When you have newspapers report – as they did recently – an annual drop of 4.5% in house prices, most investors will stop at the headlines and not give anyone the opportunity to discuss the merits of flipping homes for profit. Yet, during the recent economic downturn and the current recovery, the flipping of homes that have been foreclosed has been one of the few segments of the real estate market in which investors and developers been making money.
Flippers can buy homes at a significant discount in a number of ways: at the courthouse steps, from a very motivated seller at distressed prices, or on an all-cash basis. They renovate homes in order to resell to the general public.
When investors read about increasing rates of foreclosures and declines in home prices, they usually think these are reasons to avoid investing in this space. We have found this line of reasoning to be mistaken.
On average, the flipper typically buys at a 30% discount, spends roughly half of that discount on fixing up the house, and then another 5% for closing costs, overhead, and insurance. This leaves roughly 10% of the initial discount on a net basis. Over the course of one year, flippers can flip a series of homes roughly 2.5 times, creating a profit before partnership splits of 25%. And these figures were results achieved in a flat market – returns can be even better as the market improves.
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Flipping Makes Sense – Even In a Flat Market
Simple math helps illustrate how profits can be attained, even if the market is flat. As we mentioned previously, flippers can make an average of 10% on each home and flip the homes every 123 days. Even if housing prices were to fall while we own a foreclosed house, this would result in maybe a 2% reduction in profits on that transaction. However, since we then buy our next house in the same market environment, we hopefully also can purchase the next property at a similarly 2% lower price.
Therefore, we are still making money, because the fall in values in a small percentage of the profits due to the limited time period we own the houses. For example, let’s assume we initially expect a 10% profit at the end of one flipping cycle, but the house falls two percent in value before we sell in 123 days. We still make eight percent on the transaction, and if we flip 2.5 times per year, then the annualized return is 20%.
Admittedly there is a risk in any real estate investment, but flipping houses, when done skillfully by experienced developers, can be profitable – even in trying economic times.
Housing Econ Presentation
A while back I read a detailed presentation prepared by the housing economist, Gerd-Ulf Krueger of Housing Econ. I continue to be impressed with G.U.’s accuracy over the past 12 years. He forecasted the SoCal housing “turn around” in 2012 and 2013 with possible double-digit home price appreciation by the end of 2013 in coastal areas. It is interesting data, and I would be happy to speak with you about its implications for future investments.