Devising an Effective Flipping Strategy

Surveying Different Strategies

When developing a game plan, you want to maximize your strengths, minimize your weaknesses, and fully exploit the opportunities that surround you. Many flippers have already developed their own strategies that achieve those three goals. By becoming more aware of these existing strategies, you can choose the one that fits you best and perhaps even improvise to develop your own unique strategy.

In the following sections I reveal house flipping strategies that many flippers practice with varying levels of success.

Always buy low. If you can’t get a house for at least 20 percent less than what you estimate it will cost to buy, repair, hold, and sell it, keep looking. Chapter 12 shows you how to calculate your maximum purchase price to improve your chances of earning a decent profit.

Buy into a hot market

In a sizzling real estate market, you can turn a profit fairly quickly by buying a house, moving in, and then sitting back and watching the real estate values soar. This approach works only if you have time on your hands, are speculative by nature, and have a knack for purchasing houses in a hot market at just the right time. This strategy offers several benefits:

If the market remains strong, your property value rises without your having to lift a finger.
Your equity in the property rises, boosting your borrowing power for other investments.
By living in the home for two years or more, up to $250,000 of your profit ($500,000 for a couple filing jointly) may be tax free, at least according to the tax laws in place when I was writing this book. See Chapter 23 for more tax-saving tips.

Buying into a hot market also carries some significant risks:

Where property values are soaring, the housing bubble may burst, leaving you with a home that’s worth less than what you paid for it.
Stuff happens. You can have a great house at a great price in a hot market with the top agent working to sell it, and the house still may not sell. Prepare yourself for all contingencies.

Chapter 6 has more details on taking the temperature of the real estate market in any neighborhood you’re scoping out.

Buy low, do nothing, and sell quick

Occasionally, you stumble on a house that’s priced significantly below market value and requires few or no repairs. The property may be in foreclosure or perhaps is part of an estate that’s being liquidated, making the owner very motivated to sell. By being at the right place at the right time with ready cash and a solid plan in place, you can pounce on the deal and then put the house back on the market the very same day!

Sounds great, huh? Well, getting a house that’s way below market value is great when it happens, but being in the right place at the right time takes time and effort. You need to build a solid team (see Chapter 4 for details), do plenty of research, secure some solid investment capital (see Chapter 5 for tips on financing your flip), and be properly equipped to execute this strategy.

Beware of deals that are too sweet. If a stranger approaches you at an investment seminar with a hot tip on a piece of real estate, for example, he may just be looking for a sucker to buy a property he got stuck with. Unless you know the market values in the area, see the house with your own eyes, and research the title (as I explain in Chapter 10), don’t take the bait.

Buy low, apply makeup, and sell quick

You can learn a lot from used-car salesmen. The first thing they do when they take possession of a vehicle is clean and polish it and vacuum and deodorize the interior. Looking and smelling its best, that used car can sell for a handsome profit.

Even a good home, if not clean and well maintained, can look disheveled and smell stale. Many homeowners place their homes on the market without proper staging (showcasing). They don’t mow the lawn, trim the bushes, touch up the paint, or even tidy up the house during showings. Unknowingly, they turn away prospective buyers and lower the profit potential of their property.

This kind of home gives you a perfect opportunity to swoop in and get a great deal. You buy the home for significantly less than market value, add elbow grease, and then resell the home for thousands of dollars more than you invested in it. In Chapter 21, I show you how to properly market and stage a home to get top dollar.

Buying low, applying makeup, and selling quick is an excellent strategy for the first-time flipper. By purchasing a property that’s an easy rehab job, you can focus on the process of flipping instead of on the complexities of rehabbing. After you master this strategy, you’re better prepared to move up to more distressed properties.

