Flipping More Than a Fad?
There's still money to be made in short-term real estate investing, but with markets cooling, be prepared to put in some hard work.
Has the house flipping bloom finally fallen off the rose? HomeSmart LLC in San Juan Capistrano, California, which tracks real estate deals in 150 metro areas coast to coast, found that in every region, the proportion of home sales for properties owned six months or less has fallen dramatically since hitting a peak in 2005. HomeSmart President Mike Ela says he assumes most of that quick buying and selling was intentional, which fits his definition of "flipping." Not only are flips becoming less prevalent, but they're also becoming riskier.
In Florida, for example, only 2.6 percent of home sales were for flipped properties in the third quarter of 2003. But that percentage had more than doubled to 5.8 percent by the third quarter of 2005. As the real estate market cooled, the percentage dropped, hitting 2.4 percent in the final three months of last year. When flipping was at its peak in 2005, only 12 percent of deals resulted in a loss, according to HomeSmart. If they did dip into the red, it was for an average of $8,775. More recently, one in four deals lost money at an average of $23,250 per transaction.
That's not to suggest, however, that short-term real estate investing is a dog whose day is past. In fact, with foreclosures rising this spring in the subprime market, there will be an increasing number of opportunities for entrepreneurs in some markets. Ela says there are bargain properties coming available at this point in the real estate cycle, but that buyers shouldn't assume one is a deal just because it's in foreclosure. "The previous buyer may have overpaid for it, and the lender may have loaned too much money on it," he says. "Lenders sometimes make bad choices. Don't make their mistake your mistake."
Before you start looking for properties, there are some basics you should keep in mind. Ela assumes buyers spend an average of 5 percent of the purchase price for things like Realtor commissions and rehab work, so a "profitable" sale is one that goes for at least 105 percent of the amount originally paid. The goal usually is to find a property selling for 70 percent or less than its intrinsic value, make a series of cosmetic repairs and then put it back on the market. One popular strategy is to look for rundown houses in otherwise nice areas, on the assumption that the neighborhood's value will rub off on your ugly duckling if you can make it a little less ugly.
Now that the froth is off the market and you can't count on rapid price appreciation, how do you find these gems and beat other investors to them? Know that it can be done, but don't expect it to be easy.
First pick an area on which you'd like to focus and learn more about it than other potential investors. Drive the neighborhoods and check the public records and real estate agents' websites to see how long properties stay on the market and what they eventually fetch. Also get to know the contractors and real estate agents; there's a good chance you'll eventually want to negotiate with one of them to handle transactions for you for far less than their standard 6 percent fee. Get up to speed on the local building permit and coding process, too.
Meanwhile, learn everything you can about home buying and remodeling in general. It helps keep costs down, but isn't mandatory, if you're able to do at least some of the remodeling work yourself. Read books, lurk in the real estate forums online and talk to people with experience about potential trapdoors and hidden hurdles in the business. In fact, you might want to partner with someone more experienced for your first deal or two.
Then be patient. When and if a good opportunity does come up, you'll be ready. You'll know the market well enough to gauge the value, you'll have your financing already lined up, and you'll know what you need to do to make a profit. "There always has been and always will be a segment of the market that actually makes pretty good money with this traditional house flipping approach," says Julian Diaz III, chairman of the Department of Real Estate at Georgia State University. "What these people do is they spend a lot of due diligence searching for an appropriate property and, when they identify one, they know to inspect it very, very well. You want cosmetic issues, not fundamental structural issues."
Finally, ignore the infomercials and online promos that push flipping as a can't-lose strategy. The problem is that you can lose, and a simple troll through real estate forums on many sites will identify people who have. Some investors have emptied their IRAs or even lost their own homes when they paid too much, underestimated the cost of needed repairs or couldn't find buyers willing to pay more than they did.
Basically, work harder and smarter than the next guy, rather than trying to get rich quick. "People can make money in real estate, but it really does take hard work and the development of expertise," Diaz says.
A final caveat: Before investing, talk to a lawyer about setting up an LLC or other business. It'll cost $500 or less and could end up protecting your personal assets from a deal gone bad.