Flipping “Flipping” on its Head (L-O-N-G)

You can always count on me to bring you the flip-side of pretty much anything as I discover it, and real estate flipping is the latest.

We’ve all seen the vast array of offerings on TV—Flip This House, Flip That House, Property Ladder, Sell This House, Stage This House, Real Estate Pros, and all the rest. Now you get to toss the remote and learn from a REAL pro—John T. Reed.

He’s seen these shows too, as well as read a few of the *ahem* literary offerings by the finest of hucksters, and tells the world through his fantastically-improved website just how much bull exists in this industry when it comes to flipping for profit.

He’s a veteran of the real estate industry—he’s been there, done that, and made both profits and mistakes. His wealth of knowledge and advice is available through self-published books and in little bits on his website for free.

Now, for the flipping “flipping” part: What you see on the TV shows is not really flipping at all—it’s a cosmetic facelift. Anybody with an ounce of brains can do that, because it’s just in-depth decorating. There’s not much profit in cosmetics, unless you happen to be Max Factor (or Home Depot in this case).

REAL flipping goes back further in the home’s life than just being mildly run down—to really turn a quick and easy profit, you must buy absolute disasters and make them fixer-uppers. This entails taking on things that would drive any other buyer away screaming from the premises, like bad foundations, lead-based paint, asbestos, lack of central heat and air, and anything else you would never dare to take on yourself for lack of experience and/or perceived expense to solve the issue.

By taking on these projects (or rather calling in pros to do them), you turn a deeply-discounted non-seller into something that so-called flipping sharks would circle around, even if you bought at a 60% discount to the market value, repaired the major flaws, and resold it for a 20% discount to market value. You will have made a quick and dirty 40% profit without having to get your own hands dirty.

(Record screech) “But wait,” you say, “wouldn’t that 40% be lowered by the cost of resolving the major issues that prevented the house from selling in the FIRST place?” Why yes it would, dear reader and thinker, but not by much when compared to what these TV flippers make as their own profit percentages. Reality says that they may make so many thousands of dollars, but their math is incomplete.

Say a guy buys a house for $240k in a $300k neighborhood (a 20% discount, which is really good for fixer-uppers). This means he can spend no more than $60k in remodeling and repairs before he ends up pricing himself out of his own market. If anything major comes up in the demo and remodeling process (termite damage, plumbing issues, electrical problems, foundation issues, etc.), this could easily put him over budget and push his house right out over market value, ensuring a slow and difficult sell.

Notice that he hasn’t even factored in carrying costs (mortgage payments, utilities, outside labor costs, etc.), which all go into his $60k budget, making it a much smaller budget than he realizes and isn’t acknowledging.

The stock market mantra is to buy low and sell high. The real estate mantra is “buy even lower.” This means you’re looking at taking on more and bigger problems than the average homeowner or cosmetic flipper can handle, and that’s where the greatest profit lies.

Back to the TV flipper: Okay, he’s bought the house for $240k in a $300k market, he spends his half his budgeted $60k on actual renovations/repairs, really dolls the place up inside and out, and now he’s ready to sell (the rest of his budget is silently eaten by carrying costs and incidentals). Outside realtors come in, cruise around, look at all his improvements, and value the house at $270k ($300k minus about 10% for the market downturn).

Now his perceived profit has just lost $30k (10%) due to a force he couldn’t control—the market. The selling realtor has to be paid, and that’s another 6% ($16,200 if my math’s right), for a total of 16% off the top (or roughly $46k). The profit before carrying costs (I have no idea what those would be, but budgeted $30k, or half his original renovation budget) is a lousy $16k at minimum (just under 6.5% of the purchase price). You can safely and more easily earn that in a CD or money market account, or invest in the S&P 500 index and make even more!

His profit before carrying costs was $16k, yet his renovation budget was $30k--so where did he make any money? Why did he work so hard to lose over 50% on his supposed "value-creating" renovations? He spent $30k to ultimately end up with $16k, assuming he can sell the house for $270k (the new market value). Do you see the futility in that?

The only DIY improvement that actually pays you back nearly 100% is paint. It also happens to be the cheapest improvement you can make to a house. Non-DIY improvements pay you back even more.

Oh, and let's not forget taxes on this unearned income--$16k @ 15% = $2400, leaving $13.6k or 5% profit from his sale (fewer dollars and lower percentages for higher tax brackets). How long would you have to work at your job to bring home that much money, and which would you rather do?