Buy low, renovate, and sell high

Some homes are undervalued because they’re missing an essential feature — a livable living room, a third bedroom, a deck, or a laundry room on the main floor. Other homes may have major eyesores, such as an outdated kitchen or bathroom. In either case, moderate to major renovations may improve the marketability of the house and its profit potential in two ways:

Increase the home’s actual value. Wear and tear depreciate a home over time. Updates restore value, while added living space can boost the house into a higher price bracket.
Expand the pool of interested house hunters. A two-bedroom house, for example, appeals only to people who are looking for a one- to two-bedroom house. Adding a third bedroom attracts anyone looking for a one- to three-bedroom house or a house with office space.

Adding to the real value of a home is a great way to maximize your profit, but don’t take on more than you can handle or build a mansion among bungalows. If you’re a weekend warrior or you have contractors on your team (see Chapter 4 for details), consider this strategy. If not, you may want to hold off until you get to know some local contractors.

Buy low, move in, renovate, and sell high

To maximize your profit, reduce expenses, and take a more hands-on role in rehabbing a home, consider moving into the home and renovating it at your own pace. If you and your family don’t mind living in the chronic chaos of a construction zone, this approach is appealing for several reasons:

By living in the home you’re flipping, you avoid a second mortgage payment, tax bill, and utility costs.
Because you’re living in the home, you get a better feel for the types of renovations that can make the house more attractive to future buyers.
If you live in the home for at least two years, up to $250,000 of your profit ($500,000 for a couple filing jointly) may be tax free, as discussed previously.
You’re onsite for any repairs or renovations you have to hire out. And you’re around more often to prevent thieves from walking off with your tools and materials.

If you’re single or married with no kids, this strategy is an excellent choice. However, if you have children in school, I recommend that you avoid this approach, unless you intend to remain in the same school system after selling. Your children begin to make relationships, and big moves disrupt their lives.

If you’re planning major renovations such as gutting the house or completely rehabbing the kitchen, consider performing that renovation before you move in or plan on residing elsewhere during the renovation, especially if you have kids and pets. The persistent noise, dust, and inconvenience can rattle nerves and strain relationships.

Buy, hold, and lease

You don’t have to sell a house to profit from it. Many real estate investors opt to buy a house and lease it out for at least enough to cover the monthly expenses of holding it — mortgage, taxes, maintenance, utilities, and so on. Here’s a rundown of how this strategy works:

You buy the house at less than market value, so you earn equity at the time of purchase. In other words, if you buy a $100,000 house for $80,000, you immediately earn $20,000 in equity. You don’t realize your profit until you sell the house, but you can borrow against the equity.
Assuming the rent you charge covers your mortgage and other expenses, the rent pays down the principal of the loan, so your equity in the home gradually rises. (Your renters are paying off your debt.)
As real estate values rise, your equity in the home rises accordingly, so the house is worth more when you sell it — assuming, of course, that your tenants don’t trash it.

In short, you’re making money three ways: when you buy the house, when you hold the house, and when you sell the house. If you perform some value-add updates and renovations while you own the property, you may even boost your profit when you sell. Of course, with this strategy you won’t see the immediate influx of cash that accompanies a quick flip, but your net worth (the value of your assets minus what you owe on those assets) gradually rises until you cash out your chips at the end of the game.

See Chapter 20 to find out more about the various approaches for profiting from real estate investments.

Invest in new construction

A home doesn’t have to be old and beat up for you to flip it. Many real estate investors profit from flipping new homes or condos. Unless you’re focusing on a niche market that rules out new construction (see the next section for more about niche markets), don’t overlook newly constructed homes.

The best time to hit newly constructed homes is at the very beginning, when the builder first starts to sell units. After 60 months of construction, the cost to build may have risen by $50,000, so if you bought at the beginning, five years later you have that extra equity built up in the property compared to the other homes in the division.

When a new subdivision is starting, ask if you can buy the model from the builder. The builder can then rent it from you for a few years. It’ll be very well taken care of because it’s for showing to prospective purchasers.

