Real Estate Acrobatics: Are They Still Possible?

Physician's Money DigestAugust 2007
Volume 14
Issue 8

"Chance favors only the prepared mind." —Louis Pasteur

4%—Percentage of the average decline of the median price of an existing home since the peak in October 2005. (New York Times, 2007)

With the rapidly appreciating real estate market that has carried through the early part of the 21st century, real estate flipping seems to be a great way to make instant money. Buy a house at a low value, and sell it at a higher price. Or, buy a house and wait, allowing market appreciation to increase the value of the home, and then sell at a handsome profit.

But, it's not that easy, according to Dr. Paul Hanks, a specialist orthodontist who is also a registered California real estate broker.

"Many people have assumed that it was just a case of finding a house, buying it, and then putting it back up for sale at a higher price," Hanks explains. "Others would buy, improve, and then sell and tell everyone that they made a profit. Yet, no one builds into the 'selling profit' the costs in commissions, taxes, and expenses made to improve the property. This can eat away at profits."

Understanding the ins and outs of real estate flipping is critical to success.

Tumultuous Market Conditions

Hanks explains that the reason for flipping a property will determine the level of success and the work that is needed. And given current market conditions, Hanks believes that flipping is pretty hard work.

"Finding a house at a price that is lower than market comparisons with the hope of relisting at a higher price is difficult to say the least," Hanks explains. "The market has a downward direction, and more likely prices would not have changed since you bought the property. Added to that is the fact the buyers are aware of people making profits and the market conditions. Many buyers look at the date the property was last purchased and for how much. They are hardly likely to pay more for a house purchased 3 months previously than it is selling for now."

Tara-Nicholle Nelson, Esq, an experienced real estate broker and author of The Savvy Woman's Homebuying Handbook (Prosperity Way; 2007), agrees. Nelson's market is the East San Francisco Bay area, and she says there are several reasons why it’s difficult to flip profitably in her neck of the woods. For example, the average single family residence in her markets runs in the mid to high $500,000 range. A home that needs moderate work may be discounted 5% to 10%, but Nelson says that's simply not enough of a discount for a flipper to be able to purchase the property, do the work, and sell at a profit.

"Also, the high price of buying here translates into very high carrying costs during the time it takes to fix and sell the property, and into high closing costs and commissions on the sell side," Nelson says. "I actually flip high-end homes myself, and it is extremely tough to find the right properties, even as an insider. I estimate that I look at 75 to 100 homes before I deem one appropriate for a flip."

And the term "flip" makes the process sound easy, when it is not.

Landing on Your Feet

Robyn Roth is a real estate lawyer in Los Angeles and coauthor of Remodel This? A Woman's Guide to Planning and Surviving the Madness of a Home Renovation (Perigee; 2007). She explains that there is no such thing as an easy flip. "The risks can be high, and unless you do your homework, you can get burned and lose money," Roth points out.

According to Roth, the last property she flipped was a four-plex that looked like a complete disaster. She even had difficulty securing the 75% loan on the $790,000 purchase price because the appraiser was so put off by the property's apparent condition.

"I had to convince the appraiser of what I knew: that even though the place looked like it was about to fall apart, it actually had a solid structure, and that most of the repairs required—with the exception of repairing the chimney, installing a new electrical system, and relocating some utilities underground— were cosmetic," Roth explains.

Roth then spent approximately $65,000 to refinish the hardwood floors, replace carpeting with inexpensive- but-beautiful bamboo floors, and repair the fireplace and chimney. She also installed a new electrical system and relocated the gas lines underground, updated and beautified the bathrooms and kitchens, painted inside and out, and replaced the cracked and stained asphalt patio with simple and beautiful landscaping.

"The property went from being a neighborhood eyesore to being the cutest little cottage on the block," Roth says. "It commanded top rents for the area, and soon it was fully leased. The following year, I placed the property on the market for $999,000, and sold it after receiving multiple offers, including an offer for $1.4 million."

But, that only happened because Roth did her homework. And according to Nelson, statistics show that more people come out on the short end of a flipping experience. She points out that the California Association of Realtors recently reported that one of every four flips loses money.

"This is completely consistent with my observations and experience," Nelson notes.

Having the Right Leverage

The National Association of Realtors recently announced that sales of new homes soared 16.2% in April, the largest monthly gain in 14 years. In addition, total single-family sales—both new and existing— during the first 4 months of 2007 averaged $5.5 million, about the same pace as the final 4 months of 2006.

That doesn't mean we're in an appreciating real estate market again. And experts caution that, if you're considering entering the flipping game anytime soon, there are several important considerations to take into account.

"You have to consider flipping as buying a property," Hanks says. "You have to include all the buying costs, possible maintenance, improvements, and the selling costs. Most importantly, you are relying on someone buying the house at your potential selling cost. You need to be certain of the probability of finding a seller first."

There is no right time to flip a property. Timing varies from house to house and market to market. But Nelson believes that individuals who are looking at real estate flipping as a way to get rich quick are only setting themselves up for failure. "For the average individual flipper, there is an inherent conflict between wanting to be deliberate, taking their time and doing quality work, and the reality that every month the house sits vacant during the rehab process, someone is having to come up with mortgage and tax payments," Nelson explains. "So, time is definitely of the essence in flipping, and minimizing the time it takes to flip is a primary goal of the profitable flipper."

Nelson points out that the profitable flippers she knows have a contractor who does quality work, but do about two flips a year and focus on the high end. Many realtors feel that once you find a contractor with whom you work well, you need to keep that person consistently busy, and two houses a year will do that, if the work is involved enough.

However, she cautions that "timing is not something flippers have total control over." In fact, a rule of thumb is that you should estimate that a contractor will take 20% to 30% longer to do the job than they originally estimated. There are also often delays created by the process of getting government permits and inspections completed.

A Checklist for Flipping

Nelson and Roth offer the following checklist for successfully flipping a house:

  • Do your homework! Is the property a good candidate for flipping? Manage your risks by checking out comparable homes in the neighborhood.
  • Get renovation bids from contractors on the work to be done before you buy the property.
  • Consider doing your first flip with someone who's been there before. You may have to share the profits, but you’ll also have someone to share unforeseen costs and expenses, and you won't take quite as hard a hit if the project loses money.
  • Build and renovate everything to code and with building permits where required. Be economical, but do not cut corners.
  • Do not skimp on the commission you offer to buyers' agents when you sell. Offering a full commission to buyers' agents is the fastest and most sure way to make certain your flip house is exposed to the largest number of qualified and motivated buyers.
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