Pros and cons of 'flipping' real estate

Process not as easy as many think
By: Robert J. Bruss: Inman News
Every property is a "flipper" or a "keeper." If you are not familiar with those real estate terms, a "flipper" is a property that is bought for a quick resale profit, usually in less than six months. But a "keeper" is a property held for at least a year, often for many years.

Most houses and condos are keepers. Their owners plan to own them for many years.

But some properties are ideal for fast resale profits. For example, if you buy a foreclosure property at a bargain price, it can often be "flipped" (meaning sold) to another buyer for a handsome profit within a few days or weeks.

Flippers are especially attractive to beginner real estate investors who want to quickly build up their "cash stash" from profits of buying low and reselling higher. There's nothing wrong, illegal or unethical by earning fast resale profits.

However, sometimes a property that looks like a quick easy resale at a large profit turns out otherwise.

To illustrate, I have an investor friend who bought a house from an elderly seller who wanted an easy cash sale without paying a real estate sales commission. Her asking price was about $40,000 below market value. My friend had access to cash and he closed the purchase within a few weeks. Only then did he discover the good looking house was riddled with extensive termite damage which would cost about $25,000 to repair.

That house also needed a new roof. Rather than being a quick "flipper" the house turned out to be a long term "keeper" until its market value appreciated to make the resale profitable after about three years. Meanwhile, he rented the house to tenants who eventually bought it.

But my friend enjoyed several advantages of holding that house for several years: (1) instead of earning a quick $40,000 resale profit he netted well over $100,000, and (2) by holding title over 12 months his resale profit would be taxed as a long term capital gain at a 15 percent tax rate rather than as ordinary income

THE KING OF FLIPPERS. In his recent book, "How to Be a Quick Turn Real Estate Millionaire," Ron LeGrand explains how his student Marco Kozlowski paid $100 for an option to buy an Orlando, Fla., house for $4,000,000 from a wealthy seller. The house had previously been listed for sale with a Realtor at $8.6 million, but it didn't sell.

Kozlowski, a 30-year-old, new realty investor, hired a professional auction company, which, 43 days later, auctioned that house for $5.6 million cash. The result was a "flipper" gross profit of $1.6 million. LeGrand reports Kozlowski acquired 119 deeds on flipper houses in the Orlando area within his first year of investing. Today, he teaches others how to profitably flip properties.

SECRETS OF PROFITABLE PROPERTY FLIPPING. Lest you think flipping properties is easy and simple, it isn't. But there are several secrets for finding these properties:

(1) Find a motivated seller who wants to sell but doesn't insist on receiving top dollar and will sell at least 25 percent below market value. Strong seller motivations include out-of-town job transfers, unemployment, divorce, financial problems, illness, death in the family, and health problems.

Longtime homeowners often have large home equities and are willing to sell below market value for a quick easy sale.

(2) Look for properties in need of inexpensive cosmetic fix-up rather than properties needing major structural repairs. "El dumpo" properties often just need fresh paint (the most profitable improvement of all), new light fixtures, cleaning and repairs, new carpets and flooring, and fresh landscaping.

Unprofitable repairs to avoid include structural changes, new roof and foundation repairs, which are very expensive but add little or no market value.

(3) Sources of "fast flip" properties include local real estate agents, newspaper classified ads, foreclosure sales, probate sales, bankruptcies, recently expired MLS (multiple listing service) listings, vacant rental houses, absentee out-of-town owner lists, and properties with unpaid property taxes.

(4) Another great way to find potential flippers is to drive around neighborhoods looking for houses that appear to be vacant, run-down, or abandoned. By jotting down the address, taking a photo to remember the house, and then checking the owner's mailing address at the tax collector's office will often uncover an owner who would be willing to sell.

Even the best neighborhoods have houses meeting these criteria. If you discover the house has been owned for many years, often with a small or no mortgage and a large equity, the seller might be extremely eager to sell at a bargain price.

POSSIBLE DISADVANTAGES OF FLIPPERS. As with any profitable enterprise, there are potential disadvantages of flipping properties:

(1) Profits from the sale of investment property held less than 12 months are taxed at ordinary income tax rates. However, if you hold title over one year, then the capital gains are currently taxed at a low 15 percent rate, plus any applicable state tax.

However, if you own and occupy the property as your principal residence for at least 24 of the 60 months before its sale, then your profit up to $250,000 (up to $500,000 for a married couple filing a joint tax return) is completely tax-free under Internal Revenue Code 121.

(2) Fix-up work is a disadvantage for some investors who don't like to upgrade properties. By hiring fix-up workers, the cosmetic improvements can usually be accomplished within 30 days to increase the property's market value. A goal of most experienced "flippers" is to add at least $2 of market value for each $1 spent on fix-up.

(3) A quick profitable resale forfeits the potential for future profits from the property's long-term appreciation in market value. With median U.S. home prices currently appreciating around 10 percent annually, many investors adopt a strategy of keeping some properties and flipping others.

SUMMARY: Flipping properties for quick resale profits can be a great way to get started investing in real estate. But the potential disadvantages include paying ordinary income tax rates, rather than the lower long term capital gain tax rates. More details are in my special report, "Pros and Cons of Flipping Houses and Investment Properties for Fast Cash Flow Profits," available for $5 from Robert Bruss, 251 Park Road, Burlingame, CA 94010 or by credit card at 1-800-736-1736 or instant Internet PDF delivery at www.bobbruss.com.