Flipping Properties for Profit
Sometimes, quick profits can be made at minimal risk by flipping properties. The key to profits from flipping properties is the same as making profits in other endeavors, by buying low and selling high enough to justify the risk and the amount of work required to obtain a higher price.
Flipping properties is hard work, but offers interesting challenges, and is a great way of learning the ins and outs of real estate investing, including finding properties, evaluating deals, discounting liens, structuring contracts, and successfully completing multiparty transactions. Hence, moving into other types of real estate investments will be much easier. Additionally, flipping as a business offers a flexible schedule.
To flip a property is to buy it or put it under contract, then either sell the property shortly thereafter or assign the contract to another buyer for a higher price. With real estate, there are 3 primary methods to profit within a short time:
- buying and selling in a rapidly appreciating real estate market
- using superior knowledge and negotiating capabilities to buy at a lower price and sell at a higher price
- buying the property and fixing it up
Although there are, at times, rapidly appreciating real estate markets, they exist only temporarily, since real estate cannot appreciate much faster than inflation for long. Therefore, the 2 primary methods of profiting from flipping properties is using superior knowledge and negotiating skills to buy at low prices and sell at high prices, and renovating properties, or, ideally, a combination of both methods.
Flipping properties without doing much renovation is sometimes referred to as real estate wholesaling. Wholesalers must know the local markets well, be great negotiators, and be able to appraise property quickly and accurately to be able to set the maximum offer price. Wholesalers often maintain a list of buyers looking for specific types of property, allowing quicker sales.
Buying low and selling higher within a short timeframe is possible because real estate appraisal is not an exact science, and many homeowners do not know the value of their homes in relation to the current market. Therefore, some sellers will sell their properties for less than what they could otherwise get, either because they are not aware of current market prices or because they have to sell quickly for one reason or another. Additionally, the borrowers may be financially distressed, requiring them to sell quickly. For this reason, many properties that can be flipped at a profit were bought from a short sale or before the property entered into foreclosure. Pre-foreclosure properties can be found by going to the county recorder's office to find properties with a notice of default in nonjudicial states or a lis pendens notice in judicial states.
Foreclosed properties can also be bought well below market prices, because of the risks of buying a foreclosure, but they also offer the most opportunities for improving the property that will sell at a much higher price.
When flipping properties, several costs must be estimated:
- the selling price of the flip
- holding costs, including property taxes and homeowner's insurance
- closing costs for both buying and selling
- repair and renovation costs
To determine the maximum offer price for a property, the flipper must subtract expected profits, transaction costs, holding costs, and repair costs from the estimated selling price of the property. The flipper should always start with a price lower than the maximum offer, for room to negotiate. But if the property cannot be bought for the maximum offer, then the property should be dropped from consideration.
When estimating the potential sale price for a fixer-upper, figure that the sales price will not be any more than the top price in the neighborhood. When pricing rentals, rentals should not be expected to be more than the top rent in a given neighborhood. To reduce risk, opt for a lower price or rent, such as 15% or 20% lower than the top price or rent in the neighborhood. This increases the likelihood that the property can be sold profitably and will determine what improvements can be made while still earning a profit.
Never determine a selling price by adding the cost of improvements to the acquisition price of the property, because buyers will not care about the previous selling price or how much the improvements cost. The only thing that will matter is how the property is priced compared to neighboring properties and the quality of the property compared to the neighbors.
The profitable flipping of houses requires accurate cost and price estimations. Any property considered for purchase must be accurately appraised, and the selling price must be reasonably estimated, based on the projected time of the sale, after repairs or other alterations have been made. If extensive remodeling is required, then not only must the expected repairs and renovations be accurately priced, but their value in the marketplace must also be accurately projected. Usually, the value of an upgrade in the market may be higher or lower than its actual cost. When examining any property that is going to require extensive rehabilitation, a scope of work should be prepared, detailing the materials and construction of the repair that contractors can follow, which will allow a more accurate projection of estimated costs.
