For first-time real estate developers, starting your first project can be both exciting and scary. Exciting because you finally took the plunge. An opportunity came up and you grabbed it. Scary because a million different things are running through your head: What if nobody likes the property? What if the area changes? What if the economy tanks? What if I can’t get financing? Etc.
Because every house and situation is different, it's easy to think that there are a million things threatening to turn your "flip" into a total financial loss. However, after working with many developers as well as developing and selling my first rehab project this year (at a profit – yay!), there are four core reasons why a "flip" will flop if you’re not careful.
#1. Wrong Mindset
If you have a "flip" mindset to begin with, you’re already off to a bad start. There's a reason why “flip” feels like a dirty word for many buyers and their agents. It brings to mind quick, sloppy, cheap work done by the lowest possible bidder to squeeze out the most money possible. If that is your intention you're only limiting yourself. Margins on traditional "flips" can be razor thin, especially in Southern California. Should anything major come up – it becomes very easy to take a financial hit.
With development now the name of the game is value. You have to build value into the property. Add square footage, add a bedroom, add an ADU, add SOMETHING that will increase the end value of your project and create space for greater profit margins.
Go from Flip Mentality to Value-Add Mentality.
Ask "How Can I Add Value to This Property?"
#2. Poor Quality
The problem with going into a project with a flip “mentality” is it shows…EVERYWHERE. Crooked paint lines, bubbles in the ceiling, uneven floors, windows painted shut, cheap materials, or my personal favorite when the house looks beautiful on the inside, but absolutely nothing was done to the outside.
People aren’t dumb. They watch HGTV, they keep up with the latest design trends, they notice these things. Don't assume quality materials and quality work have to be expensive. That’s where the art of remodeling comes into play. If your budget is low, get creative: Research low cost materials that still manage to look good, hire people who can do the work right the first time, and keep a constant eye on the project to make sure everything comes together.
Provide Quality Materials & Quality Work
Pay attention to the details
#3. Bust the Budget
I’m personally guilty of this one. Going over budget is very common among developers and contractors. You had an amount fixed into stone, but ended up spending more on the rehab than you initially wanted to. Going over budget can be fatal to a project because the money has to come from somewhere, and that somewhere is usually your profit.
The best way to avoid this is to build a plan that breathes. Real estate is so fluid. Something in one form or the other will always come up, and in order to be prepared, it’s important to have a plan that is flexible. A plan that errs on the side of caution. A plan that rounds up if you will, when estimating costs for the purchase, remodel, and close.
Additionally, avoid over-remodeling your first project. For example, if your first project is targeted to first time home buyers, don't blow the budget on $10 cabinet handles or imported marble countertops. Prioritize your budget on features that will add more value to the home than their cost. Again, there are many great quality materials that look good and won't break the budget. Find them.
Build A Flexible Plan
Leave the Budget Room to Breathe
Don't Over Do It
#4. A Stubborn Sale
You finally released the property to the open market and it's not selling. First a week. Then a month. Then two months go by. Meanwhile, you’re making the loan payments. You’re sending out a gardener, handyman, or cleaner to keep the property looking good, or worse doing the work yourself. Money is going out, nothing is coming in, and you’re entering panic mood.
First evaluate how flexible you and your agent are in the sale. It’s a tough question to ask, but it’s important: is it the market that is stubborn or is it you? Is the property easy to show? Do buyers have to jump through hoops just to submit an offer? Are you writing off seemingly ‘imperfect’ offers too quickly? Is your agent downplaying really good offers? Are you listening and acting on the feedback you’ve received?
If you feel you have been as flexible as possible, and nothing is happening, it is imperative to have backup plans and be open to enact them. Ask yourself from the outset: What am I willing to do if this property doesn’t sell right away? Can I generate income in another way? Can I rent it? Can I convert it into a short term rental? Can I refinance and keep it? The beauty of real estate is that because every property is so unique, should yours not sell, there are many different opportunities available to still make money.
Don’t be stubborn
Have a Plan A, B, C, and D
Be Open to Enacting Them
Stick To Your Core
Provide Value, Provide Quality, Have a Flexible Plan, Be a Flexible Seller. Every successful real estate developer I have encountered and worked with excel in demonstrating these qualities. Take these four things as the core of your being as a real estate developer, and not only will you blow your first project out of the water, you will be well on your way to building a sustainable development business for yourself.
If you're looking for help on getting started, let's talk.