Hitting a Profit 'Sweet Spot'' From Property Flipping

A new study pinpoints how long you should hold a property before selling for a quick gain.
By: Lew Sichelman: The Wall Street Journal Online
Issues on people's minds: The ways in which property "flippers" may be getting frustrated and how to calculate where the maximum gain from flipping might come.

Question: I recently bought a home priced below market. I tried to sell it right after closing escrow. I received an offer the next day and we opened escrow right away. After two weeks, I was contacted by my broker telling me that I couldn't sell my house right away and that I have to wait three months before putting it back into the market. Is this accurate? The escrow was cancelled and I need to know if my broker is right.

Answer: As far as I know, there is no law or regulation that prevents anyone from purchasing a house one day and selling it the next, a process known as "flipping."

Some builders have clauses in their sales contracts that prohibit buyers from putting their houses back on the market for a period of time after closing -- usually a year. Whether such clauses are enforceable has yet to be proven.

If you bought a new house, your agent may have been correct, or at least prevented you from winding up in court to test your rights. But if you purchased an existing home, I'd love to hear the agent's explanation as to why you couldn't resell right away.

That said, a new research study by Christopher Cagan, an unusually glib economist who is director of research at First American Real Estate Solutions, indicates your agent may have been doing you a favor. As it turns out, the "sweet spot" for flippers is between three and six months. Hold a house any shorter or longer than that and you won't do nearly as well.

Of course, we're not talking about scam artists who use false information to buy a house. Rather, we're talking about savvy investors who purchase distressed or undervalued properties, raise their value by making repairs or even remodeling or simply taking advantage of a hot and getting-hotter housing market.

Most folks buy a house to make it their home. And they reside there for seven years on average. Flippers have a much shorter time frame, usually less than two years and often much shorter. They may or may not live in it themselves, and they may or may not rent it to others. They may make only cosmetic repairs or they might perform a complete overhaul.

About the only thing they have in common is that they typically want to get in and get out, making a substantial return on their money in the process. And that kind of flipping is very much a legitimate form of investment, even if it is sometimes highly speculative.

Since it's difficult to determine exactly what the buyer-owner-seller had in mind from a bunch of numbers, Cagan looked at all resales within the first 24 months after purchase (but not preconstruction flips) in three superheated housing markets -- Orange County, Calif.; Miami-Dade County, Fla., and Clark County (Las Vegas), Nev.

The economist was unable to know how much the investor spent beyond his down payment. But based on the price paid and the price received, he was able to calculate the gross profit and adjust for the length of ownership to estimate an annualized appreciation rate.

He found that flippers in all three markets almost always earned 15% or more in gross profit. But those who sold between three and six months often earned 50% to 100% as an annualized rate.

Similarly, almost all sellers made more than 15% when they held their properties for six months but sold before a year was out. And as did those with quicker trigger fingers, some did better than 15%. But the rate of return of those who didn't sell until sometime during their second year of ownership wasn't nearly as strong.

But Cagan's findings beg another question: Did flippers beat the market or did they merely participate in it like everyone else?

To answer that question, he looked at annualized rates of appreciation for different years of sale and different elapsed sales times, and then compared that with the year-over-year price appreciation of all single-family residences in each of the three counties, whether they were flips or not.

In perhaps his most striking discovery, Cagan found that the annual rate of return for sales in 12 months to 24 months was just a little above or a little below the rate for the overall market. The rate for a 6-to-12-month hold tended to be a little better than the market as a whole.

But appreciation in the three to six-month category, which represents almost an immediate turnaround as far as real estate is concerned, was usually 20% to 40% or more ahead of the market.

Cagan calls this time frame the "sweet spot of flipping," and said that when the market in the three towns was booming, flippers who hit that spot "reaped almost incredible returns."

In other words, to paraphrase country singer Kenny Rogers, if you are going to speculate in the housing market, you've gotta know how long to hold 'em and you've gotta know when to fold 'em.

Email your comments to rjeditor@dowjones.com.