Flipping Homes: It’s Making a Comeback.

March 22, 2012

Flipping Out.

Aside from making it insanely competitive to buy a home in San Carlos lately, the resurgent economy and red-hot real estate market has given rise to a phenomenon that we haven't seen around here for a few years:  Flips.  For those of you not familiar with the term, it's pretty straightforward — an investor buys a property that's in original or run-down condition, quickly spruces up the interior and exterior of the home, and then resells it (or “flips”) it.    The buyer ends up with a nicely updated home, and the investor (hopefully) makes an acceptable profit for the work that they did fixing up the house.  On top of that, the neighbors love the fact that a neighborhood eyesore was replaced by a comparable sale that helps increase the value of everyone's homes.   Everyone's happy, right?

In this post, I'll discuss the pros and cons of buying a flipped home, and some precautions you can should to make sure you're buying a solid home, and not a lemon that is covered up by superficial cosmetic upgrades.

Buy Low, Sell High:  The Mantra of a Flip.

Whenever a housing market emerges from a recessionary state and heads straight into a steady growth mode, you have the ideal environment for flipping homes.  Why?  For the savvy investor who is willing to take a risk, a depressed market is ripe with homes that are in neglected or in original condition that can be purchased for a very attractive price.     For that very reason, distressed homes (foreclosures and short sales) make ideal candidates for flips.  The fact that the market in San Carlos has transitioned so quickly to a seller's market is paradise for flippers, because they get the maximum return on their investment in the shortest amount of time.

What makes a successful flip is not rocket science – like any stock or annuity, it's all about buying low, and selling high.   And it's vital that you keep that in mind when you're looking at a flipped property, because that single law will explain more about why the investor did what they did with that particular house.

The Positives of a Flip.

For some reason, the term “flip” carries a negative connotation when it comes to talking real estate.  I don't know if it's the fact that network television sees flips as the closest thing to reality TV that you'll ever get in real estate.   But flipping houses can have some definite benefits for more than just the buyer and the seller.

A resurgent economy means that more people are back to work, and they're working longer hours.   When that happens, the demand for move-in condition, or “turn-key”, homes goes through the roof.  Many buyers simply don't have the time or desire to take on a significant upgrade project on their newly purchased home.  They simply want to move in on Saturday, and go back to work on Monday.   But when you have a housing inventory that's comprised of mostly post-WWII era homes,  an upgraded home becomes a precious commodity.  So a flipped house injects some much-needed youth into the inventory of older homes.

And as we already discussed, neighbors generally love it when somebody spruces up an old neighborhood dump and sells it for a much higher price.  The neighborhood looks better, and the higher home price helps push up the value of the neighborhood.

Good Quality, or Lipstick on a Pig?

While the quality of the workmanship and materials on flipped homes is generally good, you'll occasionally run across some that are downright questionable, leading to the inevitable question “Why did they do that?”   The answer to that question is always found in the golden rule of flipping – buy low, sell high.  When you see crappy materials, or obvious corners have been cut in the workmanship, it's a high likelihood that the investor's profit margin was evaporating.

It's important to have a discerning eye when it comes to looking at a flipped home.  It's very easy to get caught up in the “wow” factor and miss where inferior materials were used, or corners may have been cut.  If you're considering buying a flip, the more information you can gather the better off you'll be (isn't that the same with everything in life?)   Here are four key items that you should keep in mind:

  • Identify the  initial cost.   If the investor purchased the home from an MLS sale, it's easy to figure out how much they paid for it since it will show up as a recent sale.  If it was purchased at auction, you may need the help of a Realtor to track down that data.  But either way, knowing how much the seller paid for the house gives you great insight into how much money they had to spend on the job.   Remember —  buy low, sell high.
  • Look beneath the surface:   Most of the work that's done on a flip is cosmetic — new hardware, countertops, paint, carpets, etc… all stuff that you can see.   But it's important to understand what's below the surface — does it still have the original electrical wiring, or has that been upgraded?  Galvanized pipe, or copper?    At the end of the day, the functionality of the house is still more important than the appearance, and there still may be more work to do after you purchase the house.
  • Get Your Inspections.  Just because a home has been upgraded doesn't mean you should skimp on your inspections.   Again, the focus of a flip is generally appearance, and the underlying condition of the house may not have changed in 40 years.   Sparkling granite countertops do nothing to remedy a cracked foundation.  And because the investor is likely exempt from many of the disclosures that are normally required by a homeowner, you will rely more than ever on the eyes of a good inspector.
  • Assess the Present Value.    If the investor paid $1M for a home and then puts $250,000 of improvements into it, that doesn't guarantee that the house is worth $1,250,000.  The value of the house is dictated by how it stacks up to other comparable homes in the area, NOT by how much was spent on the upgrades.   Do your homework — it's not your job to to fix the investor's mistake by overpaying for the house.

The bottom line is that due diligence is just as important when buying a nicely upgraded house as it is when you're buying the original McCoy.

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