Profits from Flipping Properties Will Depend on the Local Market
Some local markets will be better than others for flipping properties profitably. There will generally be more distressed properties in low- and middle-income areas. Higher-priced real estate is harder to flip, since there are fewer buyers, and they take longer to decide.
Additional factors to consider:
- market inventory, or the number of houses listed for sale, which can best be found on the Multiple Listing Service, which is why many real estate flippers and wholesalers are also real estate agents
- average days on market, or the median number of days that houses listed for sale before they are under contract, an important measure of how long the property may have to be held before selling it
- median sale price for a particular neighborhood
- foreclosure rate, or the number of foreclosures for a given period over the total number of homes in the neighborhood
- what additions or renovations will yield the most profit for a given neighborhood
Changes in zoning laws may also offer profit opportunities, because properties may be worth more with different zoning than they were previously. Since homeowners generally do not keep track of zoning changes, this is where superior understanding of local market conditions can pay off.
Improving Property for Resale
When looking for properties to flip, the main concern should not be whether you like the property or not, but whether enough value can be added to resell at a profit sufficient to cover the investment of time and money. Ideas for improving a property can be found by touring new homes and upscale apartments; browsing through home decorator magazines; watching TV shows on how to improve a house or how fix-and-flippers redo a house. However, the added value of additions or renovations will be determined by the local market, so you should examine houses that sold for higher prices in the neighborhood to see what advantages allowed the property to be sold for that higher price. Generally, the best improvement in value can be made on properties that were bought for considerably less than surrounding properties in the neighborhood. Some suggestions for improving property:
- Converting an attic or basement, or even a garage into additional living space can often increase the home's value.
- Subdivide larger rooms into smaller rooms or combine smaller rooms into a large room.
- Many properties can have great views with the right openings. Because builders usually build according to a specific plan, views are not considered. Hence, a big improvement for property is to create better views. Conversely, eliminate negative views, such as windows that open to other buildings, powerlines, or anything else unattractive. Windows can be eliminated, or the outside can be landscaped to eliminate the negative view.
- Increasing natural lighting can also improve property values, especially if the house appears particularly dark, even during the day.
- Many older properties lack sufficient electrical outlets for modern electronics, so one way to improve the property is to add more outlets, and maybe even increase the amperage of the house. Older buildings are rated for 60 amps, but modern houses typically have 100 or even 200 amps.
- Increase the energy efficiency of the home, especially since there are numerous residential energy tax credits that can be claimed to reduce taxable income.
- Repair damaged or broken windows or torn screens.
- Repair cracks or holes in drywall or plaster.
- Use paint or wallpaper to cover faded, or stained walls, or to just give it a new look. Use high gloss paint instead of flatter satin paint, since it is more reflective and easier to clean. Light colors will also brighten rooms, so choose paint or wallpaper accordingly.
- Improve the landscaping. Plant decorative shrubs and trees or other attractive plants, depending on the climate and soil quality. In desert climates, choose exotic desert plants that will increase the beauty and distinguish the property from neighbors.
- Increase safety by fixing loose carpeting or damaged floors, fix broken steps and handrails, install smoke alarms, eliminate or protect wires and cords.
- Clean the place thoroughly.
Assigning the Real Estate Sales Contract to Another Buyer
Assigning a contract is a quick means to profits at lower risk, but assigning the contract can only be done if it is not prohibited by the contract itself. Many real estate contracts, including those by the Board of Real Estate Agents, prohibit selling or assigning the contract.
Under the doctrine of equitable conversion, the buyer has equitable title to the property between signing the contract and the closing date, but does not own it because the deed is still in the seller's name. The buyer's equitable interest gives the buyer control over the property even without owning it, through the contract. Thus, assigning a contract transfers the equitable interest to a new buyer of the contract. The original seller may be upset about the assignment, since the assignor is making additional profit on the property, but this is how property wholesaling is often done.
