Risks – Flipping Houses For Profit Is Not For Everyone

It is not just a fantasy that many people save their money until a time comes when enough cash is accumulated to dabble with real estate. Real estate is a natural choice for moving a step up into investments toward financial freedom.

It could be due to social conditioning, mass media exposure, or whatever. It is a fact that owning properties for financial gains is a goal for a huge number of people. And no… we are not even talking about buy and hold. People are thinking about big money that churns out quick. And that’s where we introduce the art of flipping.

Sub-sales

The first rule of success in sub-selling is that economic conditions must be conducive. You won’t be able to make any money until you are riding the wave of the market. When you fail to get on the wave, losing money is a certainty unless you have the holding power to wait till the market picks up again. Even so, you might still lose money.

If we put it that way, on the surface, flipping properties via sub-sales is not that much different from buying stocks. All you need to do is buy, wait for the market to push up your asset value, then sell. It makes you wonder why people want to get involved in the hassle of real estate in the first place.

The main advantage is that real estate market movements are more predictable. And should something happen, whether good or bad, there is always time to react as long as you are pro-active. The same cannot be said about equities where usually, by the time you can clearly observe that the market is losing speed, it is already too late.

The simplest example of quick flips can be seen in sub-sales activities. Buyers buy under construction properties by depositing a down payment. The construction would take up a number of years. And by the time the development is ready for occupation, the value has risen. This is when the units are sold at a profit.

The best part is that under construction properties have staggered payments. So usually by the time the buyer sells to a second owner, he has paid less that 50% to the developer. When we take mortgages into account, the total real money that was used by the flipper might not even exceed 30% of the purchase price.

The difference between the original purchase price and the resale price will be the profit. Of course, there will be taxes and other fees. But you get the picture.

You will fix the toilet, and I will cash out!

The real flipper

A second form of flipping which is within the realm of more advanced real estate players is to add an element of fixing into it. Anyone can ride a wave and profit. But to fix and flip? At a profit? That is another world altogether. In fact, veteran investors would probably burst out laughing if you consider sub-sales as a form of flipping.

Firstly, fixing and flipping requires more cash. Unless you have the appetite for creative financing, you will have to fork out much more cash compared to sub-selling. Again, things would be different when we take mortgages into consideration. But taking into account your credit exposure and debt service ratio, a hardcore flipper won’t be able to obtain a big loan for every house he intends to flip.

Fixer-uppers

Then we have to take into account the funding required to fix a house. The prime targets of real flippers are houses that are in need of repairs. And these types of houses are called fixer-uppers. These are the types of houses that are positioned in a market gap. A niche. The type of houses that need inexpensive repairs which also add considerable perceived value when done up.

You need a sharp eye for detail and a deep understanding of costing to be able to succeed on a consistent basis. Not to mention a special relationship with contractors will be like a god-send.

Mistakes can be disastrous. It could end up with the flipper being unable to sell at a profit. And a stubbornness to acknowledge failure can lead to him holding onto a house for much longer than planned. The longer a house is held, the more costs involved and the higher the risks. Who knows where the market will head towards tomorrow.

With the wisdom of repairs and costs playing such an important role for a true flipper to consistently profit, it is no wonder that the majority of them are usually professionals who work in the real estate industry themselves.

How would you know that the land of the house you bought could be eligible for a permit to build bigger and higher due to zoning?

How would you know that the strata can be split up into many single smaller houses?

How would you know that the government could be open to negotiating the sale of the road behind a building?

How would you know that a location is a great candidate to obtain a hotel license?

How would you make a quick estimate of fixing costs so as to account into your offer price?

How would you know that the leak can be fixed with a simple patch instead of a total overhaul?

In most cases, if you are able to identify a prime fixer-upper, you are going to profit from it. Even when you are not be able to squeeze out the maximum juice it has due to a lack of expertise, you should still be able to generate a tidy profit as long as you execute your plans quickly.

Speed is a critical element of flipping. You mortgage repayment is not going to wait for you. Your contracting bills are not going to take a back seat until you cash out. The effects of nature will take it’s toll on your property.

But the biggest fear you would have is for the market to turn against you before you finish your project and exit. You might be happy if the market is going up. Value appreciates. You are sure that your improvements increases value. But that can also mean that construction costs will increase as well. And if the market falls, the value of the house goes with it. This is why, once you make a decision to snap up a fixer-upper, you want to take immediate action to execute your plans. You see the game of cash flow here?

Tax planning

If you are a full time flipper, be sure to structure your activities to avoid tax mines. For example, if your main income comes from sales margins and you do it frequently, what you consider as capital gains might be classified as revenue in trading activities. You need to get the advice of your local accountant to sort this out beforehand.

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