Ah the glorious days of flipping real estate and climbing the property ladder. Buy a cheap home, toss some in some new paint, carpet, cabinets and maybe an air conditioner and furnace and pocket a quick $20,000 – $50,000.
I for one think flipping is dead for the foresee-able future, but let me make my case before you condemn me entirely. I want to first acknowledge that there are ways for professionals to make a small margin on flipping, and that I am directing this post towards “normal everyday” people.
There are some good sides to having a downward economy when it comes to real estate of course. The biggest benefits that I can think of would be pricing, interest rates, and cheaper labor. After reading that last sentence you might think – cheap houses, lots of inventory to choose from, and easy to find labor – Sounds perfect for flipping…but not so fast.
Pricing: The reason why prices are so cheap is because there are no buyers and there is an excess of inventory, which is perfect for you as a buyer – but terrible for you as a seller. You will have to complete for the few buyers that are out there with quality, location, and price. That means no cutting corners and maybe cutting into your margin to persuade buyers.
Interest Rates: Low interest rates can be good, but they also can be a double edged sword. If interest rates turn around, it can hurt how much people can justify financing as a purchase price for your property. If you get stuck with a property for a substantial period of time and interest rates spike, you stand to get destroyed.
Cheap Labor: Cheap labor is pretty hard to argue against, except for the argument before – which is that there is excess for reasons that don’t hint towards strength in the housing market.
So let’s talk about hypotheticals.
You find a house in a neighborhood listed for 180k, where a similar house in good condition is listed for $250k . The house only needs approximately 30k in work if you do some of the work yourself. You purchase the house for $180k and somehow manage to stick to your budget (which is rarely the case). Maybe you replace the kitchen and install new paint and carpet (which is 30k alone). Okay – now’s lets talk about your break even scenario.
You have $180k in the purchase price + 30k in Work = $210k in the home
You carried the home for lets say 2 months which cost you $3k and you had closing costs of $3k = $216k in the home.
You opt into using a local broker and you list the home at 250k, assuming your broker takes the standard 6%, your break even is 216k = .94x, $229,787 assuming you sell it within the 2 months.
Now’s talk about reality. Most likely you are not going to sell it in 2 months and most likely you are not going to get full asking price since there are other homes in your neighborhood listed as well. Probably you are going to have to shave off $10-15k off the sale price and it is going to take 6-12 months to sell at that reduced price.
Factoring in $240k as the sale price and you hold the property for a more realistic 6 months (until time of closing) the numbers become: $240k – $210 (PP + rehab) – $9k (Carry Cost) – $14.4k (realtor fee) – $3k (closing) = $3,600 profit. I would view that as almost a “best case scenario” as well, and would warn that its very easy for this situation to produce a loss.
The point of this is that people commonly do not take conservative estimates in how long it will take to sell, what they will actually get for a sales price, and how much money it will cost to get ready and to actually sell the house. Now let’s step back and think about this though. You are tying up a lot of cash (20% down-payment, 30k in repairs, closing costs, etc.) for an optimistic $3,600 profit. I think I could make a good argument that this attempt to earn this $3,600 profit is probably just as risky or even risker than going to Vegas and putting $3,600 on black.
I eluded that *some* people would be able to flip still, so who can still flip? People who are able to find unbelievable prices through questionable means and people who can avoid fees on closing and selling.
When I say “unbelievable prices” – I’m talking not listed on the MLS prices. Let me give you an example, you see those billboards and benches for “we buy ugly houses.” Those are people who can flip because they lowball people with cash offers, but you can argue where they are making the money isn’t on the flipping process – their services as a real estate pawn shop are where the margins are generated.
Avoiding fees, maybe you are a realtor yourself or have connections – if you have the ability to find ways to sneak in and out of real estate market without taking a 6-8% hit, you may have a competitive advantage.
Sadly I must once again warn though that the real estate market has a lot of moving parts and a lot of variables and once you “put a pencil to it” – it rarely seems worth the risk. The stress, the labor, the idea of tying up such a large sum of money – no thanks. If the market does turn against you, be prepared to take a GIANT hit or become a landlord.