How to Account for Operational Costs in House Flipping

Operational costs, sometimes called quiet costs, are the cost of doing business. To accurately calculate your return on investment and ensure a profitable house flip, it is essential to calculate your operational costs accurately. Account for them now and ensure profit later.

If not done correctly, operational costs will eat up your return on investment. You can go from $10,000 in profit to $0 just by miscalculating operational costs. In the big picture of house flipping, operational costs left unchecked can be a weakness to your business and hurt your bottom line.

Of all the estimated costs in the house flipping business, operational costs are the simplest to estimate, and the most often overlooked.

Recommended: Learn how to flip a house with our guide.

What Are the Operational Costs to Flip a House?

House flippers buy investment properties that need to be updated to renovate them and sell them at a higher price. The difference between all the operational costs and the price the house sells for is their profit.

If you’re starting a business to flip houses and are trying to learn more about how to purchase your first investment property, you’ll want to learn more about these costs.

In house flipping, operational costs include:

• Buying costs
• The cost of money
• Holding costs
• Selling costs

Within these operational costs, you will have to account for loan interest, real estate commissions, and property taxes. These are not the most glamorous expenses, but they are necessary to run your business. Avoid miscalculation by keeping your operational costs in mind from the very beginning.

Follow our five-step process to calculate operational expenses:

Step 1: Buying Costs

Buying costs are the initial expense output required to purchase a property. To estimate buying costs, you need to know the final purchase price. To create an estimate, simply select a reasonable price for the property based on your research of the target neighborhood. This will be your estimated purchase price.

What buying costs include:

Buying costs include more than just paying the real estate agent fees.

You’ll also need to consider:

• Survey Costs
• Appraisal Costs
• Title insurance
• Documentation

While many of these are usually paid for by the seller with your fast closing and no-hassles offer, it can be a good strategy to pay these for the seller. This can help keep the price down and the transactions quick.

A simple estimate of buying costs is 1.5% of the final purchase price.

Example: If your final home purchase price is $220,000, then your buying costs will be:
$220,000
x .015
= $3,300.

In this example, with a final purchase price of $220,000, you should budget $3,300 for buying costs.

Step 2: The Cost of Money

You have to spend money to make money. In real estate investment, you need capital in order to grow your business. If you have the full amount of cash to invest in house flipping upfront — great. If not, you will need to accurately account for the cost of obtaining a loan either from a bank or from a private investor.

If you choose the loan approach, you’ll need to have good business credit to qualify. You can learn more about how to build business credit, improve your business's credit score, and apply for a business loan with our business guides.

Even if you have the funds available for your first house flip without a loan, this step is important. By learning how to use loans to leverage your business, you can obtain the resources you need for multiple house flipping projects at once.

Recommended: Once you’ve formalized your business as an LLC or a corporation and are making a good profit, you may want to consider electing an S corp tax status. You can learn more if this tax classification is right for your business in our guide Why Would You Choose an S Corporation?

When calculating the cost of money, there are three important components:

• Loan amount
• Loan duration
• Loan terms

Put simply, you need to ask yourself:

• How much money do I need to borrow?
• How long do I need it for?
• How much will it cost me in interest and other fees?

Loan Amount

The loan amount is fairly simple to calculate. You need to account for the cost of the house, the improvements you plan to make, plus the buying costs. From this number, you will subtract the amount of your down payment.

Cost of house + improvement costs + buying costs - down payment = loan amount

Example:
$220,000 cost of house
+ $40,000 improvement costs
+ $3,300 buying costs
- $40,000 down payment
= $223,300 loan amount

Loan Duration

The second consideration is the loan duration. This is how long you will need the money for. In house flipping, this will have to be estimated unless you have a final buyer lined up from the moment you purchase the house.

The biggest variable in this calculation will be how long it takes to fix up the house. With more experience, you will become confident in estimating the time to complete improvements. Here is a shortcut:

Time of improvement costs are correlated with the cost of improvement per square foot.

That means that there is a big difference in time required for cosmetic upgrades ($10 to $15 per square foot) versus major remodels ($40+ per square foot). The same number you use to make a quick estimate of improvement costs can be used to estimate time required to finish improvements.

Estimate Time for Improvements
If you take the total cost per square foot for improvements and divide by 10, you get the months required to fix up a house.

Cost per square foot ÷ 10 = months to renovate

Example 1:
A house needs new paint, new carpets, and a few minor fixes.
Renovation is estimated to cost $10 per square foot.
$10 ÷ 10 = 1
This house can be renovated in one month and flipped to sell.

Example 2:
A house needs a new kitchen and a new bathtub. You plan to add an outdoor hot tub, new paint, new carpets, and other minor fixes.
Renovation is estimated to cost $45 per square foot.
$45 ÷ 10 = 4.5
Renovation will take about 4.5 months for this house.

Once you have the estimated time for improvements, add 2.5 months for the time required to hold and sell the house. This will be your total estimated loan duration.

Estimated time + 2.5 months = loan duration

Example 1:
1 month renovation
+ 2.5 months to complete sale
= 3.5 month loan duration

Example 2:
4.5 months renovation
+ 2.5 months to complete sale
= 7 month loan duration

With a clear estimate of how many months you will hold the house, you can calculate how much you will pay per month in interest. You can also calculate the total estimated expense on interest and other fees, according to the terms of the loan.

Loan Terms

It is worthwhile searching out different sources of funding to find the most favorable loan terms. Often, a private lender will have the cash available more quickly and with less paperwork to go through. Banks often offer a lower interest rate but take considerably longer to process the loan and have strict criteria about who qualifies for a loan.

