Flipping houses is harder than it looks
Forget no-money down
and other late-night TV fantasies. In the real world, flipping requires
deep pockets -- and plenty of hard work.
By Pat Curry, Bankrate.com
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On Bankrate.com: Tax guide for real estate flippers
On Bankrate.com: Buying a home sight unseen
come home from a long day at work and while channel surfing, you come
across a show in which guys are buying run-down houses, fixing them up
and reselling them for huge profits before the first mortgage payment is
Wow. What's more, they claim they make as much money on this one house as you have in the last year.
don't look or sound any smarter than you are and they're raking in the
cash. You start crunching numbers and before you know it, you're
thinking about a career change.
Before you quit your day job, can we talk?
not as easy as it looks on TV. The price run-up of the past few years
led thousands of people to reach the same conclusion you have. There is a
boatload of competition out there, which means that the obvious deals
are gone in a heartbeat. The pros will tell you that they make their
money on the front end by buying properties for at least 30% below
market value. Finding those houses takes time and once you find them,
you'll need to move fast. And no matter what the late-night gurus say
about doing this with no money down, it hardly ever works that way. That
means you'll need access to cash to do the deal, not to mention the
"The masses believe in the dream that's
been promised to them, that they'll be making a fortune in the next six
months," says Manuel Iraola, president of Miami-based Homekeys.net, an
online real estate company. "They don't have the basic know-how. If it
were as easy as they make it seem, 286 million people would be flipping
Richard C. Davis, owner of Charleston-based
Trademark Properties, and creator and star of A&E's reality show,
"Flip This House" says no one can watch his show and get the impression
that this is an easy way to make a living.
"In our original
video, we had a warning," Davis says. "'Do not try this at home. It's
for trained professionals. You will lose money.' I got two guys
following me around with a camera. There are no scripts. If I lose
$100,000, you see it."
While he understands the desire of people
to get in on the action, he doesn't have a lot of sympathy for people
who don't want to invest the time that's needed to learn the business.
now, you have people jumping in on frenzy and it will bankrupt a lot of
Joes and Susies who have no business doing this," he says. "I mean, my
wife is a doctor, you don't see me going out doing heart surgery."
Here's the catch
there to learn? Atlanta-based financial adviser Bill Kring wishes
people understood that they need to have adequate savings in place to
pay the bills while money is flying out the door for cabinetry, plumbers
"In a business with zero income until liquidation,
what are your resources?" Kring says. "What are your abilities to
borrow? Without that, you'll never make it."
Access to large
amounts of cash is the hardest part -- and one of the biggest
misconceptions -- of the business, says Raphael Isaac, who has been
rehabbing and reselling houses in the metro New York market for 14
years. For most of his deals, he puts at least 10% down and then has a
month to close.
"If you don't close in 30 days, they keep your
money," he says. "Then you need more cash to carry the house, the
insurance, the utilities and the maintenance. You won't get a contractor
to renovate a house for no money. People go to trade shows and buy
these books and tapes on how to buy a house with no money down. I've
never seen someone actually do that."
Working against you
reason that access to cash is so important is that you'll probably need
to hold on to the house for at least three months because of Federal
Housing Administration (FHA) anti-flipping regulations. Houses sold less
than 90 days after they were purchased aren't eligible for FHA mortgage
insurance; those sold between 91 and 180 days are OK but require an
additional, independent appraisal to make sure the sales price is
What that means for you as the owner is additional
carrying costs. Every day you own the house costs you money in interest,
utilities, taxes and insurance.
If you're taking out a mortgage
to buy the house, talk to your banker about pre-payment penalties. "We
make money when people hold loans; we lose money when they pre-pay,"
says St. Petersburg, Fla.-based banker Mark Dannenmiller. A typical
pre-payment penalty, he says, is 80% of the balance of the first
mortgage, times the interest rate, divided by 2. So, if you borrow
$100,000 and get a mortgage for 5.75%, your pre-payment penalty would be
$2,300 ($80,000 times 5.75%, divided by 2).
advice to individuals who are considering going full-time is to keep
your job, make a little bit of money and pay yourself back, building up
your cash reserves.
"Hopefully, by the fifth or sixth house, you
don't need me anymore and you're buying houses for cash. That's
important because as soon as you (quit) your job, you can't get a loan."
To Joseph Patton, getting cash is the easy part. The hard part is finding the properties to buy.
properties are not for sale through Realtors and they're barely
available through auctions," says Patton, who buys primarily in
Philadelphia. "(Finding them) is very time-intensive. You have to be out
there on the street. It's almost banging on doors ... It's not an
insider's game but you need to put in time to build the network."
The taxman cometh
other point to consider: As far as the IRS is concerned, buying and
selling real estate as an investment strategy and doing it as a business
are two very different things. If you buy a house, fix it up and resell
it while you're working another full-time job that provides the bulk of
your income, that's an investment and the proceeds will be taxed as
short-term capital gains (if you own it for a year or less) or long-term
capital gains (if you own it for more than a year). A short-term
capital gain is taxed at the same rate as your ordinary income. A
long-term capital gain currently is taxed at 15% of the gain.
if you're doing it year-round and it pretty much pays all your bills,
that's a business and the IRS might consider you a dealer-trader, says
Los Angeles-based CPA and tax attorney Bill Abrams. Then your gain will
be taxed as ordinary income no matter how long you own it, the real
estate taxes and interest will be regarded as an expense and you'll have
to pay self-employment tax of 15.3%.
Plus, you won't be able to
take advantage of IRS section 1031 like-kind exchanges, which can help
with taxes when you have a property that sells for substantially more
than you paid for it. Only property that's held as an investment
qualifies for this tax break; while the tax code doesn't specify a time
frame, the rule of thumb supported by case law is that you need to hold
it for at least a year to qualify.
Right place, right time
does it make any sense at all to do this? For the right people and the
right reasons, sure. Detroit-based real estate broker and investor Ralph
R. Roberts tells people to learn everything they can about the industry
and don't consider making it a career until they've made double the
amount of money in a year that they do in their current job.
person I went to high school with bought a house every year for 30
years," Roberts says. "He's flipped about 10 of them. Now he's building a
mammoth house. But he never did it to get rich; he did it to have
financial independence. You can't go into it for the hype. You do it for
financial security down the road."
If that's your plan, maybe
you don't need to quit your day job after all. It's possible, although
often exhausting, to moonlight as a flipper, says New York-based real
estate attorney Neil Garfinkel.
"I know plenty of guys who do
two, three, four houses a year, keep their health insurance and do this
on the side," he says. "Many times, they can double their salary."
And that's all you really wanted to hear, isn't it?