I'm often approached by potential real estate investors about 'flipping' houses. Like them, I've seen the myriad of TV shows on HGTV, DIY, Discovery, etc. that show individuals and companies around the country taking run-down homes, fixing them up quickly, and making huge profits. It looks great, and it looks easy. A recent news article, featured in the Everett Herald suggests that maybe the shows are making it look too easy. The article focusses on charges against one of the featured flippers in Atlanta that include faking parts of the show, including the sale. Now, I don't know how legal or illegal his actions were… its a TV show, and we would all do well to remember that shows like this are for entertainment purposes and are not news reports.
Personally, I try and encourage new investors away from flipping houses. And, here are some of the reasons why:
- Its really, really, really hard to find a house that makes a good flip. We have a sophisticated market, and typically the problems with houses are built into their market value. If you buy a house way below 'market' (so, the house fixed up would sell for more), there is a good chance the amount below market you get it for is roughly equal to the cost of repairs and upgrades… and in fact reflects its market value. Unless you are able to do the work, the chances are there won't be much profit in it after paying contractors for repairs. However, buying fixer-uppers is a great way for folks with more time/skills than money to get into Real Estate, but its not a way to get rich quick.
- Loss of tax advantages and the ability to do tax-free exchanges. As a rule, you need to hold your investment properyt for at least a year in order to qualify for a 1031 Exchange, one of the great advantages of real estate investment. To top it off, sell too many homes to quickly and the IRS will classify you as a 'trader' and not an investor. Forget paying capital gains rates on profits… you'll be paying regular income rates! OUCH! Real estate is one of the most tax-advantaged investments there are, with tax-deductible interest payments, depreciation, and tax-deferred (tax free) exchanges. But, flipping loses you most all of those advantages.
- Its capital intensive. All those repairs won't be free. Even if you do the work yourself, you still have to pay for all the materials. And, if you are buying a really rough property, how will you even finance it? If you plan well, you might get a rehab loan, but chances are you will be looking for private financing, or coming up with cash out of pocket (or borrowed against other property). But, if you buy real investment property, one that generates income, you can purchase it with little money (sometimes no money) out of pocket. And, once you have properties that pay for themselves, your ability to obtain more property is almost unlimited. How many houses can you flip at the same time?
- Flipping is work. This is one of the biggest disadvantages of flipping. Its one-time income and it typically means you put hours in, working on the flip. I'd much rather own an income property (or better yet, multiple income properties) that brings me cash in every month with little or no effort on my part. Income real estate is like owning stocks or bonds, only I'm betting you know more about your neighborhood, city, state, and the real estate market than you do about the business of your favorite stock.
Easy flipping opportunities are disappearing and we are seeing the casual 'flipper' leave the market. The past couple of years made it possible for almost anyone to buy a property, do very little to it, and sell it at a profit in just a few weeks or months. The market is still strong, but price appreciation has slowed. If you want to flip properties, be very selective and do your homework. Most importantly, know your marketplace and make sure that killer deal is really that good. If you are interested in putting in some sweat equity, give me a call (425-417-5389) or drop me an email. I'd be glad to show you some properties that you can get into inexpensively that could make good rentals and that will likely have good price appreciation over the next few years.
In the mean time, enjoy watching those home-improvement and house flipping shows… but don't believe everything you see…