I don’t know about you, but I certainly refuse to perform the kinds of miracles you see on TV for a lousy 5% profit unless I was moving in. If the TV flippers knew how little they profit, they wouldn't either. The TV shows won’t tell you that, though, out of fear of losing ratings.

Moving in would save me the 6% selling costs, so I'd already be ahead of the game!

The less work a house has to have done to it, the more it costs to buy. The closer to move-in condition it is, the more it’s going to cost--end of story. This is why you want to take on the tough problems, then resell to “flippers”—it’s the only way to make a fast sale and a clear profit on real estate.

Those profit tallies you see after the open house and sale shots are NOT the whole picture—it’s incomplete math. You aren’t getting the whole story, only what the producers know will get you to watch the show. The prior incarnation of this phenomenon is the old “nothing down” schemes that used to be perpetuated in books and on late night TV infomercials.

TV executives don’t care about the integrity of the product—they just need to fill air time, and these companies will buy it up because it’s cheap.
On one show, I saw a flipper investor ask his scouting crew what they could do to find properties with fewer nasty surprises, and everybody looked at each other blankly. I had the answer, and I shouted it back to the TV: “Get an INSPECTION!”

The shows also don’t cover things that take up time like contractors who never show, courthouse-related things like getting permits and getting a condemnation order rescinded, police matters like getting a tenant evicted and getting a squatter removed, waiting for an available construction dumpster, emptying out a fully-furnished house, disposal of said furnishings, scheduling and waiting for inspectors, and getting contractors back on the job site after inspections have been passed.

Now you see why speedy timetables, large crews, access to ultra-large financing, and speedy sales are paramount to flipping. Your profit, even after spending large bucks to solve large problems, is surely to be a much bigger percentage than the paint-and-tile guy who comes along behind you. He needs many deals at the same time, or many successive deals close together, in order to make flipping a profitable career. Let's face it--there just aren't enough of these truly profitable disastrous gems out there for the picking in today's market.

Now, let’s go back to that same house and throw in a true flipper scenario: a house in a $300k market with lead-based paint, asbestos siding, and plumbing issues—all bright red flags for regular buyers and TV flippers, but not you. You get permission to go through the house with a qualified inspector or two, determine the problems, and get estimates on repairs BEFORE SPENDING A DIME ON PURCHASE.

You subtract all your costs from the $300k market value, then make this your bid (40% of market value is doing good, depending on estimates). This particular house should have a bid no higher than $180k. Whatever your estimates come to plus 10% for overruns, plus the cost of buying and selling, incidentals (permits, utilities, etc.) and a 20% market discount to attract TV flippers (and make a quick sale) is what you need to subtract from the current market value, and that’s what your offer number should be. Many times it’s turned down, and that’s life—move onto the next opportunity. If it's accepted, then take possession and get to work on those nasty red-flag issues AND NO MORE. Let the flipper sharks do the rest and lose money on it. You IMPROVE the property by merely making it habitable, and they just slap make-up on it--that's the difference.

Now you know why true flipping is rare and seldom done—it's the fleeting opportunity for meaningful profit. If the planets were to align, and a miracle were to occur, you might just find a dream property that fits all your true flipper parameters—but it will be hazard-laden and produce enough headaches to turn you away from real estate forever, let alone true flipping.

Another reason why true flipping isn’t done more often: money. If you plan to take your sweet time on a property, plan to eliminate carrying costs by paying cash. If you cannot pay cash, then get adequate financing with the least monthly carrying costs while you work on the property. TV flippers don’t do this, and it eats into their profit before they even swing a hammer. Market fluctuations also do a big number on profits, as you've read above.

These TV flipper shows are a terrific example of what NOT to do. None of the cosmetic improvements they do to a property pay them back 100% or more—the highest-returning improvements are in the “adding square footage” range: adding a second bath, a second or third bedroom, a big deck or sun room, expanding a kitchen, or adding a second story. All the cosmetic things don’t return nearly what is spent on them, so why spend money to lose money?

If you’re a homeowner now, you might want to ask yourself that same question—why chase the LAST dollar with granite counters and stainless steel appliances, when you can go for the FAST buck selling your house “as is” to TV flippers? People do it now out of greed, not speed, and get caught in market down-drafts, buyer taste fluctuations, and credit crunches in the end.