CHAPTER 8: Sell or Hold?
The inevitable struggle for real estate investors is in knowing when to hold a property in order to allow it to appreciate in value, which will ultimately net a higher profit, and when to sell. Several options exist and timing is the key to all of them. When deciding what to do, consider the state of the market. Is it in the midst of a slump? Do you stand to gain more by holding on to the property while weathering the slump or would it be best to do a few minor improvements and turn a quick flip? Is this particular property right for renovation or should you transfer it immediately? Of course, if you have decided to pursue your career in flipping exclusively as either a dealer or a retailer, then these decisions are bit clearer. However, for those who hope to generate earnings utilizing the method of flipping that will earn them the largest profit in a flip, there are many factors to consider.
The condition of the market, your financial well being, and the actual economy at large can all play a role in the decision to hold on to a property or flip it immediately. Some flippers actually make a career out of simply buying houses and immediately selling them. This type of flipping or dealing, as it is known within the industry, is a profitable niche for those who have neither the desire nor the patience for long term projects and who can overcome the perplexity of the laws governing real estate. Whichever approach an investor chooses, the strategy involved in the decision making process is often as complex as that used to decide whether to buy the property.
Sometimes investors simply become overwhelmed or exhausted by a flip that proves to be a particularly large headache, and they simply wish to unload the property. That is okay, too, and sometimes it is just wise. One of the primary themes of real estate, if you have not already noticed it, is always to leave yourself an out. Never box yourself into something that can lead to the ruin of your business. If a property is just simply not working for you, get rid of it.
Immediate Transfer—The Art of Being a Dealer
If you are the type of person who can see a diamond in the rough but really do not feel like polishing it, the role of dealer might be ideal for you. The trick to being a dealer is being able to seek out properties that are either on the market or whose owners are willing to sell for significantly less than what they are the worth. Remember; a dealer makes his profit from the immediate resale of the property. Therefore, there must be enough room in the deal for you to make a profit in the resale and for the investor who purchases it to make a profit upon resale. The primer types of properties for dealers are those that are in a neighborhood that is on the verge of a rebirth. This will often allow you the opportunity to get more than a good deal on a piece of property that those who only bet on sure things might otherwise see as intimidating. You will still be able to resale at a profit to an investor who has a talent for forecasting to get in on the ground floor with the anticipation of rapid appreciation.
Some question the ethical issues of being a dealer and whether or not it is a form of scamming. The facts of the matter are that supply and demand is at the heart of capitalism. If you have something someone else wants and you can sell it to them at a price that is fair, is reasonable, and is a suitable project to earn them a profit, then you have acted professionally. As long as you disclose all relevant information concerning the property to the investor in your sale and you are not intentionally attempting to artificially inflate the market value of property in the area, then you have not misrepresented yourself in any way. You may have the talent to locate those properties ideal for flipping, but you are not particularly interested in or equipped with the skills to do the work to bring them to retail standards. You, as a businessperson, are still entitled to acquire the property with the intention of finding a suitable investor to realize the full potential of the property. One could even argue that in doing so, you are performing a service of sorts. Earning a profit is what business is all about, so unless one has a wish to argue that trying to make money is wrong in the most generalized form, dealers are not unethical in their nature. As with any business, there are unethical dealers, but the profession itself is not questionable.
In order to maintain ethics, though, it is important to stay abreast of the sometimes-legal parameters of flipping. There are very specific clauses in some contracts and mortgages that apply specifically to double closings, which are the bread and butter of dealers. It is important to follow these legalities, not only for ethical affirmation, but to keep your business and reputation professional and avoid governmental interference. For instance, although you can close with your seller and retailer in the same transaction, it is not advisable. It is perfectly legal. However, seeing you turn from one party immediately to the other may plant the seeds of doubt in both parties’ heads, leaving the former to think he could have sold at a higher price and the latter to think he could have bought for less and both thinking you have taken advantage of them. Instead, it is recommended that you do two separate transactions: the first with your seller and the second with your investor. In doing so, not only will everyone feel satisfied, but also you will be drawing a definitive line between the transactions, making them two separate business deals, and that will preserve the ethical stance from a business perspective.
