Fix it and Flip it – How I Lost Money on Real Estate
I've known a lot of people who have lost money when they sold their homes. In fact, I'm one of those people, and it's happened to me more than once.
There are a number of factors can cause a financial loss when you sell your house, including the need to sell at the wrong time due to divorce or an impending foreclosure, or a downturn in the local real estate market. However, it's also common to lose money simply by making too many expensive changes to the house before putting it on the market. This is how I lost money on real estate, before I wised up.
My most resounding failure in the fix it and flip it market was a house I bought in Spokane, Washington. Knowing what I know now, I would have restricted myself to replacing the carpets and the kitchen and bathroom fixtures, painting inside and out, and buying new appliances. I probably would have replaced the old-style windows, too, to make the place look nicer and appeal to the energy-conscious buyer. These fixes could have been done easily within the two years I needed to live there to avoid capital gains taxes.
Since I didn't know what I know now, I made major renovations, which included moving the bathroom. I did most of the work myself, but the materials alone cost more than I could get back when the house was sold. With the exception of repairs done to the house to make it eligible for an FHA loan and watering the grass, I doubt that any of my major projects really helped me sell the house or increased its value.
If a house is actually sound, with no structural damage or insect problems, the biggest reason it will sell for less than its worth is usually cosmetic. This was certainly true of the house I bought in Spokane. Dirty carpeting, and a wall in the living room covered with mirror tiles, kept most buyers from going any further into the house. I could see past the cosmetic problems and see the home's full potential - but my imagination went a bit too far.
The floor plan was odd, and slightly inconvenient, but leaving the bathroom where it was would have been far more rational, financially. Why didn't I do that? Because my emotions and my nesting instincts took over, pushing aside all thought of future gain or loss.
Let's face it - most people don't buy their own homes with the intention of making a profit, although they certainly hope the house will be a good investment. In fact, the emotional stress caused by the process of buying a house and moving into it can be enough to completely erase any thought of moving again a few years later. However, I know several families who have made a very good living by buying underpriced homes, living in them and fixing them up, and then selling them when the IRS will allow them to do so without paying extra taxes. Clearly, these folks don't make any changes to these houses without carefully considering the bottom line.
After my Spokane adventure, I decided to learn from my mistakes, and find out how to stop losing money on houses. I read books by authors who are experienced in fixing and flipping houses - and then read them again. When I saw that most remodeling projects almost never recoup their costs when the house is sold, I was a little shocked, because I had been guilty of almost every mistake on the list at one time or another. I know many people who have also made the same mistakes, even when they started those remodeling projects with the intention of increasing the value of their homes.
When I bought my next house, I kept that list very firmly in mind. For instance, my kitchen was badly in need of a major overhaul, (or so I believed), and it was far too small. I pored over the latest home decorating magazines, and ideas came flooding into my head. I thought about knocking out some walls, and I even tried to imagine adding on to the house to make the kitchen bigger. New cabinets would be needed, and new appliances...
In the end I painted the kitchen cabinets and replaced the sink with a new one I purchased at Ikea. I covered the chipped orange Formica counters with printed cotton fabric, and coated it with many layers of water-based Verathane that was intended to protect wood floors. The complete "remodel" cost less than $400, as opposed to the thousands of dollars that I would have spent if I followed through on my idle dreams of a "perfect" kitchen. Since the house sold at a very good price within two weeks of listing it, my buyer obviously didn't mind that the kitchen didn't meet my idea of perfect. Because I kept my costs down, I made a handy profit on the sale.
Would I have been able to sell the house for more money if the kitchen had been remodeled and expanded? Perhaps, but not enough to cover the cost of the remodel. Although the National Association of Realtors lists a kitchen remodel as one of the projects that will increase a house the most, they still advise that you should expect to get back only 80% of the costs. If your new kitchen is far fancier, bigger, and more expensive than any other kitchen in the neighborhood, the returns will be even less. A full kitchen remodel can cost thousands of dollars, so the 20% you don't get back can be a big chunk of change.
Does this mean that you shouldn't make changes to your home that would make you happy? Not at all, especially if you intend to live there for many years. But it does pay to sit down with your spouse or partner before you start making your remodeling plans, determine exactly how long you'll be staying in the home, and then think about the full financial implications of the remodeling project. Even if you don't think of yourself as a professional house flipper, it might pay to slow down a bit and find ways to improve the home without spending money you'll never see again. As a bonus, your family might be able to avoid the stress and disruption of all that remodeling mess.