A frenzy for flipping houses
If you’re among the many people who watch television programs such as “Flip or Flop” or “Flipping the Block” and think you can become a master flipper yourself, you’re not alone.
The frenzy for flipping — which refers to homes that have been purchased and sold within one year — echoes the height of the housing bubble before it burst, but most industry experts say the market dynamics are different this time.
“The housing market is in full boom mode, with prices up and homes selling quickly and consistently, which gives flippers more confidence to jump into the market,” says Daren Blomquist, senior vice president of ATTOM Data Solutions, an Irvine, Calif.-based property data firm. “At the same time, they don’t have to compete against a flood of new construction like they did during the last spike in flipping in 2005-2006, when home builders were building like crazy.”
Blomquist says today’s flippers often go into older neighborhoods and create like-new houses that serve buyers who might prefer to purchase a new house but cannot find one in their price range.
After the housing bubble burst, investors were purchasing distressed properties and foreclosures, and holding them for rental income and to wait for their value to increase. Rising housing prices and low inventory in recent years have shifted the priorities of real estate investors.
“About a year or so ago, we saw that investors purchasing property on Auction.com flipped from holding their properties to flipping them in the majority of markets,” says Rick Sharga, chief marketing officer of Ten-X, an online real estate marketplace that owns Auction.com, in Irvine, Calif. “While these investors can sell their property within three or four months, the investment return isn’t quite as high as it was during the housing bubble, depending on the cost of repairs.”
Another difference from the 2005-2006 flipping frenzy, Blomquist says, is that loose lending drove that market at an even faster pace.
“It was easy to buy places without cash, so a lot of flippers would buy places and not bother to fix them up,” he says. “They would use an exotic loan that required them to make almost no payment at all and then just sell within six months for a profit.”
Driving up prices
Flippers, particularly after the housing bubble burst, sometimes have had a bad reputation as damaging neighborhoods by driving up prices too quickly and by forcing first-time buyers out of the market when they can’t compete for entry-level houses.
“A house that’s been flipped sells on average for $60,000 more nationwide when it’s been rehabbed,” Blomquist says. “But we see it as a problem only if flips become too big a part of the market, such as more than 7 or 8 percent of all sales. Nationwide, flips were 5.1 percent of all sales in the third quarter of 2016, but there are some markets, such as Memphis, Tampa, Miami, Las Vegas, Phoenix, New Orleans and Mobile that are getting near or above that danger zone of more than 8 percent.”
Nationally, the initial purchase price for more than 50 percent of flips is in the $100,000 to $300,000 price range, says Blomquist, which disproportionately hurts first-time buyers.
However, he says that some of the houses that are flipped wouldn’t appeal to first-time buyers, anyway, because of the level of work required. But about a third of all flipped homes sold for cash in 2016 after they were renovated, which typically indicates that the property was purchased by an investor who wants to own a ready-to-rent property for the long-term income.
Sharga says that flippers can add value to a neighborhood when they buy a distressed property that a first-time buyer wouldn’t necessarily want and that could be impossible to finance conventionally because of its condition.
“They take inventory that’s not ready and make it available for buyers,” Sharga says. “They’re not selling them for prices above the local market, either, because they want to be able to sell quickly to move on to their next project.”
Flipping as an occupation
The vast majority of flippers are individual investors who flip houses for a living rather than large-scale developers, Sharga says.
“The smallest investors flip a handful of homes each year and do the work themselves, while the larger ones have a network of real estate agents to identify deals and contractors to do the work,” Sharga says.
Fans of HGTV shows may see flipping as something fun and a relatively easy way to make a profit, but experienced flippers warn that’s not as easy as it looks.
“The biggest hurdle for a novice or a pro is that you need a mastery of your budget for each project,” says Leslie Suarez, a real estate agent with Evers and Co. Real Estate in Washington. “For instance, if you buy a rowhouse ... for $400,000 and think you can sell it for $700,000, it sounds like an easy profit. But you have to account for the cost of repairs, interest payments on your loan, property taxes and utilities for six to nine months or a year. Plus, you need an extra 10 percent of your budget to pay for unknown problems.”
Allen Shayanfekr, chief executive and co-founder of Sharestates, an online real estate investing platform, in Great Neck, N.Y., says people who do this as a career flip five to 10 houses a year and have an architect, a lawyer, contractors and subcontractors on standby so they can work on every project together.
“Professionals are good accepting it if they made a mistake and their profit is smaller than anticipated, because they want to start on their next flip,” Suarez says. “Novices get tied up in a piece of property and don’t want to drop the price or move on because they were counting on a $70,000 profit instead of a $45,000 profit.”
Beginners tend to overpay for the property and underestimate repair costs, Sharga says.