Of course, it is also necessary to give careful consideration to the legal aspects of your deals. Be sure to check with the lender that is providing the financing to confirm that there are no seasoning restrictions. Seasoning restrictions are clauses lenders attach to mortgage contracts to prevent double or simultaneous closings, since many lenders consider this a bit of a risk. Seasoning clauses simply state that a piece of property must be held by a new owner for a certain amount of time before it can be transferred. It is also a good idea to check the specific requirements for deeds in the area in which you are purchasing.
It should be noted that, due to the sensitivity of the situation one faces as a dealer, many dealers are also real estate agents. It is much easier and much less questionable for an agent to conduct a transaction with one party and then, within a couple of hours, conduct a second transaction with another party. The fine line of sensitivity in this approach, though, is that an agent who is not careful can very easily wander into areas that could be classified as conflicts of interest, so it is important that agents consider their approach as a dealer.
Rehabbing—From Wholesale to Retail
Although it obviously comes with fewer questions of its ethical qualities, the field of retail flipping has considerably more dilemmas from an entrepreneurial standpoint. Because it is a significantly larger time commitment, it requires a larger financial commitment. Most retailers err not in their ethical approach, but in their failure to determine how much is enough. Of course, the idea behind retail flipping is to purchase a property, hold it for a very short period of time while renovating it, and then immediately sell it for a profit. However, sometimes, between the time an investor assumes a property and the time he is ready to sell it, circumstances change, creating new decisions. Sometimes, immediately selling a home upon completion of renovations does not make good business sense. When this happens, a retailer is faced with the decision of whether to sell the property at a lower price than he originally intended, maintain the property as a rental for a period of time, or hold it long term in order to earn a larger profit from its sale.
A somewhat new and increasingly popular option many professional flippers are exercising is a professional project planner. Professional project planners are simply individuals who contract their services to oversee and supervise the flip of a home. The concept is somewhat akin to hiring a wedding planner to plan your wedding. These individuals typically have a background in either real estate or design and work with you to bring your budget and aspirations together to help you achieve the profit you hope to achieve. If you plan to flip more than one property at once or begin your real estate career part-time while maintaining your full-time employment, a professional project planner may be ideal for you. Although it is an added expense that will detract from your construction budget, a professional may prove to be worth multiple times his fee in the amount of stress and money he will save you from over budgeted and timeline busting projects. If you have little or no experience in the field of real estate, utilizing the services of a professional on your first couple of projects may also be a good method of training, so that you can get an idea of what improvements sell, how to get them done, and when to do them.
Choose your contractors carefully, and plan for the unexpected. Both of these things can very quickly make your profit disappear if you are not careful. Make sure you select contractors with care, that you are in complete agreement about the expectations, and that everything is in writing. If you need to, pay your lawyer to draw up a contract. If you do not know what you are doing, do not attempt to do it yourself at the risk of it turning out to be a very costly mistake later. Always keep in mind that there are going to be change orders to contracts, as well as some unexpected expenses of which you were not originally aware. Furthermore, make sure you leave room in your budget for such occurrences. Rare will be the project in which you do not encounter at least some unexpected expense.
Visit your project site regularly—daily if you can—to ensure the work is being completed as you agreed and to the appropriate standards. If work is not being done, do not avoid being confrontational. One can confront a contractor who is not fulfilling his obligations in a professional manner, and it is a poor project manager who does not. It is your job to keep this project on task and on budget, which means that sometimes you may have to be the bad guy.
Know how your budget stands. Do not rely on loose figures in your head. Look at your numbers on paper daily. This is the only way to know where you are financially. Be on the lookout for unauthorized or unexpected expenses that creep in without your knowledge or prior consent and act accordingly. If someone made a necessary judgment call, accept it and move on. However, if it appears as though one or more of your contractors has decided to build to his standards instead of yours, it may be time to have a talk with that contractor.
