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Flipping Properties In A Drastically Down Market
In earlier years, “Flipping” was a negative term utilized by governmental agencies to designate a mortgage fraud situation where there was massive collusion between, straw buyers, appraisers on the take, title companies and other players all committed to defrauding a lender and making ill gotten gains. In time these little bit players went to jail. Over the years this term is still used in some legal circles to denote a fraudulent practice. Now, like many words in the American culture, the word has now morphed and is utilized in the vernacular to denote a legitimate effort to buy low, fix and remodel and sell for a profit without any of the negatives from the prior usage. Many who perform the legitimate practices of the term gain some sensitivity when dealing with lenders and term the process as Buy-Fix and Sell to get away from the formal negatives connotations of the term and in some way harm their loan process. In any case, good or bad, it is now referred in the trade as “Flipping”.
With mainstream cable systems now featuring programs showing house flips it all looks so glamorous and easy. In an up market, few of the key elements of protecting an investors downside risk were brought into play. In the most recent up market with multiple offers on one listing the feeding frenzy was blinding. In that type of red hot buying and selling climate many savvy investors headed to the side line to await the inevitable pendulum swing in the other direction. Lenders setting on inventories of repossessions had little worry of moving the REO (Real Estate Owned) properties, as the market would make them all go away. Much like the dot.com stocks of the 90’s, last man holding loses. Last person holding in an up market witnesses any perceived profit vaporizing and perhaps becomes upside down in the property.
There are rules to successfully “flipping” properties. If the rules are violated, the investor loses. Real estate is such a forgiving medium; however, it may take years to get back even if you can afford to wait for making a grievous error. If an investor will adhere to a set of principles in good times or bad, it will lay a foundation of principles to avoid major hiccups. Is it problem free? No it isn’t and it never will be. It simple minimizes the downside risk. Like with any investment, there needs to be a balance in a real estate portfolio with buying-fixing and keeping and renting as one strategy. Another portfolio management strategy is to buy on a contract for deed and resell on a wrap around while jumping the price ,000 to ,000 above acquisition price plus fix up and holding costs. If an investor is able to negotiate as an example an interest rate of 7.5% and resell with a rate of 9.5% or higher the old principal applies of making 2% on the debt and 9.5% on the new money. These work out very nicely for long term returns however people move all the time and cash out may be imminent. In wrap around situations, fixes up costs tend to be limited and more restrained. Properties with structured terms tend to be very attractive to buyers with challenged credit. The buyers will need good income sources but for whatever reason have had a bad spell of negative credit. It can’t be so bad that you might lose the patient on the operating table, but good enough to survive to make another payment.
The aforementioned is just to caution against just focusing on “flips”. If and investment situation presents itself great. Just don’t step over a bunch of potential profit opportunities with the notion, “I just do flips” while the very next property makes a huge gash in an investor’s cash position. Stuff happens. By being positioned with monthly cash flow properties with equity, gives good flexibility when something takes a bad turn.
In a soft market, when the market has changed and the cheese has moved, “flips” may be more feasible. It’s a whole lot tougher in an euphoric and climbing market. When this softer market happens, foreclosures are up and banks are now wringing their hands trying to move their REO
Portfolio as directed by bank regulations so an investor may have a ready listener to offers. When the market average sale time went from less than 30 days to 120 days or more, change is afoot. To successfully “flip” a property an investor starts with probable fixed up value and then works backward to arrive at an offer price. In fact, many investors take the probable fixed up sale price and reduce it by 5% to 10% to ensure a quick sale upon roll out and putting the home on the market. It is here that an investor needs to focus on a cookie cutter home with no radical architecture or uniqueness. No log homes, domes or small square footage homes will work on this endeavor for maximum returns. Rather, a three bedroom, two baths with a two-car garage in subdivision will hedge the bet. A thorough home inspection will point out the needs of the property. Initially, this has to be done by the investor for cost purposes. A running cost total is tabulated to determine the amount of fix up cost. Then with a little arithmetic the end sale price minus the fix up costs, the holding costs, the selling costs less the desired profit of ,000 or more will leave a resultant number which will indicate the maximum acquisition price. Any negotiator would not go in with this price but rather would offer perhaps ,000 below “THAT” number leaving some negotiation room. The investor is looking for structurally sound properties with good life on the roof, no settling or foundation cracks, with good stable soil conditions. Anything less than that requires a high level of expertise and even then it is risky business.
The key to this whole effort is to work with a Realtor who will bird dog potential properties and is willing to initiate a lot of low offers and does not fear tainting their reputation. Bottom feeder offers are soon recognized, however, for a good volume of offers their will be some interested sellers who need to move the home. Ideally, the property will need to be vacant, on a lock box for ready viewing and have some sort of pressure on it. Either repossession, estate with an out of town heir, divorce, bankruptcy, illness or some other sort of motivation is necessary. The property will typically be very tired looking with a need for paint, landscaping with bath and kitchen upgrades required and new floor covering. Weeds growing high or a bad smell and/or trashed property are all positive buy signs worthy of further investigation.
In practice, it takes a lot of offers to buy one property. All the more reason for an investor to be diversified and take a shot at a “flip” when it makes sense and not until. Acquisition prices can be further tempered with the notion of paying up to 6% of the sales price in the way of closing costs and prepays to further separate the attractiveness of the property from the surrounding competitive homes. To make this all happen the seller has to take a hit in the pocket book to make it happen, otherwise the investor is the one taking the hit by over paying. Investor giants in the industry have laid this all out before in tombs of material. It’s nothing new or a radical breakthrough. It’s just that now the market has put this “flipping” back on the front burner.
Just to review, when the deal makes sense, for a quick sale stay below the market for a targeted sales price, reduce that price by acquisition, fix up costs, holding costs, selling cost, buyer help, profit (,000-,000 plus) for a maximum offer price. Deal with motivated seller’s only. Listing agents can be interviewed to see if there is an atmosphere for a lower offer without violating any fiduciary responsibilities of the listing agent simply by polling the seller and not waste a lot of time. If the seller insists on a written offer-give them an offer. The key is to make a lot of offers to motivated sellers. Six months ago a buyer could not get an ear. Now sellers are listening closely for ANY offer. Again, “flipping” is a simple tool, it should not be a real estate investors only means of acquiring wealth, just one of the ways. In all cases, after offer acceptance, a thorough home inspection must be completed up and down complete with termite inspection all within the allowable inspection period to either accept the deal OR renegotiate the price based on what was found. This is one of the methods to hedge an investor’s bet. Some areas of the county are more conducive to this practice than other areas. If the deal does not hit the numbers, move on.
About the Author: Dale Rogers is a thirty-year mortgage veteran and frequent contributor to the Broken Credit Blog. The BCB is a free website created to assist the general public with information about credit repair and responsible mortgage lending.