Precautions in Flipping
If you’ve recently purchased real estate as an investment, you’re in good company. Reports suggest that as many as 25% of recent home purchases have been made by those who plan on using the property for investment purposes. Thinking about jumping into the real estate market? You may want to think again if you’re in it for short-term gains. Even experienced real estate investors make mistakes when trying to make quick profits. Real estate investment is best viewed and practiced as a long-term strategy.
Case in point: Back in 2007, I went to a real estate investment seminar and afterward felt like I had a good grasp on short-term “flipping.” I had already sold numerous homes as a real estate agent, so I figured I knew more than most and had the data to back my decisions. The market was booming, properties were selling at or above list price, and figured I couldn’t lose. My partner and I bought three homes that December, each with really high leverage, expecting to be able to return a hefty profit come spring. Well, I’m sure you can guess what happened. The bubble burst… and so did our expectations for any profits in the spring. The rental market was at a low due to the fact that everyone could financially qualify to buy. Banks were lending to almost anyone that had a job or stated they had a job. Needless to say we had to rent the homes at a loss and ended up losing money for many years. It wasn’t until interest rates dropped that it made sense to refinance, turning the homes into great long-term investments. The outcome of winning or losing is known only when you sell. Right now, those homes are awesome investments but it did take some early struggles and lots of time spent. The most important things I learned out of the mistakes I made early on in my real-estate-investment career are the following: 1. never invest on anticipated appreciation 2. never try to predict the market, and 3. never invest in real estate short term expecting a low-risk investment. There are winners and losers in the short-term flipping of homes. The worst part about flipping is that many of the eventual losers had actually won early on, which fueled them to dig deeper into this kind of short-term, high-risk investment, which ultimately caused them to lose big.
If you still want to try your luck at flipping a property, here are some things you should consider:
First of all, not all foreclosures are priced below market value. The best way to determine market value is by using a reputable Realtor to research the area you are buying into. Don’t forget to factor in your closing costs (prepaid taxes, title insurance, administrative fees, etc.) when looking at the final cost of purchasing the home. Cash buyers will pay fewer closing costs, but will usually end up paying at least a portion of them.
If you leveraged the property purchase (by taking out a loan or mortgage) there is, of course, your monthly payment to make. Because the property will not be owner occupied, your mortgage rate will be higher. If you’re using a “hard money” or “private loan, the interest rate on these short-term loans can come with very high interest rates—in El Paso, we currently see those floating around 8-10%.
Now to one of the biggest expenditures in any flip—rehab and construction costs. You may have purchased a "fixer upper" at a bargain price but will you be able to recover the expenses and make a profit? A lot of times that will depend on how much the renovation ultimately costs. Do you know what actually adds value to a home and what may be an unnecessary expense? What if your renovation expenses are more than what you initially calculated? Did you budget for unforeseen repairs (termites, water damage, wiring and electrical issues, foundation repairs, etc.)? Do you know what permits you have to pull with the city? Not obtaining the proper permits could lead to fines, penalties, and delays! Are your contractors bonded and insured? While most contractors and subcontractors are hard working and ethical, there are some bad eggs out there who will happily take your deposit and disappear. Making just a few mistakes can quickly eat away at of your profits.
Don’t forget to budget for other monthly expenses while you own the property: insurance, taxes, utilities, HOA fees, maintenance and emergency repairs, etc. can add up quickly. Remember that these expenses need to be factored into the total cost of owning the property to get an accurate picture of your profit (or loss) when it sells. Now to the hidden cost of any investment—and one many people don’t consider until they’re already in too deep—opportunity cost. What are you giving up (time with your family, potential earnings from other sources, etc.) in order to buy/rehabilitate/manage/sell your short-term investment?
I’m sure you’ve heard the investment axiom, “You don’t lose money until you sell.” The same can be true for real estate. Now that you’ve made it through the purchase and renovations and that eyesore has become the best home on the block, it’s time to sell! Hiring an experienced Realtor for the sale is as important as hiring the right one during your home search and purchase. They will have access to a database of information you need in order to set a smart sales price. How long do homes in your chosen area tend to spend on the market when they are for sale? What if the value of your renovated property is above those in your neighborhood? Did you make enough renovations to make it competitive? Can you withstand a correction in real estate values? The longer your flip is waiting to be sold, the less money you will walk away with. And here come those pesky closing costs again....oh and wait, don’t forget about the short-term capital gains tax you have to pay when you sell.So hopefully this is where we say CONGRATULATIONS on a hefty profit!!!
But... what if you find out that by selling NOW you are actually going to take a loss and that loss may not even factor in the time you spent on the whole process? Insert meltdown here. Go back to my earlier story and remember, even though the short-term investment strategy failed, keeping the home as a long-term investment may eventually produce a great return. In 2, 5 or 10 years, you may be able to recoup not only your initial investment, but gain even more equity from renters paying down your liability, not to mention all the tax advantages you have by holding the property for the long term.
At One Realty Investments, we can help you avoid the pitfalls of flipping. We don’t flip homes and don’t recommend it to others seeking to invest in real estate. However, if you are looking for stable, long-term returns, we can help you navigate El Paso real estate investment. We have an inventory of already renovated and rented homes with income data, letting you see your returns BEFORE you buy. No crystal ball needed. With partners such as Property Lift (www.propertylift.us) and We Rent Homes (www.werenthomeselpaso.com) our network of professionals can also help you maximize your return on current rental homes or take the stress and time commitment out of managing a rental. Let us do the work so you can do the things you love!