When purchasing a newly constructed home or condo, read the purchase agreement very carefully and check the following:

The purchase agreement should have a clause stating that the purchase is conditional upon the satisfactory completion of the building and on your ability to secure financing for the purchase. If you sign a purchase agreement and then are denied financing, the builder may keep your earnest money and perhaps even sue you for breach of contract.
Watch out for clauses that give the builder a percentage of the profit when you resell the unit — a common practice in a strong market.
Beware of inflated profit estimates. You’ve probably heard stories of people who invested in a development and made $100,000 in short order. What you don’t hear are the stories of people who lose money, and those stories are much more common.
If, after doing your research, you’re convinced of the benefits, then at least make sure you’re among the first 10 percent of buyers. These buyers make the lion’s share of the profit because as construction proceeds, building costs rise.

Focus on a niche market

When you’re looking for properties to flip, the first impulse is to cast a wide net in your search for the best deals, but sometimes you can find better deals by fishing deeper in one spot, such as one of the following:

Foreclosures: You can find more homes in foreclosure than you can possibly flip, and by focusing your efforts on these properties, you quickly discover the ins and outs of locating them and effectively negotiating the price and terms you want. See Chapter 8 for details about foreclosures.
VA foreclosures: To narrow your scope even further, consider focusing on VA (Veterans Affairs) foreclosures.
Probate: You can get leads from probate lawyers and the neighborhood grapevine to locate families who need to unload a house in order to settle an estate.
Divorces: When couples divorce, they’re often stuck with a home that neither of them can afford. By keeping your ears open and letting people know that you buy houses, you can often get first dibs on these homes.
HUD homes: Working with an agent who specializes in HUD (Department of Housing and Urban Development) homes, you can build a career purchasing these homes at a discount and rehabbing them for quick, profitable sales.
FSBO (For Sale By Owner): When everyone else is searching the MLS for great deals, you may prefer driving around the neighborhood looking for homes with a For Sale By Owner sign on the front lawn or searching for the ugly duckling on the street and then visiting your county’s Register of Deeds to see who owns it. (MLS stands for Multiple Listing Service — an organization that maintains a database of houses and other real estate for sale or rent. They’re all over the country.)
Seized homes: Law-enforcement agencies commonly seize property and then have to unload it. By focusing your energy in this area, you can corner the market on seized homes.
Teardowns: Homes that are beyond hope may still hold opportunities if the price and location are right. Some investors earn a great return by tearing down old homes and building new ones in their place.

Don’t try to be a high roller and master everything all at once. Select a niche (foreclosures, probate, divorce, whatever) and work that niche until you achieve success. After you establish yourself in that area, you can add another to expand your operation. Chapter 9 provides more guidance on niche markets. Your niche market can also be a specific area that you farm by becoming an expert in the area and establishing a strong network. Chapter 6 offers additional details on how to effectively farm a neighborhood.

Flip contracts (or do it all on paper)

Flipping contracts (also known as pass-throughs) consists of locating a distressed property and then contracting with the homeowner to sell it to an investor. In other words, you earn a finder’s fee by serving as an investor’s bird dog, and you don’t even have to lift a hammer.

Here’s how it works: You pay the homeowner a deposit, typically $1,000 or 5 percent to 10 percent of the estimated purchase price. In return, you get a purchase contract giving you the right to sell the property to an investor. You then find an investor who’s willing to purchase the property and pay you a fee in excess of the amount you have tied up in the property.

This strategy may sound rosy, but I strongly discourage you from flipping contracts. I include the strategy here only because you’re going to hear about it elsewhere, and you should be aware of the high risk, especially the risk of buying from a bird dog. If someone ties up a $100,000 house and wants to sell you her purchase agreement for $5,000, you’re purchasing the house for $100,000 and paying a fee of $5,000. You’re taking all the risk and giving that person $5,000. If it’s such a good deal, you need to analyze it and ask yourself why she’s not flipping the house herself.

Cook up your own strategy

Successful investors, whether they invest in real estate or stocks, devise unique strategies based on their personalities, their abilities, and the resources they have at their disposal. If you like to help people and you’re good at dealing with uncomfortable situations, for example, you may want to focus on foreclosures or divorces. If you’re good at primping a house but not so good at rehabbing, consider focusing on homes that require only a little makeup.