The assignor sells the agreement while the assignee buys the agreement. When assigning a contract, the assignor generally only needs money for a down payment to secure the contract with the seller. However, if the contract is assigned, then the buyer of the assigned contract will pay for the property at closing with his own funds. Hence, the assignor needs little of his own cash. If a double close is necessary, than other types of lenders for short-term loans, such as private lenders, hard money lenders, transactional lenders, and maybe even some banks, may be able to supply the necessary funds. The seller of the contract will never appear in the chain of title, since his name will never be on the deed to the property, because it is the assignee of the contract who will close the deal and whose name will appear on the deed to the property. An assignor will only appear in the chain of title if a double closing is necessary.
The buyer of a contract then executes an Assignment of Real Estate Purchase and Sale Agreement, but must also agree to the price and the provisions of the original purchase and sale agreement. The assignee should receive a 3rd copy of the purchase and sale agreement and any other disclosures or addendum's that were part of the original agreement. Typically, the assignee gives a deposit to the assignor, and then the rest of the money at the closing.
An assignor usually likes to deal with cash buyers, since if the assignee does not close on the property by the closing date, then the assignor will have to double close to sell the property. Moreover, banks may not lend money for the purchase of an assigned contract.
A double closing (aka simultaneous closing, back-to-back closing) occurs when a flipper buys property from the seller and then shortly thereafter sells it to another buyer. The double closing involves 2 escrow accounts and 2 separate settlement statements. The main difference between a double closing and an assignment of a contract is that the flipper is actually buying the property, so he will appear in the chain of title. Closing costs for both properties will also have to be paid, reducing the profitability of the flip.
For the 2nd closing transaction, a purchase and sale agreement will also be used, but there should be a contingency that the 1st closing succeeds.
If the property is bought as a short sale, the bank's short sale acceptance letter may have to be checked for any type of resale or deed restriction. To assure that they are getting the best price possible, some lenders will restrict the resale of the property for at least several months after the short sale. Banks holding REO properties may forbid assignment of the contract, in which case, the flipper will have to double close on the property.
Flippers will often have to contact the lenders for buyers who are not paying cash to ensure that there will be no problems with the buyer financing the flipped property. Some lenders have title seasoning requirements, meaning that the sellers must have lived in the property for a minimum duration. Unseasoned properties, ones that are quickly resold, are much more closely examined by the lender's underwriter to assure that there is no fraud. Lenders are stricter on unseasoned properties because they generally sell their loans to the secondary market. If a loan defaults shortly after being sold, then the lender will be forced to buy back the loan.
Private money, transactional, or hard money loans are essential for back-to-back closings unless the flipper has sufficient funds. These loans are always secured by the property and a hefty loan origination fee is generally charged because of the brief loan term. The flipper would have to find out how quickly he can receive the funds, where the money would be coming from, and the loan amount.
Lenders will generally require title insurance and property insurance so that their loan is secured by the property. Moreover, many will want a personal guarantee, so that if the property cannot be sold for at least the loan amount, then they can sue the flipper for the remainder.
A good source of private money lenders are relatives with money, especially if the money is in a savings account earning less than 1%. Convincing people to become private moneylenders may be easier by showing them the business plan, the history of the company, and how their loan is protected through a security interest in the property. The loan-to-value ratio will typically be much less for private loans than for conventional loans. Additionally, pertinent information should be provided for the property that will be purchased with the money.
Additionally, moneylenders can be found through referrals from real estate agents, accountants, title agents, or attorneys. Real estate records can also be examined, since the names of the lenders are usually recorded along with the loan. However, securities laws forbid advertising for private moneylenders, since such advertisements can be considered a security sale.
Transactional funding is temporary funding for a contract that has been assigned to a new buyer. Since the real estate crash in 2007, lenders and title companies have become stricter in their requirements for funding properties. They require that the buyer 1st close on the property before selling the property to another buyer. The terms of transactional loans generally run from 1 to 120 days. In some cases, the term may be extended 60 days longer. Transactional lender fees may include 2 or 3 points of the loan amount + a 12% to 15% interest rate, though terms are negotiable.