Lenders often require both interest and points as a return on their investment.

Interest
Interest is a percentage of the loan to be paid in addition to the initial loan amount and is usually calculated annually. For example, the interest of 12% annually on a $100,000 loan would mean that at the end of a year you need to pay back $112,000. Taken on a monthly scale, this would be 1% per month in interest.

However, interest can also be given as a monthly rate. A 12% monthly interest would mean you have to pay back much more. In the first month, you will owe $12,000 in interest plus a partial or complete repayment of the loan.

Be alert to the interest terms to ensure you are getting a good rate.

Points
Points are a term used by investors to mean a percentage of the loan. One point equals one percent of the loan amount. Points are usually paid when the loan is repaid. A lender might say they are charging 12% annual interest plus five points, three points, or any other number. Be alert to include points and interest in your calculations.

Example
Let’s revisit the example above of a $100,000 loan. Suppose the investor says they will charge 10% annual interest plus five points.

The repayment amount at the end of the year would be:

$100,000 loan amount
+ $12,000 interest ($100,000 x 12%)
+ $5,000 points ($100,000 x 5%)
= $117,000 repayment amount

This example assumes you hold the house for an entire year. If you only hold the house for 3.5 months, the new calculation will be:

$100,000 loan amount
+ $3,500 interest ($100,000 x 3.5%)
+ $5,000 points ($100,000 x 5%)
= $108,500 repayment amount

With these simple calculations, you can take the steps to accurately calculate any loan amount. Just plug in your numbers in the examples above, and the estimate is done in minutes. While it may look intimidating, calculating the cost of money can be quick and simple.

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Step 3: Holding Costs

Holding costs are the costs, other than interest, that you must pay while holding a house for flipping.

Typical holding costs are:

• Insurance
• Property taxes
• Utilities
• Cleaning services
• Yard services
• Trash and waste removal
• Neighborhood association fees

While these costs will vary greatly from house to house, experienced house flippers take a simple educated estimate of 1.5% of the final house sale price or the estimated sale price.

Example:
If the house will be sold for $220,000, then 1.5% will be $3,300. In this example, $3,300 will be your holding costs.

Notice that this 1.5% estimate is the same as the estimate you calculated in step 1 for the buying costs. If you prefer, you can skip a step and calculate buying costs and holding costs together as 3%.

Buy costs = 1.5% = $3,300
Holding costs = 1.5% = $3,300
Buying and holding costs together = 3% = $6,600

Step 4: Selling Costs

Selling costs are the final costs incurred in the house flipping process. Selling costs are the cost associated with listing the house and selling it.

The two main components of selling costs are:

• Real estate agent commissions
• Closing costs

Real Estate Agent Commissions

You should plan to pay 3% of the eventual selling price, often abbreviated as ESP, to the real estate agent representing the buyer.

You should also plan to pay the real estate agent representing you a commission of 2% to 3%. It is worth this fee to have a professional handle all the steps for you and also negotiate the best price in your favor.

While you may be able to sell the house yourself, as a real estate investor, your time is better spent following leads for the next house to flip. A real estate agent is familiar with all the steps involved in closing the transaction and can facilitate a quick close. Let them work for you while you line up your next house to flip.

If you’re looking for a great way to find houses to flip, foreclosure.com is a great way to find local, low-cost (distressed), foreclosed properties online that would otherwise be difficult to find. With a database that updates twice a day, you can quickly secure your next real estate investment deal and create new opportunities for your business.

Many of the same expenses you had when buying the house will need to be paid when you are selling it.

These are:

• Survey Costs
• Appraisal Costs
• Title insurance
• Documentation

Just as in step one, these closing costs will be about 1.5% of the ESP.

Calculating the Selling Costs

When calculating the selling costs you need to include:

• Real estate agent’s commission (buyer’s agent): 3%
• Real estate agent’s commission (your agent): 2% to 3%
• Closing costs: 1.5%

Your total selling costs will be 6.5% to 7.5% of the ESP.

Example:
You plan to sell a house for $350,000. Your selling costs will be:

$10,500 commission for buyer agent ($350,000 x 3%)
+ $7,000 commission for your agent ($350,000 x 2%)
+ $5,250 closing costs ($350,000 x 1.5%)
= $350,000 x 6.5% = $22,750 selling costs

Step 5: Putting It All Together

Now that you have estimated each of the operational costs associated with house flipping, you are prepared to make your final estimate in operational costs for your next house flipping project. The formula is simple:

Operational Cost Formula

Calculate the operational costs as follows:

Buying costs
+ Cost of money
+ Holding costs
+ Selling cost
= Operational Costs

If you use the estimation guides outlined in this article, your operational costs will look like this:

Buying costs (1.5% of ESP)
+ Cost of money (variable)
+ Holding costs (1.5% of ESP)
+ Selling cost (6.5% to 7.5% of ESP)
= Operational Costs

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Summary

Now you’ve seen how simple it is to break down operational costs into the key components of buying costs, the cost of money, holding costs, and selling costs. With this information, you can effectively calculate the operational costs on any house flipping project.

It is worth practicing the simple formulas mentioned here until they are automatic. Once you have a clear grasp of operational costs, you avoid the hidden trap that catches the profit of so many house flippers.

The ability to accurately calculate operational costs brings value to you and to investors. You need to know how much money you will make after rehab and operational costs. If you miscalculate the operational costs, you could lose your profit. The ability to clearly foresee and calculate operational costs ensures a profitable house flip.

As always, calculate twice to ensure the greatest profit. With a clear overall picture of the expenses of your project, you ensure a good return on investment and secure your profit on every house flip.