Price risk as it applies to California flippers is the potential for any one of a number of factors to erode the expected profit margin of a property flip.
In worst case scenarios, some flippers might even suffer a loss on their investment.
Inexperienced and rookie flippers are particularly vulnerable to the threat of price risk.
That is because they make basic mistakes when formulating their business plans by not allowing for the possibility of cost blow outs.
Many flippers focus heavily on ARV (After Repair Value), material costs and interest costs.
But they overlook all the things which can go wrong along the way – and they all cost money.
That’s why it is so critical to build enough margin into every flip.
Here’s what to be wary of when assessing a property for flipping and how to avoid the price risk trap.
Permit or zoning delays
Waiting on building permits, zoning and environmental approvals can chew up a significant chunk of your budget if you haven’t allowed for it.
Every county is different but in LA County, permits can take anywhere between 30-90 days.
Expedited approvals often come at a premium of up to 20 per cent.
Every day your property lays idle, your financing, holding and potentially labor costs rise.
You could even miss the optimal time to sell.
Always do due diligence by checking zoning and objective standards before you buy.
Ask for a pre-application meeting and use pre-approved or standard house plans where possible to skip lengthy design reviews.
Avoid the following that can trigger long approval delays:
- Properties in historic districts
- unpermitted additions that need to be legalised before new permits are issued
- properties with unrecorded easements, septic systems or shared driveways
- projects that require variances for setbacks, height or lot coverage
- Projects in coastal zones, on floodplains or on protected tree lots
Building delays
Flippers can have all the approvals they need but unforeseen building delays or a burst of bad weather can grind any construction project to a halt.
Contractors usually work on multiple projects at once and are notoriously unreliable.
That’s why it is so important to build strong relationships and work regularly with people you trust.
There’s not much you can do about rain except know you have the buffer in your budget to weather the storm.
Construction cost inflation
Construction cost inflation is another significant price risk.
In Los Angeles alone, construction costs rose 5.9% in 24 and a whopping 44% over the last five years.
Lumber, steel and drywall costs have risen 5-15% annually in many California hubs.
These costs are unavoidable.
The only way you can protect yourself against them is to build in a contingency in your budget of 10-20%.
Holding costs
Holding costs of a property are among the biggest price risks for flippers because they are so often underestimated.
And there are so many of them.
They include:
- Mortgage costs of between 8-12% for a hard money loan
- Property tax between 1.1-1.5% per annum
- Utilities
- Cost of permits
- Selling costs
A porch.com analysis revealed 63.5% of flippers underestimated their total costs with 36.2% working from budgets that were too small.
Every additional month a flipper holds a property can cost several thousand dollars, substantially eating into margins.
That’s why it is recommended to build an additional buffer of between 5-10 per cent into budgets to allow for holding costs.
Market shifts
Flippers already impacted by permit or zoning delays triggering additional holding costs may suffer a double or even triple whammy when markets shift.
Interest rate rises, over supply or changing buyer demand can all see markets cool and prices fall.
It can leave flippers in the uncomfortable position of having to accept a less than desirable offer or hold out for a better one at the expense of ongoing holding costs.
That’s why multiple exit strategies are so critical.
The 70% rule
The safest way to avoid price risk is to carefully apply the 70% rule.
This rule stipulates that the purchase price should be no more than 70% of the ARV, minus the renovation costs.
The rule ensures a ready-made buffer to allow for unexpected expenses, delays, cost blow outs and market shifts.
But it relies on an accurate assessment of ARV and renovation costs which are two more common price risk pitfalls.
Get funding and advice today
Negating price risk is something which must be built into a budget before purchase – not as a reactionary measure when things start to go bad.
Regular review of risk assumptions throughout the renovation are also necessary, giving flippers scope to tweak budgets throughout the build or on rare occasion, abandon the project.
There’s so much to consider when undertaking a flipping project in California.
And price risk can quickly destroy margins.
That’s why partnering with an experienced hard money lender and guide in California makes perfect sense.
And Equidy is just that!
Equidy has an intimate and personal history with all aspects of property development in California and has done so for more than 40 years.
They can help ensure your budget stacks up and has all the room necessary to withstand any costly delays you may face, leaving you to do what you do best – renovate.
Equidy works closely with their clients to ensure they maximize the return on their investments without putting themselves at unnecessary financial risk.
They do this because they know the business backwards and advise their clients every step of the way to reduce the risk of costly delays.
The best part is that Equidy is also a hard money lender who will finance flippers and developers in as little as 48 hours.
They stand by their core belief that anything is possible and they are determined to prove it every single day.
Even in difficult economic times, they love to reward entrepreneurship and strive to help their clients realize their wealth creation dreams.
Equidy enjoys long and established relationships with serious investors, sellers and real estate professionals while leveraging their reputation and trust, using clear communication to minimise the risk to all parties.
Contact Equidy today to book your free strategy call.
