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Be a Flipper, not a Flopper

How to make money (and avoid losing money) when flipping real estate 

“I want to get into real estate and flip houses!  How do I do that?”  This declaration and the question that invariably follows are addressed to me again and again during the course of every week.  Although a few flippers out there do very well flipping homes, most flippers end up as floppers, if the truth be told.  At the outset remember this:  Because real estate typically deals with hundreds of thousands of dollars, a small mistake in real estate buying decisions is a BIG mistake!  In this article I discuss some basic  principles that will help to guide you in making these important decisions.

Let’s consider some basic dos and don’ts (not in any particular order):

• You make your money when you buy the house, not when you sell it.
• Identify the market you are in:  Is it a seller’s market?  A buyer’s market?  A neutral market?
• Do not use the shotgun approach when looking for a house to flip:  Be specific about the area in which you are looking, and do your research about that area before buying.
• Gather a trusted team of professionals to help you with the flip (VERY IMPORTANT).
• Give due diligence by running your numbers up front.  Settle on a profit amount; then get it done.

Now, let’s address each of these dos and don’ts.

You make your money when you buy

First and foremost, every real estate investor must understand that you make your money when you buy the house, not when you sell it.  Even better, you make your money when you buy the house, and you cash your check when you sell it. 

With this first point in mind, determine that you will not let your heart rule in real estate investment decisions:  Find a house that “works.”  Use your knowledge of the market to find a house that will fit your flip strategy, and do not deviate from this decision without giving deliberative thought to the consequences.

Identify the market you are in

You must identify the type of real estate market in which you are working.  By identifying the current market conditions you can employ the correct flipping strategy, which is where most first-time flippers flop.  To help you avoid flopping at this point, let’s first divide the market into three categories:

• Buyer’s market – low demand/high supply
• Seller’s market – high demand/low supply
• Neutral market – demand and supply are equal

Buyer’s market – the cosmetologist flip

In a buyer’s market there are more houses for sale than buyers to buy.  Let’s assume there are three buyers and ten houses to choose from.  These three buyers will choose the top three houses to buy and leave the others untouched.  In this situation a savvy flipper can get involved by identifying the reasons the other seven houses did not sell (i.e., identifying the deficiencies).  After remedying the deficiencies the flipper can then bring the house into the top-three group and sell it.  Identifying the deficiencies is the tricky part:  Do just enough to bring it into the top-three group, remembering that the more you do, the more you spend potential profit.

Here are some first things to address for a buyer’s market flip:

• Curb appeal.  If you can’t get buyers out of the car, you have little chance of getting them inside the house.
• Entryway.  Once you have the buyer in the house, create the mood.
• Carpet and paint.  Lipstick and other makeup are what the cosmetologist needs in this market to move the house into the top-three group.

It is noteworthy that most experianced flippers believe that a great buyer’s market is the best time to flip.

Seller’s market – the cosmetic surgeon flip

In a seller’s market—one of the most difficult markets to flip in—there are more buyers than homes for sale.  Let’s assume that for every three homes for sale there are six buyers.  When a home is listed for sale in this market, it sells because it is always on the top of the list, regardless of its condition. 

During a seller’s market you need to find properties that are not at their highest and best use, for example, a two-bedroom, one-bath house in an area in which most houses have predominantly three or four bedrooms and at least two baths.  Adding an extra bedroom and bath would bring the house up to its highest and best use. 

A second strategy is to take a duplex home in a nicer neighborhood and convert it to a two-unit condo project.  In this scenario individual units have a higher value than multifamily units.  Remember, rental rates affect the value of multifamily units; and the existing home sales market determines the value of single family units.  These types of flips are the most difficult to accomplish because of the time, money, and expertise involved. 

Do not choose a flip in a seller’s market as your first flip.  Why?  You are sure to flop!

In summary, to profit from a flip in a seller’s market

• Find a home that is not up to its highest and best use.
• Add square footage to the home.
• Change the type of property

Neutral market

Because the neutral market is typically a transitional market, it is very important to determine which way the transition is going.  Are you moving into a buyer’s market, or are you moving into a seller’s market?  Making this determination up front is very important.

Do not use the shotgun approach

As a first-time flipper, choose an area of town that is near to where you live, and choose an area with which you are familiar.  It is vital that you carefully research the area you choose.  To help you do this, carefully consider the next principle.

Gather a team of trusted professionals

Of the utmost importance is choosing the right team to help you succeed in real estate flipping. 

First, an experienced, active, and knowledgeable real estate agent can help you to research the area you are considering.  Choosing the wrong real estate agent can cost you, but if you employ one who meets these criteria, your job will be much easier and your bottom line much bigger.  Find an agent who is experienced.  If the agent does not have at least five years’ experience under his belt, find someone else.  Find an agent who is active in the market.  Some agents do only five to ten transactions per year; find one who does at least double that.  Find an agent who is knowledgeable.  Just because an agent fulfills the first two criteria does not mean he knows what he is doing.  To find such an agent, speak to his past clients.  Ask the agent to supply references from repeat clients, preferably clients who have already bought and sold investment homes.  Because dealing with investors is a specialty, not all agents recognize the differences between owner-occupied and investment homes.  After all, you wouldn’t go to a general practitioner of medicine for heart surgery, would you?

