To Flip or Not To Flip…
- March 30, 2017
- Author: Tom K Wilson
Wow, flipping surely seems exciting on “reality” TV. Actually, it is exciting in real life too. However, the flat screen doesn’t reveal the high risk, hard work, and stress. Flipping is primarily a US term (most often applied to real estate, although it can be any asset) that defines a purchase below market with the intent of selling (with our without adding value) at a higher price.
Critics often project that it is somehow unethical and fraudulent. Indeed any potential fast profit business can bring out some bad elements, however, with rare exception flippers provide a great benefit to the marketplace by removing blighted properties from communities, return them to the owner and rental marketplace, and increasing property values and tax revenue to the community. I am proud to be a flipper.
Make no mistake, I am first a long term hold investor. Why? These are assets that provide relatively passive income, and have appreciating income and asset values with inflation. Flipping is a business with very active participation with the highest tax bracket. However, it can produce a lot of short term income if done well.
A very small percentage of investors have done flips for a long time. Many more jumped on the 2000 to 2007 boom, and as we know, many caught the falling knife when the greater fool model collapsed in 2008.
Most good cities for flipping now a have short supply and high demand, especially at median to lower price ranges, encouraging newcomers to this dramatic cottage industry to bid too high in desperation to get a product and then count on the market being higher when they sell. Dangerous on both counts. The supply demand imbalance is better at higher prices where they are out of spec for hedge funds and the barrier to entry is higher, but you take on more risk and capital requirements. But if you still want to enter this cottage industry and give it a shot, at least I want you to go into it with your eyes open.
The goal is to make maximum profit per month with minimum risk. For example making $50K on a $500K resale in 3 months in an $800K median price neighborhood is better than making $100K on a $1,000K resale in the same neighborhood in 12 months. You want to keep your money moving. Don’t buy what looks like a killer deal in a low demand area only to find it takes you 8 months to sell it after dropping the price 3 times with two buyer fallouts (guess how I know that).
Know your market or get someone who does. Critical analysis of the sales comps on both the purchase price and resale price is mandatory. This is as much of an art as a science. Your resale price assessment has to be based on what the product would appraise for with a Federally backed loan, because like it or not, that is what sets the market.
Plan your improvements in proportion to the relative price of the neighborhood. Nice consistent finish with Home Depot stainless appliances and prefab granite will be fine for median price houses. But when you get to 1.5x median and higher, design is critical (see table X). In either case, I believe that 80% of buyers make up their mind if they want the house by the time they get through the front door, so curb appeal and feeling upon entry is king at any price. Put more money in the front than in the back. I always want my product to be the best on the market in it’s class. And if your agent tells you it is not necessary to stage because others don’t, say that’s perfect and exactly why I am going to; this is a high ROI item.
The example on this page was completed in 2013 in Campbell, Ca., in the heart of Silicon Valley. It was a high value added flip with a strategy to fully leverage a highly appreciating market and a neighborhood that had some recent sales that were three times higher than our purchase price. An exceptional opportunity indeed. We could have remodeled a non-code compliant wing, but we chose instead to scrape it and rebuild it with additional square feet for higher value added. This decision paid off well.
I knew from 38 years of investing and experiencing my fourth real estate cycle that I should not count on the appreciating market, i.e., it had to pencil out for a profit without an up market, but if my educated prediction (lucky genius guess!) was right, I could increase my profit. The bad news was that because of city inspection and permit challenges, the schedule was overrun. The good news is that the appreciating market indeed increased our profit by a factor of about 2.
Proceed cautiously and with expert partner, coaching, and consultants. Narrow down what and where you want to focus. Don’t be in too big a hurry or you will overpay. Know what your maximum price is before you offer and negotiate. Don’t fall in love with it; be prepared to walk away if it doesn’t pencil out. After you win, do your homework, set subs in place, prep for permits and be ready to demo on day one after COE.
Set artificial deadlines and/or give contractors incentive and penalty clauses. Set high expectations and drive for closure. Use planning tools to make sure no material or sub sequence delays the project. Motivate your crew with compliments, buying lunches, bonuses; let them know that you feel that they are important; they are. Get rid of non-performers. Re-evaluate your market carefully and set your specific strategy when you list. And when the project is complete, celebrate with your workers and team, and when it closes, celebrate again!
- Wholesale with assignment contract
- Wholesale with purchase & resale
- Cosmetic Added Value
- Structural Added Value
- Added Value with addition
- Scraper with new build (Spec)
- Get an experienced partner & consultants
- Buy only in high demand areas
- Line up lenders before looking for your deal
- Focus on non-listed properties
- Purchase the cheapest house on the block
- Get fixed bids for major work
- Put more money in the front than the back
- Minimize risk: permit structural work, 1099, insure
- Pay your GC directly; let him pay the workers
- Follow the herd; instead find a niche
- Over Improve for the neighborhood
- Underestimate Rehab Costs
- Over estimate resale price
- Make many changes: they are costly
- Count on Market Appreciation
- Have a failure & not learn from it
- Feel Invincible because you have a success
- Subject-To Assumptions
- Hard Money Loans
- Private Loans
- Equity Share
High End Flip Requirements
- Exceptional Curb Appeal
- Dramatic Architecture but not Eccentric
- Great Open Floor plan
- Volume (cathedral or high ceilings)
- Totally Updated
- High Quality Consistent Finish Throughout
Purchase Close Date
Purchase Closing Costs
Resale Close Date
Resale Closing Costs
Total Rehab Cost
Total Holding Cost*