t forget your insurance guy like I just did.
So, then they’re going to fix it up and they’re going to pay their plumbers and their roofers and their painters and electricians and flooring guy. when they go and sell it, all of these transactions happen all over again and of course they’ve gotta make their profit too. I put 15% because that is kind of nationally a bellwether. the amount of profit that needs to be there for it to make sense for a flipper. If they’re not making that much, they probably should not be buying the house.
Now for the case of this example, we’re going to assume the house cost $1 million. I know there’s going to be a lot of you in other parts the country that may watch this and go “million dollars that’s crazy”, but million dollars is a nice round number. So, it keeps the math simple, and I just ran the numbers last night. This is data pulled from Redfin and over the last 12 months over 15,000 homes sold in Los Angeles County at a price of million dollars or more. If houses in your neighborhood cost $500,000 just dived by 2, but it will still give you a really good idea of how the industry works.
So, again all of these folks have to get paid on every single transaction. If you add all that up, it’s about 8%. Now some of you may say, wait that sounds high, that is not what it costs to sell a house, well you forget there is transaction cost on both sides of the transaction, true. Most of those costs are borne out by the seller, in the neighborhood of about 6.5% and in some parts of the country that is high as 7.5%, but there’s along with 6.5% on that side, there is another 0ne and a .5% or 1.5% that’s on the buy side. If you add those together ballpark you’re around 8% and when we’re talking about a million-dollar transaction that’s $80,000. and then when our intrepid flippers fix that property. In this case, we’re going to assume they then resell it for $1.3 million, well 8% of that is $104,000.
So you’ve got $80,000 in transaction costs on the first transaction, you’ve got $104,000 in transaction costs on the second transaction for a total of $204,000. That’s a lot of transaction costs. That’s a lot of friction.
Now, they buy it with all cash right, well not exactly. Typically there’s a lender involved then an investor or investors involved. So, in this case our lender Mr. Drysdale, he’s charging about 9¼ to 16%. Our investor Mr. Burns is getting all of his cash back first plus the first 8% and typically he is going to end up with about 50% of all net profits.
Every single deal with an investor can be different. Flippers, operators can negotiate whatever they want with their investors, but this structure is not uncommon. It’s pretty straightforward.
So, let’s take a look at our lender. Again, he is charging between 9¼ and 16%. Typically, there’s about 1¼ to 3% upfront in fees and then the interest rates are between about 7.9, 14%. How quickly can you move compared to a regular bank? You can move fast. Now, they’re going to say they can get stuff done in days or in a week . But typically is 1 to 2 weeks and I’d say closer to 2 weeks than 1.
This used to be sort of a small private industry, country club type loans and what not, but now this is a large multibillion-dollar industry with groups like Goldman Sachs coming in, you know when they bought Genesis Capital, giving you an example Genesis Capital has done over 9000 loans probably now over 10 or 11,000 loans since 2013 for over $6 billion.
Now, when we look at Mr. Burns here. He’s an accredited passive investor, which means he has got a net worth of a million dollars or more. He typically is putting in the majority of the funds here. Sometimes, the operators are putting in as little as 3 to 5%. He gets all of his invested capital back. First, he’s going to be getting an 8% return off the top then the flipper or the operator typically gets to clawback the next 8%, if there’s anything after that, they split it 50-50. Fees? again, completely negotiable, but long story short, Mr. Burns is going to get about half of all the profit here.
So, in order for Homer’s house to get to the Flanders in move-in condition, all these people have to get paid. Mr. Drysdale’s got to get his money. Mr. Burns has gotta get half the profit, our flippers need to make their money and then don’t forget there’s $204,000 in transaction costs.
Does that seem kind of bloated to you, wasteful, not necessarily efficient, we agree. That’s why we created FlipGreat. We basically give away free money, no? really let’s show you how.
Homer here has a fixer house. Homer has a dilemma. Homer can either sell to the flippers, but remember the 10-35% discount on a one million-dollar home so he’s gonna lose $100-350,000 and it’s probably going to be closer to the 350 than it is to 100 or he can fix it up himself. Problem being Homer doesn’t have the time, the money or the expertise to do that. Even if he had the time. It’s very time-consuming and the money, he is going to paying retail rates, which means he’s probably paying about twice what we pay to do this work, and he doesn’t know what to do. He doesn’t know what type of floors to put in, he does know what the roof needs. He doesn’t know if someone’s overcharging him. He doesn’t know how to design the interior of the house to get the highest possible price. He doesn’t know what repairs and renovations will make him money and what will actually cost him money, so it’s going to be a huge-huge burden in his life. It is just good to be a time sucking black hole and he’s probably going to completely overspend on this and he may not make any money.
That’s where we come in because remember all of these people have to get paid, but we make it all go away. Imagine if all of these costs could go away. We could just get rid of all the waste, make it super simple. So, it just goes from Homer to the Flanders because we are going to use our money to fix up Homer’s house before he sells it. Isn’t simpler and that leaves much more money when he sells for 1.3 million for Homer. We are going to get a part of that too. So, Homer does nothing because we’re doing it all. Homer spends nothing because it is all our money. Homer’s is going get an extra $125,000 when he sells the house.
At the close of escrow, he is going to get the million dollars. He would’ve gotten anyway. Plus an extra $125,000 for doing nothing and spending nothing and just letting us take care of all the problems for him. Not only that, not only is he going to do nothing, spend nothing and get an extra $125,000, he is also getting get that $125,000 typically two weeks faster than if he had just sold the broken-down house as is. That is even after the construction time. I know that sounds crazy.
The reason is, there is all kinds of things to argue about when you’re selling a home that needs significant repairs. How bad is the foundation problem, how bad is the asbestos, how bad is the roof, etc. etc. but when you’re selling a house that looks like this, now there is nothing to argue. The buyers do their inspection reports and it passes with flying colors. Because everything works. There’s no need that to ask for repair credit and they’re afraid to do it because there was a bidding war and there’s four people behind them who want the house too and they know if they start to be a problem. We can always just go to the person that’s in second position and sell to them.
So, FlipGreat will renovate and prep your fixer home for sale at zero upfront cost to you. We pay for it, we do all the work that is the same kitchen transformed there. This is actually a project we did a few years ago, it is not like we’re borrowing these photos from somebody else. 30 days or less, so it’s fast, use any realtor, make far more money when you sell. We split the increased value of the home with you. The increased value that we created, we split with you. Sell far faster. No hassles. You’re not going to waste a day and Home Depot picking up tile, you’re not gonna ruin your afternoon arguing with a plumber. We take care of everything.
Now if you don’t have a fixer house to sell, but you know someone who does and you refer us to them and they use us, at the close of the escrow on that transaction, you’re going to get directly from escrow $5000. So, if you don’t necessarily have a fixer house yourself, you can refer us to a friend, a neighbor and you can participate.
Just so you know it doesn’t come out of their end that comes out our end, okay, it is not taking any money away from your friend. It’s coming out of our profit. We want to build the company; this is not about getting rich overnight.
If you have any questions contact us either via email or on Facebook and we hope this was helpful and if you have any other questions whether it’s about this subject, or any others, or the age-old question of what goes in first, the cabinets or the floors. Again, just reach out to us on Facebook or via email. Happy to answer your question, or even do one of these because maybe there are other people that are in the same quandary. Everybody be safe and thanks for listening