There’s a good chance you’ve watched the TV with rapt attention as Tarek and Christina El Moussa scout homes to buy and renovate for profit. Their million-dollar project in Laguna Beach, California was especially engaging since the couple had a lot of money on the line—and we were all left hanging without knowing whether they actually got it sold. But that’s exactly how they hook you. Whether you are a experienced or just beginning to invest in real estate it’s important to have a more realistic perspective on whether flipping high-end homes is worth it.
Flip or Flop: Can Mansions Deliver the Best ROI?
The luxury housing market is looking pretty strong so far in 2017, but is it a good time to invest? High-end home prices rose 4.2% in the first quarter of the year with an average price point of $1.65 million throughout 1,000 cities nationwide, according to research by RedFin. But, a growing inventory of luxury homes may slow these rising prices. The supply of homes priced above $1 million grew by 1% while those costing $5 million and above climbed by 15%. All this is to say that there is still an opportunity to make good returns on a high-end house—if you can get a deal significantly below market value and make economical renovations.
Let’s take a look at the El Moussas’ 11,000 square-foot Laguna Beach investment to understand the numbers and the risks. The property had been gutted for renovation when the home seller decided to back out of the project and put it on the market for $1.1 million. They managed to snag it for only $900,000, which seemed like a deal until they started pouring money into the renovation. At the start, their contractor estimated that the project would cost $80,000 to $100,000.
However, once you start refinishing a high-end home, it can get really expensive. In the El Moussas’ case, the contractor closed off the transom windows above the sliding glass doors to bring the construction up to code. However, that blocked the highly-marketable ocean view. So the couple had to pay up for custom doors to be fabricated and installed. Then, Christina decided that she didn’t like the newly-installed master bathroom tiles and paid another few thousand dollars to redo them. In total, the Moussas paid $120,000 for renovations. All of which eats into the bottom line.
This is evident in the Moussa’s high-end house flip. Although their show didn’t reveal whether the house sold or not, it’s said that they eventually offloaded the investment for $1.15 million. So, what did their profit margin look like in the end?
PROFIT MARGIN FOR SELLING $1.15 MILLION INVESTMENT PROPERTY
|Initial Cost Basis||$900,000|
|Real Estate Agent Commission/ Fees (estimated at a standard 6%)||$69,000|
|Escrow and Title Fees (estimated for Orange County, CA)||$6,800|
|Title Insurance (estimate at .15% + $500 base fee)||$2,225|
|County Transfer Taxes (typically $1.10 per $1,000 of sale price)||$1,265|
PROFIT AFTER COSTS: $50,210
That’s not a very impressive return-on-investment, especially when you consider that the El Moussas likely had other costs that were not included in this chart, like holding costs.
The reason behind the lower returns is that higher-end homes tend to come with more renovation and sale-related fees. Sellers who work with these homes have to renovate their investment property with a particular niche market in mind, requiring more expensive finishes. In addition, all the costs figured as a percentage of the sale price, like real estate agent commissions and closing costs, naturally increase at the higher price points.
Risk-Benefit Analysis of Real Estate Investing
The bottom-line is that you need to weigh your ability to absorb risk against your personal financial goals. Investing in higher-end homes ties up a lot of cash and comes with significant risk. As a result of taking on that risk, you may see higher gains, but it’s not set in stone. You could end up like the El Moussas and see only moderate returns for your money.
Investing in more modest single-family homes from distressed homebuyers can bring the same returns—or even higher—than what the El Moussas realized from their luxury project and they can be renovated and re-marketed more rapidly. If you are interested in learning more about real estate investment strategies that work, it’s time to reach out to HomeVestors®, the largest professional home buyer in the nation.
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