Leave yourself an out in your contracts. This allows you to dismiss contractors who are unable or unwilling to fulfill their obligations to you. It is important to be flexible, but it is equally important to remember that every dollar that you go over your budget is one more dollar shaved off your final number. Keep telling yourself that you are a businessperson now. Flipping is your business, and you must conduct it as such.
Remembering to remain neutral about a project can sometimes be the most challenging aspect to real estate investors, particularly to those who are new to the business. Many first timers become emotionally wrapped up in their projects. Instead of sticking to a strict plan to get the house market ready, they begin to chase after their own personal aspirations for the house. This can be, and is, the downfall of many would-be successful investors. Budgets and timelines are cast aside in the effort to achieve the vision one has for a piece of property.
Unfortunately, knowing when to say when is not restricted to only those flippers who choose to renovate property. Many otherwise stable investors can get so caught up in the idea of a great find that they are unable to recognize the reality of a neighborhood that has taken an unexpected turn for the worse or that riding out a market slump while holding onto a particular piece of property will most likely deplete any profit potential it may hold.
Knowing When to Move On
Knowing when to move on can be a heart wrenching decision, especially when it becomes obvious that there is no way to unload a property without a loss. However, understanding that it is wise to cut your losses while they are small is just as much a part of being a smart businessperson as is turning a profit. Although it might be tempting to hold a property with the thought that you may be able to turn it around, it is important to remember that with each passing day, you are also spending more money. Three situations, in particular, can often reduce an investor’s profit before he even realizes what has happened.
• Over Improving: It is oh-so-easy to become so personally wrapped up in a property that you become somewhat obsessed with making it perfect. However, remember that the goal of flipping is to improve a house to the point that it will turn your desired profit. This may or may not mean installing top of the line appliances, replacing the roof and siding, installing hardwood floors, etc. What this does mean is it is essential that, when you do acquire a new property with the intent to rehab, you evaluate it in comparison to other properties in the neighborhood to determine what it will take to make that house comparable to others in the area. Then, set your renovation goals and budget. If you set out to make a perfect house that will ultimately cost you more than you will reap in earnings from the sell of it, you are defeated before you even begin.
• Market Slumps: Market slumps are touchy, because sometimes they can be realistically weathered, and it is a good business decision to ride them out. However, sometimes they extend beyond their anticipated duration and can become very costly to investors. When you encounter a market slump as an investor, be honest with yourself about the outlook on the economy in comparison to your budget. If you have the budget, it may be wise to hold a piece of property until the market improves. If the slump is brief and the anticipated profit for a particular property high, it is possible to earn a smaller profit or at least break even in holding the property through the worst part of the slump. However, if the economy appears to be in an extended period of decline and the anticipated profit for the property is not that high, the smartest business decision may be to cut your losses on that particular property and move on before it begins eating your earnings from other properties as well.
• Bad Investments: Sometimes problems in properties do not become evident until after the renovation process has begun. Although the improvement budget should be large enough to allow for some of these instances, there are times when the problem is simply too large to compensate for and the best solution is to just resale the property to someone who is willing to spend the money to correct the problem. Again, it is best to be honest with yourself about whether or not pushing on with a sure fire budget-buster in the pursuit of what, in the end, will be a phantom profit eaten away in the renovation, or if it is best to resale early in order to recoup and move on before the project turns into a virtual money pit that pulls all of your finances and literally drives you to financial ruin.
• Failing to recognize that a piece of property is not going to realize the profit for which you originally planned or hoped: Although many investors will advise you to hold out for your desired asking price, this is usually neither wise nor profitable in the end. The more unrealistic of a price tag you attach to a piece of property and the less negotiating room you leave potential buyers usually translate to a longer, sometimes indefinite, holding period for you. For each month you own the house, you must pay the mortgage. If the property stays on the market for several months, you will also eventually have to begin investing in the upkeep. In other words, for each month that you own the house, your profit becomes smaller. Remember that asking prices should be aggressive, not unrealistic. Setting a profit range is usually a good way to remedy the ideal of a specific number. Understand the comparable range in the area of a property you undertake prior to assuming the project. It is usually an expensive mistake to attempt to compensate for an over blown budget by inflating the asking price for the property and hoping for the best.