Second, make a determination about your role in this process.  Are you going to be the person changing out the carpet, painting the walls, tearing down walls, and adding bedrooms and a bathroom?  If you aren’t in the construction business, I recommend that you hire a construction project manager to manage the trades for you.  Although this will eat into your profits, you my actually save yourself money and aggravation if you can complete the project correctly and on time the first go-around.  I recommend this strategy for first-time flippers because they probably don’t have a list of trades that will help them to turn investment into profit.

Third, consider financing.  Most flippers—or should I say floppers—tend to ignore financing by choosing a mortgage lender based solely on rate or closing costs.  A big mistake!  Therefore, choose the right mortgage lender to maximize your bottom line.  Choosing the wrong lender can cost you in the end.  Use the same criteria for choosing a mortgage lender as those recommended for a real estate agent:  experienced, active, and knowledgeable.  Most lenders do only three to four transactions per month and have been in the business for less than five years.  Choose a lender who has at least ten years’  experience, closes at least ten deals per month, and specializes in investment homes, not just primary residences.  Many programs are available to qualified investors, and the right mortgage lender can match you with the program best suited to meet your needs.

Give due diligence

Give due diligence by running the numbers up front.  Know what your flip is going to cost.  Because there are so many hidden costs in flipping a home, not adding them up before you purchase can lead to a flop.  Here are some typical costs involved when flipping real estate:

• Cost to purchase.  Buying real estate involves closing costs, which your mortgage lender should detail for you.  Ask your real estate agent about other costs not related to your mortgage (e.g., inspections).  Note:  Never pass on the inspection—the associated cost is the best money you can spend!
• Holding costs.  Many floppers totally ignore payments for the mortgage, insurance, taxes, HOA dues, utilities, and on and on.  Add these to your spreadsheet when calculating your bottom line.
• Rehab costs.  These costs include items as simple as paint and carpet and as extensive as adding 1,000 square feet.  Get bids for this work.  These costs should also be added to your spreadsheet.
• Costs of sale.  Selling real estate involves certain costs, including agents’ commissions, title, and attorney fees.  Be sure to include these costs on your spreadsheet.
• Tax implications.  Profits on flips are treated differently than profits resulting from the sale of  real estate that you have previously rented out.  Because flips are considered real income, you will be taxed at whatever bracket you fall in.  Rental-property sales profit is taxed at a rate of 15 percent (as of the date of this article).  Don’t let anyone convince you that you can use a 1031 exchange on a flip—they are not eligible.

At this stage of flipping you should know the profit you will walk away with.  Take that number and divide it by the time you have put into the house.  If the result is less than $20 per hour, you might as well go to work for a general contractor who is working on a house for someone else.  You can make the same money with NO risk.

I counsel all my clients to run their numbers up front to determine their profit in the end.  Stick to this number.  After you have worked for a while on the house you want to flip, you may believe that it is worth more than you initially thought.  Don’t do it!  If this happens to you, remember one of the initial points of this article:  Don’t let your heart get in the way of a good real estate decision.  Choose an acceptable profit margin, finish the house, sell the house, and then move on to your next flip.

Let me briefly summarize my answer to your question, What leads to a successful flip?  Identify the current market conditions so that you can apply the correct strategy, choose a team of  experienced, active, and knowledgeable professionals to back you, know your market, and run your numbers.  Sounds simple, doesn’t it?  Just remember:  A small mistake in real estate is a BIG mistake.  Good luck!

John McClellan

You’ve heard of people who are passionate about their work – but did you ever imagine someone could get so excited about, well, about mortgages and real estate?  If you are looking for someone who truly eats, sleeps and breathes mortgages, and is more than happy to tell you all about it, then you’ve come to the right man.
John McClellan has more than fifteen years of experience in real estate and mortgages. He has been consistently ranked as one of the top 10 mortgage brokers in Central Texas by the Austin Business Journal. John is an experienced professional mortgage expert who is thrilled to give you access to the best rates, best programs and greatest service.
John has been involved on the broker and banking side of mortgages, and handles hundreds of various types of transactions each year.  This training has given him a unique insight to the inner workings of the mortgage industry. With this expertise, he can advise and place his clients into the best loans that are tailored to meet their individual needs.
John is employed with Supreme Lending, a full service Mortgage Bank that has its corporate offices in Dallas, with branches in Houston, San Antonio, Austin and 24 other states. Supreme Lending funds almost half a billion dollars a year in residential mortgage loans.
John grew up in Central Texas and still resides here today.  John is married to his wife Laura, a native Austinite and former teacher in the Round Rock Independent School District. They have two children: Emma and Noah. John and Laura are very involved with their church and their children’s lives.
Anyone who has had the good fortune to spend even a few moments discussing mortgages and real estate can see John’s obvious passion and enthusiasm; and his commitment to his clients is legendary.  When you want a passionate, professional, mortgage expert, you want John McClellan on your team.