Finding a house to flip is the biggest challenge, particularly in markets with low inventory.
“The best opportunities are not found; they are created,” says Scott McGillivray, host of HGTV’s “Income Property” and “Flipping the Block” and a spokesperson for Owners.com, an online real estate brokerage. “I probably make 10 offers for every one that’s accepted, because I know if I pay market price for a property there won’t be enough profit at the end. What’s nice is that unlike when you’re buying your own house, you’re never desperate as an investor. You can walk away if the price is too high.”
McGillivray says investors should look outside the hot areas to find properties and not be afraid to knock on doors to find out the owners of abandoned properties.
“We find some properties on the multiple-listing service, some by networking with other agents, and some we find before they are on the market just by talking to people,” says Ati Williams, co-owner of real estate brokerage DC Home Buzz with her husband, Rob Williams, and hosts of the HGTV pilot show “DC Flippers.”
Cash is king
A decade ago, only 35 percent of flippers paid cash for their properties because mortgages were easily available, Blomquist says. In 2016, about 68 percent of flippers paid cash, but Blomquist says that is an eight-year low, as more investors opt to finance the purchase.
While a handful of community banks loan money to flippers, Sharga says, most investors turn to what are known as “hard money” lenders, which are individuals or small companies that specialize in making short-term loans, such as a one-year term at higher interest rates. Typically, these are local companies that know the real estate market and property values well and will cap the amount they will lend so they will be able to recoup the money if the borrower defaults on the loan. Sharga says they often require a down payment of 25 to 30 percent.
Rob Williams says they put a little of their own cash in each flip and then finance the rest with a hard money lender. He says that sometimes a community bank such as Eagle Bank will finance their larger projects.
Recently, Blomquist says, a new industry of companies has started up to provide capital to real estate investors. For example, Sharestates has investors from 30 states who fund real estate investments in 10 states and the District of Columbia.
Shayanfekr says Sharestates lends 40 to 50 percent up to a maximum of 80 percent of the purchase price with mortgage rates of 9 to 12 percent. The loans require interest-only payments with a balloon payment due in 12 months.
“We focus most on the loan-to-value and the borrower’s experience in their local market with flipping houses,” Shayanfekr says. “We also look at the market to estimate the borrower’s ability to sell the property and check the borrower’s credit, especially for foreclosures or delinquencies.”
From distress likes opportunity
While there are opportunities everywhere to flip houses, McGillivray says that it’s best to look for a distressed property to have an opportunity to increase value quickly.
“Make sure you have enough of a profit margin to cover all the costs, especially the transaction costs,” McGillivray says. “You can reduce some of those costs by selling your property with an online brokerage and sometimes get a rebate if you buy the property that way, too.”
McGillivray says the “sweet spot” to achieve the fastest and simplest returns is finding a property that needs an intermediate level of work such as a new kitchen, new floors, new fixtures and painting rather than a complete gutting.
“I’d recommend that people start with their primary residence, because you can build personal wealth by renovating your own home and selling it before you go on to the next project,” McGillivray says. “Your risk factor goes down significantly because you need a place to live anyway.”
Ati Williams did just that. She started by renovating and selling her own house for a $30,000 profit.
“You need to go through the process of getting permits, creating a budget, getting bids and working with contractors before you know if you’re ready to do it as an investment,” she says.
McGillivray says flips usually take six to eight months if everything goes smoothly. He says that in recent years he finds that he makes the biggest profit by holding onto a flip and renting it after a renovation for three to five years, which technically isn’t a flip. For example, a house he bought five years ago in Tampa for $150,000 and spent $40,000 renovating could have sold immediately for $250,000. He chose to keep it as a rental property and recently sold it for $400,000.
“If you plan to flip as soon as possible rather than rent your property, your biggest enemy is time,” McGillivray says. “The longer you hold it, the more money you’re spending.”
In addition to evaluating the costs and profitability of a flip, McGillivray says novice flippers need to be careful not to take on projects that are beyond their expertise.
“Start with something simple, even if the profit is lower, to gain experience,” he says. “Pick one or two things you can do yourself for a good return on your investment, such as selling it on your own or painting.”
To be successful, says Rob Williams, you need detailed market knowledge so you know whether something is a good deal. And you need to visit the job site daily for quality control.
“On your first flip, the more work you can do yourself, the better you’ll do financially,” Rob Williams says. “At first it’s best to take on properties that just need cosmetic work, but as you gain more experience, there’s opportunity for more profit if you take on a place that’s in worse condition and needs to be completely overhauled.”
Ati Williams says that flipping can be lucrative, but she warns that it’s not easy to find the right property or to go through the renovation process. And, when you finish, selling it at the price you want isn’t a given.