You can even mix and match strategies to develop a custom strategy. You may, for example, choose to buy a quick flip in a hot market or buy only duplexes, move into one half, and rent out the other half while renovating the half you’re living in. The variations are limited only by your imagination.

Re-evaluate your situation and be ready to shift your strategy as your skills, knowledge, resources, and market change. At this point, you may not feel confident taking on major renovations, but in a year or two, it could well become your area of expertise.

Drawing Up a Detailed Plan in Advance

Every day you own a property, holding costs chip away at your profit, unless of course the property is a rental. Holding costs are the daily expenses — mortgage interest, property taxes, utility bills, and maintenance costs. The trick to reducing these costs is to flip the property as quickly as possible, and that means planning well in advance. Make sure that your plan covers all five stages of the flipping process:

Get cash or secure financing.

With financing or preferably cash in hand, you can move on the deal much more quickly than other buyers and negotiate from a position of power if other prospective buyers don’t have cash. See Chapter 5 for more about financing your flips and Chapter 12 to determine how much you can pay for a property to earn a decent profit from it.
Search and research.

The fun, exciting step in the process of flipping houses is searching for and finding diamonds in the rough. To limit your exposure to risk, however, you need to follow up your search with research, particularly if you’re buying a home in foreclosure. See the chapters in Part 2 for more about finding properties to flip and Chapter 10 for guidance on how to research distressed properties.
Purchase.

Buying the property is probably the easiest step in the process, but you want to be sure to negotiate (or bid) a price that’s at least 20 percent less than the cost of buying, renovating, holding, and selling the property. You also need to negotiate other terms, including the closing date and the date on which the previous owners move out.
Rehab.

Jot down a list of improvements you want to make to the property when you first see the house, and schedule the work before you close on the purchase. Ideally, you should start renovating the property the same day or the day after closing. Chapter 11 walks you through the process of inspecting a property for the first time; Part 4 is devoted to fixing up your fixer-upper.
Sell or lease.

As soon as you know your closing date for purchasing the property, set the date on which you want to put the house back on the market or have it available for tenants. If you’re selling the house, also decide whether you want to sell it yourself or work with an agent. You don’t have to wait to market the house until renovations are complete — the activity that surrounds the house during renovations can be an excellent marketing tool. It gets the neighbors talking. See Chapter 20 for various ways to realize a profit from your investment and Chapters 21 and 22 for more about selling your rehabbed property.

Mark Workens, owner of Mortgage One (http://mortgageone.com) and a good friend of mine, offers some other FHA-related mortgage input every house flipper should know. As you develop your flipping strategy, keep the following rules in mind:

HUD/FHA 90-day rule: According to the department of Housing and Urban Development’s (HUD’s) 90-day rule, you must own the home for longer than 90 days before you can transfer the title to a buyer who’s using a Federal Housing Authority (FHA) loan to finance the purchase. If you’re planning to sell to first-time buyers, this rule can reduce your pool of prospective buyers, and you may need to hold the property for longer than you had planned. Owning the home for less than 90 days voids your eligibility for an FHA-insured mortgage.
HUD/FHA 91-to-180-day rule: If you resell a home between 91 and 180 days after you buy it, and the resale price is 100 percent or more than what you paid for the property, a second appraisal is required if the buyer is using an FHA loan to finance the purchase. If the second appraisal is 5 percent or more higher than the first appraisal, the lesser of the two appraisals is used for FHA loan approval.
The 24-month history rule: Banks require title reports to determine chain of title dating back a 24-month period. If any more than one person has owned the property in that 24-month window, fraud might have played a factor. As an investor, always be careful about how many sales there were in the past 24 months. Anything more than one, and there might be a problem.

Simply strolling into your county’s Register of Deeds and asking for everything recorded on a particular property within the last 24 months will alleviate all doubts about the chain of title.

For more information on FHA mortgage related questions, visit http://portal.hud.gov/hudportal/HUD.