Hard money lenders specialize in short-term real estate backed loans, offering longer loan terms than transactional lenders. Although there are some national hard moneylenders, most of them are local. Local lenders generally offer better terms. Loan periods will range from at least 6 months to up to 3 years. Additionally, hard moneylenders will also lend money to rehabilitate the property. Hence, rehabbers often use hard moneylenders, because they require more time to fix the property. Hard moneylenders can generally charge higher interest rates because they accept loans that banks would not accept, such as properties that need extensive rehabilitation. Hard moneylenders generally deal with people who are in the business of flipping properties, and because they have a secured interest in the property, they generally do not verify borrower's income, assets, or even look at their credit score. As traditional lenders pay for construction projects, so do hard moneylenders only pay the money as it is needed, especially for extensive rehabilitation projects. To lower risk, hard moneylenders will offer only a loan-to-value ratio of 65% to 70% of the properties after-repaired value (ARV). A lower loan-to-value ratio allows hard moneylenders to give less consideration to creditworthiness, or uncertain income. Hard moneylenders typically charge 3 to 5 points with an interest rate ranging from 12% to 18%. Many hard money loans are interest-only loans with the balloon payment due at the end of the term, when the property is expected to be sold. Since hard moneylenders have individual requirements, it pays to shop around for the best terms.
Beware of House-Flipping Seminars
House-flipping is heavily promoted through seminars and reality TV, such as Flip This House. The seminars themselves are heavily advertised on radio and TV as a quick means to wealth. Although the initial seminars are free, those seminars are more to promote expensive training workshops, often referred to as boot camps, that can cost up to $40,000.
After the free seminar, the next workshop may be only a couple hundred dollars, then later workshops can be thousands, often tens of thousands of dollars. Evidently, each seminar or training workshop serves to market a more expensive workshop. Even short workshops can be expensive. For instance, one promoter charged $1500 for a 3-day workshop.
However, most of what you learn from these workshops can be learned by reading books or watching the many videos on the Internet. Much like Ralph Nelson Elliott who made more money selling techniques on how to profit from the stock market than from playing the market itself, these house-flipping seminars are far more profitable than the house flipping itself. Indeed, a major restraint on profits in house flipping is competition, so if house flipping was so profitable, then why would they create more competition for themselves? Furthermore, if they train many people in one particular locale, then they will effectively be increasing the competition for each of those people, making it that much harder for them to profit.
Oftentimes, they also try to sell a system where they would help you find properties or hard money lenders to finance your deals. However, they never guarantee that you will profit. Although some of the organizations provide coaches, the information they provide can easily be found at the library or on the Internet.
Success in house flipping requires intimate knowledge of the local real estate market and a solid foundation in construction and being able to price jobs accurately. Accurate appraisal of real estate is also required. The real estate must be accurately priced before it is purchased and the selling price after rehabbing must also be accurately estimated. This also means being able to accurately estimate how much particular improvements will yield in the current real estate market. This type of knowledge is difficult to obtain without extensive experience in the local market.
Furthermore, house flipping is far more profitable and easier to accomplish when home prices are rising rapidly. In a slow market, it becomes much more difficult to even eke out a modest living. And if real estate prices decline, then losses will be the more likely result.
In hot markets for house flipping, profits are easier, but easy profits always lead to more competition, reducing, and then eventually eliminating the easy profits — just as with any other business. In any case, people who already work in construction or in real estate in those local markets will generally be much more successful than others who travel there to make their fortune.
A primary current concern about the house-flipping business should be the fact that several groups of people have already looked at the property that you think may be profitable. Foreclosing banks generally have the 1st look at the property, then real estate people, who can look at the property before it ever goes on the MLS. If there were easy profits to be made with the property, one of those people would have already bought it or promoted it to friends.
Remember, house flipping is hard work — it is not an investment. Even the term "house flipping" makes it sound quick and easy, but it is misleading. It takes a great deal of effort and specialized knowledge to be successful, and even then, there will probably be losses.
Virtually none of these organizations promoting health flipping seminars reveal any statistics on the success rate of their graduates, and there is probably a good reason for that: the success rate is very low.