Real Estate

Changing properties in a drastically declining market

In previous years, “Flipping” was a negative term used by government agencies to designate a mortgage fraud situation in which there was massive collusion between front men, appraisers in the take, title companies and other players, all committed to defrauding a lender and making ill-gotten gains. Over time, these little 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 American culture, the word has now morphed and is used in the vernacular to denote a legitimate effort to buy cheap, fix and remodel, and sell for a profit without any of the negatives of earlier usage. Many who do the legitimate practices of the term gain a certain sensitivity when dealing with lenders and refer to the process as Buy-Fix-Sell to get away from the formal negative connotations of the term and in some way impair their lending process. In any case, good or bad, it is now known in the trade as “Flipping”.

With major cable systems now hosting shows that show changes around the house, everything seems so glamorous and easy. In a bull market, some of the key elements were brought into play to protect investors’ downside risk. In the most recent bull market with multiple listings, the feeding frenzy was blinding. In that kind of red-hot buy-sell climate, many savvy investors headed to the sideline to wait out the inevitable swing of the pendulum in the other direction. Lenders who looked at foreclosure inventories didn’t care much about moving REO (real estate ownership) properties, as the market would make them disappear. Like the stocks of the 1990s, the last man to own it loses. The last person to participate in a bull market witnesses any perceived gains evaporate and perhaps turn property upside down.

There are rules to successfully “flip” properties. If the rules are violated, the investor loses. Real estate is such a forgiving medium; however, it can take years to get back, even if you can afford to wait to make a serious mistake. If an investor will stick to a set of principles in good times or bad, he will establish a foundation of principles to avoid major setbacks. Are you free of problems? No, it is not and never will be. It just minimizes downside risk. As with any investment, there must be a balance in a real estate portfolio with buy-fix-and-maintenance and rent as a strategy. Another portfolio management strategy is to buy on a deed contract and resell in a wrap around while raising the price $10,000 to $15,000 above the acquisition price plus repair and maintenance costs. If an investor can negotiate, for example, an interest rate of 7.5% and resell at a rate of 9.5% or higher, the old principal of earning 2% on the debt and 9.5% on the new money applies. These work great for long-term returns, however people move all the time and cash out may be imminent. In enveloping situations, fixed costs tend to be limited and more constrained. Properties with structured terms tend to be very attractive to buyers with credit difficulties. The buyers will need good sources of income but for some reason have had a bad run of bad credit. It can’t be bad enough to lose the patient on the operating table, but good enough to survive and make another payment.

The above is just a warning not to focus only on “changes”. If an investment situation appears excellent. Just don’t pass up a bunch of potential profit opportunities with the idea that I “just do flips” while the next property makes a big wound in an investor’s cash position. These things happen. Being positioned with monthly cash flow properties with equity gives you good flexibility when things take a bad turn.

In a weak market, when the market has turned and the cheese has moved, “switches” may be more feasible. It is much more difficult in a euphoric and rising market. When this weaker market happens, foreclosures increase and banks now wring their hands trying to move their REO

Portfolio as indicated by banking regulations so that an investor can have a listener ready for offers. When the average sales time in the market went from less than 30 days to 120 days or more, the change is underway. To successfully “flip” a property, an investor starts with a probable fixed value and then works backward to arrive at an offer price. In fact, many investors take the probable fixed sales price and reduce it by 5-10% to ensure a quick sale when the home is rolled out and put on the market. This is where an investor should focus on a standard home without radical architecture or uniqueness. No amount of log houses, domes, or small square foot homes will work in this endeavor for maximum returns. Rather, a three-bedroom, two-bath, two-car garage subdivision will hedge the ante.

A thorough home inspection will point out the needs of the property. Initially, this must be done by the investor for cost purposes. A total cost of operation is tabulated to determine the amount of cost to repair. Then, with a bit of arithmetic, the final sales price minus costs to fix up, costs to maintain, costs to sell minus the desired profit of $20,000 or more, will leave a resulting number that will indicate the maximum acquisition price. Any trader would not go in at this price, but would instead offer perhaps $10,000 below “THAT” number, leaving some room for negotiation. The investor is looking for structurally sound properties with good roof life, no settlements or cracks in the foundation, with good stable ground conditions. Anything less than that requires a high level of expertise and even then is risky business.

The key to all of this effort is to work with a real estate agent who scouts potential properties and is willing to initiate many low offers and not be afraid to tarnish their reputation. Bottom feeder offers are soon recognized, however for a good volume of offers there will be some interested sellers who need to move house. Ideally, the property should be vacant, in a safe deposit box so you can see it and have some kind of pressure on it. Recovery, property with an out-of-town heir, divorce, bankruptcy, illness, or some other type of motivation is necessary. Typically the property will have a very worn look in need of painting, landscaping with bathroom and kitchen upgrades required and a new floor covering. Tall growing weeds or foul odor and/or discarded property are positive buying signs that warrant further investigation.

In practice, many offers are needed to buy a property. All the more reason for an investor to diversify and take a chance when it makes sense and not until it makes sense. Acquisition prices can be further tempered with the notion of paying up to 6% of the sales price in the form of closing costs and prepayments to further separate the property’s appeal from surrounding competitive homes. For all of this to happen, the seller has to take a hit in the pocket for it to happen, otherwise the investor is the one who takes the hit by overpaying. The giant investors in the industry have left all this in graves of material before. It is nothing new or a radical advance. It’s just that now the market has again brought this “change” to the fore.

Just to review, when the deal makes sense, for a quick sale, stay below market for a target sale price, lower that price per acquisition, repair costs, keep costs, cost to sell, buyer help, profit ($10,000-$20,000 more) for a maximum offer price. Deal only with motivated sellers. Listing agents can be interviewed to see if there is an atmosphere for a lower offer without violating the fiduciary responsibilities of the listing agent simply by probing the seller and without spending a lot of time. If the seller insists on a written offer, give them an offer. The key is to make lots of offers to motivated sellers. Six months ago a buyer couldn’t get an ear. Now sellers listen carefully to ANY offer. Again, “flip” is a simple tool, a real estate investor should not be just a means to acquire wealth, just one of the ways. In all cases, after offer is accepted, a thorough inspection of the home from top to bottom with a termite inspection must be completed, all within the inspection period allowed to accept the offer 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 falls short of the numbers, move on.

“Flip” someone?

dale rogers

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