Understanding Your Target Buyer Is Critical When Flipping Houses
When deciding on doing a fix and flip deal and considering the exit strategy, you must understand what type of buyer you’re planning on marketing to. Remember, you are not living in the property, a buyer is, and the better you understand the ideal buyer who is going to buy your home, the more successful you will be. There are two primary types of buyers.
Livable-Condition Homebuyer: This type of buyer is looking to be in a certain neighborhood but doesn’t want to pay market value. His primary goal when buying is to get a bargain. In order for him to buy, the home must pass a mortgage inspection. In other words, all the mechanics need to work, everything needs to be functional and it needs to be in “move-in” condition. It can be outdated; it can need a new kitchen, new carpet, new paint, new bathrooms, etc. but it must be in move-in condition. In fact, these buyers are your competitors a lot of times because they’re bidding on some of the same deals you’re trying to buy. They are willing to put in the sweat equity or at least they tell themselves, “We’ll fix it up later.”
Perfect-Condition Homebuyer: This is a much different buyer. He wants everything to be modern and new. He wants an updated kitchen, granite, tile, nice landscaping, refinished hardwood floors, new carpet and paint. He wants stainless steel appliances. In a nutshell, he wants a really nice home. He basically wants a “like-new construction” home with everything included and is willing to look at dozens of homes until he finds the right one. He goes into a home and looks for a reason NOT to buy the home, and tends to always have a home inspection. He doesn’t want to buy an outdated home and usually refuses to even look at REOs or short sales. Best of all, he’s willing to pay top price.
Comparing the Numbers: Let’s look at an example of marketing to the two different types of buyers. Let’s say you get a deal for $65,000. You have two options. First, you could market to the livable-condition homebuyer and do minimal repairs by only spending $7,000 in rehab costs and re-sell it for $115,000, earning a net profit of $24,000. Or, Option 2 is to market to a perfect-condition homebuyer and do extensive repairs by spending $30,000 in rehab and re-sell it for top market price of $140,000, earning a net profit of $27,000. At first glance, the livable-condition strategy seems better. The rehab is smaller and would be completed faster. The total turnaround time would be less. It seems better to make $24,000 and not do nearly as much work, than to sell it for $27,000 and have to do more work and have it take longer. However, by taking a closer look, marketing to the livable-condition buyer is not the better choice.
Marketing to the Livable-Condition Homebuyer: Marketing to a livable-condition buyer consists of buying a deal, making minimal improvements (what I call “lipstick on a pig”) and making it “mortgage-able” (able to pass a mortgage inspection), then re-selling it to a livable-condition homebuyer. There are two problems with this strategy:
- Problem #1 – Competition: The majority of homes on the market for sale appeal to the livable-condition homebuyer. There are a plenty of outdated retail homes on the market so there is no motivation to buy your home (nothing special here).
- Problem #2 – FHA Appraisal Issues: Remember, one of the FHA flipping guidelines is that if you re-sell a property for more than 20% of what you bought it for, you must prove significant improvements. If all you did was put in new carpet and paint, you may run into a problem with the FHA.
Marketing to the Perfect-Condition Homebuyer: Marketing to this type of buyer consists of buying a deal, making significant improvements (going all-out), making it the nicest house in the neighborhood and re-selling it to a homeowner. This is where I’ve had tremendous success because the perfect-condition homebuyer is greatly underserved. Here’s what happens. A perfect-condition homebuyer is looking for a home to buy and looks at ten properties for sale and nine of them fit the livable-condition buyer. They’re dated, they’re plain, there’s nothing nice about them but they’re priced well. And then he/she comes into my home and it’s sparkling. They walk in and see stainless steel appliances, a brand new kitchen, granite, refinished hardwood floors, new paint, new windows, new roof and everything looks brand-new. It is the most beautiful home they’ve seen yet and they have to have it! At all of my closings I ask the buyers, “why did you buy my house?” They typically tell me, “I looked at 25 homes before yours and yours was the nicest one out there.”