In the wake of the housing crisis large institutional investors swooped into beaten-down real estate markets and bought up foreclosures, turning some into rental properties but “flipping” others.
Now, thanks to the popularity of cable TV reality shows like “Flip This House” the public has jumped into house flipping with both feet, hoping to make some fast money. And it's true that some people have made money flipping houses.
But like any get-rich-quick fad, there are things that can go wrong. And when they go wrong with something as expensive as a house, they can go very wrong indeed.
Entry and exit
As with any short-term investment you must know your entry and exit prices. Your entry price will be the price of the property, closing costs, repairs and improvements, taxes and insurance while you own it and closing costs on the sale.
If you plan to list it with a Realtor, closing costs will include a 6% sales commission. If you have to borrow the money to finance the flip, you'll pay interest between the purchase and sale closings.
The spread between your entry and exit prices may not be all that wide, meaning your potential profit may not be all that great, considering the risk. So it makes choosing the right property all the more important.
Location, location, location
The first consideration in a flip is where the property is located. A good location, near shopping, good schools, major transportation arteries and health facilities, will make the house more desirable and easier to sell at the best price.
But if it is all that desirable, you might have to pay too much for it. The market is pretty efficient at determining the fair market value of real estate.
If a nice home in a desirable location needs new carpet and roof, the price will take those improvements into account and discount the purchase price to reflect them. But you aren't going to get the property for much less than those discounts.
So after you buy the property and make needed repairs you might actually lose money on a sale.
Find a foreclosure
That means you need to find a property where the market has made a “mistake” in its valuation, pricing the property well below the market value. That rarely happens except in one situation – foreclosure.
In most instances of foreclosure, the loan servicer has purchased the property at auction for the loan amount in order to make the mortgage investors whole. It then lists the property with a Realtor at a heavily discounted price in order to sell it as quickly a possible, not worrying about the loss.
For a house-flipper, buying from a seller who is not too concerned about the size of their loss is the best seller of all. Considering flipping any house that is not a foreclosure is probably a waste of time.
Cash is king
If you must get financing in order to do a flip, buying a foreclosure at a bargain price will be very difficult. One reason banks discount foreclosures so heavily is they often require repairs in order to meet lender standards – repairs the lender trying to sell the property typically refuses to make.
If the foreclosure you want to buy has damage, in most cases you won't be able to finance it. If you are paying cash, on the other hand, it gives you enormous leverage because you won't be competing with other bargain hunters who must get a bank loan. That's where the real bargains are.
When you are looking for a foreclosure, don't overlook condos and townhouses. There is an advantage to flipping them.
A roof repair, for example, isn't something a condo or townhouse buyer has to worry about. Normally the homeowners association fee covers replacing a roof and other exterior maintenance. But make sure you read the HOA covenants carefully before making a purchase.
Go with a pro
Many house flippers plan to do the renovation and repair work themselves, but unless you happen to be a remodeling contractor, that isn't always advisable. There are two main reasons.
First, any work needs to be done professionally so that you can get top dollar. If you have a little experience you can probably do painting and wallpaper yourself but let the pros do the rest.
A second reason is time. Refurbishing a house takes longer than you might think, especially if you are trying to do it nights and weekends. Paying to have a home center store lay the new flooring and install the new appliances will allow you to get the house back on the market faster.