Understanding the Costs of House Flipping: Closing Costs, Holding Costs, and Total Project Cost

One of the expenses that house flippers need to consider is closing costs. These are charges imposed by the title company to ensure a smooth transfer of ownership and to guarantee that the property is free from any liens or encumbrances. The title company acts as an insurance provider, coordinating the transaction and ensuring that everything is paid and settled properly. Typically, closing costs for both the buyer and the seller range between one and two percent of the total transaction amount.

In addition to closing costs, house flippers also need to account for holding costs. Holding costs include expenses such as vacant property insurance, utility bills (electricity, water, gas), sewer fees, and even homeowners association (HOA) fees if applicable. These costs are incurred during the period when the property is being renovated and held before it is sold. As a general rule, estimating around $2,500 for holding costs is a good starting point, and if there's an HOA, the associated fees for six months should be added to this amount.

When all these costs are combined—purchase price, renovation budget, closing costs, and holding costs—they form what is known as the total project cost (TPC). The TPC represents the total amount required to bring the property to a condition where it can be sold for the projected resale value, also known as the after repair value (ARV). It's a critical number to consider whether you're using your own funds or seeking financing from others.

For instance, let's assume a hypothetical property is purchased for $250,000, with a renovation budget of $50,000. Adding the closing costs of around $3,500 and holding costs of $2,500, the TPC amounts to $306,000. This TPC reflects the amount needed to turn the property into a marketable asset worth $400,000.

If you're using your own funds and are not subject to interest payments, the potential profit can be calculated based on the difference between the resale value and the TPC. In this scenario, with a resale value of $400,000 and factoring in 5% realtor commissions on the sale and 1.5% closing costs, the profit would amount to $68,000. This profit can be realized within six months or the time it takes to sell the property.

However, not everyone has the necessary capital to finance the entire project independently. In such cases, hard money lenders (HML) can be a viable option. Hard money lenders offer loans based on a percentage of the ARV. For example, if the lender offers a loan-to-value (LTV) ratio of 65%, and the ARV is $400,000, they would provide a loan of $260,000 (65% of $400,000).

When using a hard money lender, there are additional factors to consider: points, interest, and junk fees. Points are upfront fees charged by the lender, typically expressed as a percentage of the loan amount. In this case, if the lender charges two points on a $260,000 loan, the fee would amount to $5,200. The interest rate is the annual rate at which interest is charged on the loan. A 12% interest rate would result in a total interest payment of $15,600 over six months. Lastly, junk fees refer to miscellaneous charges for administrative and documentation purposes.

By understanding the costs involved in house flipping and considering various financing options, you can make informed decisions that maximize your profitability. Remember to account for closing costs, holding costs, and the total project cost when planning your flip. With careful calculations and thorough research, you can embark on your house flipping journey with confidence, knowing that you have accounted for all the necessary expenses.

"Understanding the impact of closing costs and holding costs allowed me to accurately calculate my total project expenses and make informed decisions. It was a game-changer for my real estate investment journey, and I highly recommend it to anyone venturing into house flipping" - Marko Lust