Flipping homes profitable, but not risk free

Yahoo Finance - November 2008

If flipping a house in today's real estate market seems riskier than trekking with a ragtag band of hobbits to Mordor, take heart: Home flippers can still find plenty of opportunities, though they're not entirely without risk.

It may seem counterintuitive to invest in real estate when the housing market is in its darkest hour. But in fact, it may prove to be the most optimal time for such a venture. According to RealtyTrac, a seller of mortgage default data, the foreclosure rate is at its highest level in 50 years, rising to record numbers in the third quarter of 2008. Real estate investors are finding bargains everywhere, particularly in formerly hot housing markets such as Florida, Nevada and California.

Angie Hicks, founder of Angie's List, a compendium of consumer-service reviews, says a recent informal poll of list members found that of those who had purchased a home in foreclosure, 29 percent of respondents had done so within the last six months. Of those, 95 percent said their purchases were profitable.

"The key ... is doing your research and knowing what you're getting into," says Hicks. "Know the area you're buying, the market, how the price compares to the neighborhood."
The horizon is flush with opportunity for those with the money and know-how to snap up a bargain and flip it, but to make it pay you first must understand how the rules of the game have changed.

The new rules for flipping homes
1. Stick with familiar territory
2. Check your capital
3. Cut your costs creatively
4. Consider it a long-term investment

1. Stick with familiar territoryCharlotte, N.C., resident Emma Allen, CEO of Emma Allen Enterprises and an experienced flipper, says there's lots of inventory on the market.
"The prices that were recently so outrageous are down again, so those with capital or access to credit will find it's a very good time to pick up bargains in the marketplace," Allen says.
Allen finds those bargains mostly in neighborhoods where she would like to live. "Properties I've added lately are near our downtown area, with an urban feel to them," Allen says.
Areas undergoing urban renewal present good investment opportunities. Allen, who owns a home on a large, popular lake, also thinks waterfront is a win-win on a flip, but she echoes Hicks' caution. "If you're not terribly experienced, stick with what you know -- just like buying stocks," says Allen.

The dreary economy has resulted in increased inventory, but it has also affected financing. Allen and other veteran home flippers say the days of flipping on a thin wallet have officially ended.

2. Check your capitalIt seems elementary, but in the recent past many flippers found themselves in trouble because they had not correctly calculated the amount of money it takes to finish a flip and market it. Allen says investors should figure out how much money they'll need right up front, and not just the purchase price. It translates to being realistic about both renovation costs and the hidden expense that gets so many in trouble: carrying costs.
"You may have carrying costs on the books longer than you think. The days of the 60-day flip are gone," Allen says.

Carrying costs, or house payments you must make until you sell the property, can subtract thousands from the bottom line. And even though you are technically chipping away at the debt incurred when you purchased the property, the interest you're paying at the top of the flip probably won't be earned back in the sale. Those payments come right out of your potential profit.

What about financing in general? While it's certainly more difficult to obtain a bank loan, it still can be done. But having a stash of cash is still important. Veteran Southern California flipper and interior designer Nicole Sassaman advises would-be flippers looking for a loan to: "Be sure to have 25 percent down and 18 months of reserves in the bank."

If you can't come up with it any other way, consider putting together a consortium of investors -- either share the cost of the project or divide the responsibility by contributing the manpower while your investor brings cash to the table. But when partnering on such a deal, Sassaman cautions, remember that the process has changed.

"In the last 10 years, any dummy could make money in real estate. Now you must buy sharp, do a professional finish job on your product, (and) you must create something very special," Sassaman says. "You must have the staying power and the stomach to go with it all."

3. Cut your costs creativelyFlipping in an economy that's not terribly user-friendly takes guts and creativity. Home flipper and Internet entrepreneur Scott Patterson says he increases his chances for success by breaking as many rules as possible, including making aggressive "low-ball offers" on potential flips.

"(I) offered $80,000 on a house I would have offered $100,000 (on) a year earlier," Patterson says. His strategy worked and he sold the renovated home for a tidy $160,000 a few months later.

Patterson also hopes to cut the middleman by obtaining his real estate license, letting him pocket the commission he would normally pay to sell his flips. He actively seeks capital via Internet and e-mail lists, marrying projects to the right investors.

"The stock market tanking has more people thinking that real estate is looking good right now," Patterson says.

He also expands his chances of selling his flips by targeting VA and FHA homebuyers. "We are concentrating on the first-time buyers market (and) will offer to pay closing costs where possible," Patterson says. He plays up a home's VA or FHA eligibility when advertising.
But buying and selling aren't the only places where a flipper needs to become adventurous to succeed. It also helps to get creative with materials.

Think good secondhand appliances or new ones sold as scratch and dent models, refinishing old cabinets by painting them and changing out the hardware, purchasing leftovers from rolls of carpet, close-outs on tile and fixtures, clearance items and even recycled stuff. By cutting renovation costs, you can keep your asking price low and make your property attractive to more potential buyers.

4. Consider it a long-term investmentReal estate consultant and mortgage broker Todd Huettner of Huettner Capital says changing markets have forced his clients to alter their business practices. Huettner says that while a quick flip is possible, investors should be prepared to hold the property for several years as a rental.
"If they flip it at their price, then they made their short-term gain. If they can't sell it at their price, then they will have a good long-term flip investment and just sell it in a few years," he says.

Huettner says renting protects investors from losing properties they can't sell. "Some complain they tie up too much money if they hold a property, but I point out they will be much better off with money tied up with a return than losing money." In other words, a positive return is always better than a negative one.

Huettner concedes it's more difficult now to qualify for loans and the terms are not always as favorable to buyers, but that well-qualified investors can still make a profit if they meet three criteria: understand their risk tolerance, know their market and come prepared to hold a property long term if needed.

The journey from Point A to Point B may take more time, but in the long run, there's still profit to be made in flipping homes.