House-flipping? Proceed with caution

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Despite the continued popularity of house-flipping reality shows on cable TV, it’s getting harder to find that diamond in the rough that can produce a hefty profit with just a little elbow grease. Back in 2011, it was a different story. The market was flooded with foreclosures and the banks that repossessed them had no clue what to do with them. Instead of putting a small amount of money in them to repair issues that would prevent most financing, they sold them as-is to cash investors at a significant discount.

There was good money to be made and thousands of homes were renovated and put back on the market, improving not just the foreclosed home but often the entire street. Just like vultures, house flippers served a very useful purpose.

It’s a different market

It’s a different market now. Yes, if you are able to find a house at a big discount, the chances of selling it quickly have improved because of tight inventories. The chances of realizing a nice profit are there too, for the same reason.

The problem is that finding a property with good potential at the right price. Finding a foreclosure at 40% below market value is kind of like spotting a unicorn.

RealtyTrac reports more homes were flipped in 2015 than the previous year, but what it doesn’t say is whether the flippers turned a profit. If they had to make major improvements to the properties, they probably didn’t make much of one. It’s not a stretch to assume that plenty of novice flippers lost money.

“More inexperienced home flippers with a smaller financial cushion could be a sign of an over-speculative market, but the data indicates that flippers in 2015 continued to operate within relatively conservative margins,” said Zillow VP Daren Blomquist.

Less forgiving margins

Still, today’s flippers are dealing with less forgiving margins. Blomquist says they bought at an average 26% below market and sold at an average 5% above the market. The above market premium is likely where the profit was.

Buying low and selling high is just part of the home flipping equation, however. The cost of improvements – and with foreclosures they can be significant – is where most of the risk lies. If the flipper is skilled in the building trades, then it’s easier to make money. If not, look out.

One of the biggest risks in a flip is encountering more damage than expected, or repairs that will cost more than budgeted. Roofs, foundations, and HVAC systems can be the most costly repairs. Code issues can also run up the costs.

That’s why a less risky flip is a condo or townhouse. The roof, foundation, and landscaping are covered by the monthly HOA fee. For the most part, renovations will be limited to the interior – things like flooring, paint, and appliances. The most costly repair will be replacing a heat pump, but there should be few unbudgeted surprises.

In spite of how easy it looks on TV, house flipping isn’t for everyone. Before trying it, consider partnering with a more experienced flipper and choose your property carefully, understanding that the right one may be hard to find.

 

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