Foreclosure Property: Deal or No Deal? Part 2 "Flipping"

Ever heard of "Flip This House", or "Flipping Out"? If you haven't, "Flipping" refers to buying distressed property: foreclosure, short sales, estate sales, or just plain dumpy property, fixing it up comparable to other houses in the neighborhood very quickly, and putting it back on the market for sale, and then sell it for huge profits. Don't be fooled by these "Reality" shows. Remember "Flip This House" never really discloses exacly what the house sells for and how much the flipper actually makes in profit on the deal, they only offer projections. Check out this video below about one of the stars of "Flip This House."

Check out the story of the "Flip This House" veteran

In booming real estate markets you might have heard investors (on radio/TV infommercials) boasting about how they made $300,000 in three months using some "Home Flipping System." Fast money is sexy money, isn't it? Even the term "flipping" evokes the same type of emotion as high stakes poker or day trading technology stocks. These activities sound glamorous because they are seemingly fast easy profits. Who doesn't want make more money by working less? Its human nature. We tend to want to go through the path of least resistance. The action phrase at the beginning of the paragraph is "In a booming real estate market." Are we in a booming real estate market right now? It's not too bad in the Rochester, NY market but it's certainly not "booming." The point I am trying to make is that flipping property is only very profitable when prices are rising very quickly. Let's be honest, when prices are rising, everyone is making money not just flippers.

The house flipper reminds me of the "Dot Com Boom" day trader. Think about it:

1. Wake up at 8:30




2. Pour yourself some coffee




3. Buy 1000 shares of Microsoft for $20 at 9:30




4. Then sell for $22 a share at 10:30




5. Repeat or take the rest of the day off.

And you didn't even have to get rid of your morning breath or bed head! Fast forward a few years, now those people lost their shirt and ended up having to get a real job like the rest of us. If making fast money was easy, and since many of us don't like working harder for less money, wouldn't we all be doing it?

Now, I don't mean to say that there is no money to be made flipping houses, there just isn't nearly as much money to be made as you might think. Sure, some people get lucky (even in crappy real estate markets), but do you really want to leave your hard earned money to a draw of luck. It requires patience, constant supervision, and a lot of homework (HOMEWORK?!) Yes, homework. Do not do this by yourself. A second opinion always helps, work with your real estate agent to develop the best plan. Rehabbing and selling homes is some of my clients full time businesses and have been for a long time. They do not live a decadent lifestyle like you see on TV, but at least they have the opportunity to be their own boss and do something that they love.

If you are going to flip a house, keep three things in mind:

1. Before investing in any private business venture, make sure you have a detailed plan and be sure to budget for unexpected expenses, especially with older homes. For instance, if the entire project cost is estimated to be $185,000, including the purchase and renovation cost, budget at least 10% or $18,500 towards unexpected costs that may arise. The more distressed the property, they higher percentage you will want to dedicate. We call this contingency planning in the business world. Wall Street and government are not role models for the aspect of contingency planning (refer to current events) but I digress. For example, you may not be aware of a collapsed sewer line to the street because the property has been vacant for years and the water is shut off. Don't underestimate the benefits of getting an inspection from a reputable company after you have come to contract with the bank. Even if you think you know the ins and outs of home construction, you are bound to miss something. So get an inspection lest you lose your shirt.




2. Take into account that whatever profits that you earn upon the sale of the property may be subject to capital gains tax, which will be taxed at the same rate as your ordinary income. Keep records of all your expenses associated with rehabilitating the property, no matter how small each may be. Every Home Depot reciept can add up big time. In any event, you should consult with a Certified Public Accountant before doing anything, so that you can develop a plan which will leave you with the least amount of tax liability, unless you actually like paying more than what you owe.




3. On a recent note, flipped properties can cause problems with financing when you put it back on the market, especially buyers using an FHA mortgage. Since flipping and over extended investing did its part in causing the market turmoil that we have now, banks are scrutinizing everything and that includes "Flipped" property that their borrower intends to purchase. They will want to know, "The property was sold recently for $80,000, what justifies a new value of $200,000?" Right now, some lenders are requiring two appraisals to be done on a flipped property, doubling the up front appraisal fee for a potential buyer. This may not seem like a big deal, however it puts your investment property at a competitive disadvantage. Some banks will require you to have all documentation about the improvements done to the property to justify its new higher value. So have that in order right from the start. These new guidelines may even get tighter in the near future so be wary. Below is an example of exactly why banks are doing this now on "flipped" property:

As the saying goes, "You need to spend money to make money!" And these days, cash is king. Overleveraging can leave you in a negative cash flow position very quickly, so be very careful when borrowing money to spearhead projects. If you do not want to use your own cash, you can always look into borrowing against other assets that you might own. If you have a large equity position in your current primary residence, a home equity line of credit could help you finance a real estate investment project. If you have a 401(k) or retirement plan, some employers allow you to borrow a certain percentage against these retirement assets. When it comes to capital, you have to be creative when not using your own cash. If you must, there are still mortgages that allow income verified individuals with excellent credit to buy an investment property with 25% down. Or Fannie Mae allows their REO properties to be financed with just 10% down for investors using their HomePath Finance through select lenders: http://reosearch.fanniemae.com/reosearch/. Whatever you do, shy away from "Flipping Systems" that claim to allow buying investment property with no out of pocket cash, an overwhelming majority of these are scams. And be very wary of internet characters insisting "Use My Cash To Flip Real Estate!" If you get involved with them, you might find yourself with a lawsuit on your hands and possible time behind bars!

I sincerely hope that this helps. Next installment will be guidelines and specifics for the buy and hold real estate investment strategy (one of my favorites).