Don't believe everything you see on television.
Some documentaries, news reports, other well-researched features, as
well as entire cable networks, do provide educational content as worthy
as that from a college or university curriculum.
However, most TV programming comes from the realm of entertainment
where the emphasis is more on the rose-colored "tell" rather
than true "vision."
That's especially so when it comes to investment realty TV, more
specifically, programming pushing flipping, say experts who've been
there, done that.
Flipping houses typically includes buying, perhaps cosmetically
upgrading, and then quickly selling, within about six months or less,
for what is hoped to be a hefty profit.
In today's market where double digit depreciation is, to some
degree, about to replace double-digit appreciation, consumers should
consider additional sources of real estate investment reality.
"It may look easy, fun, and exciting on TV," says Scott
Frank, a real estate investor from Atlanta who, along with Andy Heller,
also an investor from Atlanta, co-authored "Buy
Even Lower: The Regular People's Guide to Real Estate Riches"
(Kaplan Publishing, $18.95).
"But remember, TV is entertainment. The real world can be
anything but. I've found that most of the time people who jump into
flipping real estate based on TV shows and/or hearsay from friends
never fully know what they are getting themselves into," Frank
added.
Flipping, never for the faint of heart, isn't as easy as it may have
been even a year ago, primarily because sales have slowed.
Speculators aren't sticking around for good reason.
It's the same reason today's housing market is better suited for the
long term investor.
Not only are sales a shadow of what they were a year ago, home
prices are beginning to fall as well, further increasing the risks
inherent to flipping.
During the second quarter this year, 2.4 percent of the existing
homes sold in California had been owned for six months or less, down
from 3.5 percent during the second quarter in 2005, according to HomeSmartReports.com,
a San Juan Capistrano, CA-based real estate sales, value and risk
analyst.
That was the lowest level of flipping since the first quarter of
2003, when it was also 2.4 percent. Flipping recently peaked in
California during the first quarter of 2005 when 3.8 percent of
properties were sold within six months of the purchase.
As flipping has declined so have the profits -- 24.7 percent of the
second quarter's flip sales in California resulted in a loss. The
percentage of flippers who lost money was the highest since 25.8
percent during first quarter of 2002. A year ago only 14.4 percent of
flipped sales resulted in a loss.
"A lot of people do not take into account that if you are in
the business of buying and selling houses and are in an ordinary
income/tax bracket, 35 percent of your gain goes to Uncle Sam and
another 5 percent, depending where you are, goes to the state,"
says Michael Eckerman, founder and CEO of Residential
Asset Management, LLC, a real estate investment company in Phoenix,
AZ.
The rest can get chipped away by carrying costs including rental
vacancies, fix-up costs, insurance and taxes, not to mention mortgage
payment costs not covered when tenants are present -- if they are part
of the equation.
Frank, Heller, Eckerman and a growing number of experts are coming
out against get-rich-quick real estate investment advice spawned by a
housing boom that came with a televised assist.
Here's why, according to Frank and Heller.
- Flipping takes time. Time is money, especially in a
falling real estate market. To profit, it's typically necessary to
purchase a home at a deep discount, but the pool of such properties
is small and that means lots of searching time right out of the
gate.
- Flipping is stressful. Unless you use a real estate agent
(which cuts into your profits), you'll probably deal with a host of
people interested in buying the property. Each day the house
remains unsold, holding costs eat away at your profits. Weighing if
and when to reduce the sales price or to include a real estate
agent adds more stress.
- Flipping costs can get crazy. Typically, discounted homes
are far from pristine. You'll often need to make some improvements
in a condensed period of time and sell at a profit large enough to
offset buying, fixing up and selling costs. Surreal best describes
those slick and dramatic transformations depicted on television.
- Flipping can leave you holding the bag. You could get a
discounted "dog" that needs more than a few coats of
paint, one that's in a bad neighborhood or other poor location or
one with other conditions that contributed to your discounted
purchase price, and now haunts your sale.
"Everybody has this day-trading mentality. Too many look at it
as a quick fix, but it's really just another wealth building strategy
for the long term," said Eckerman.
He recalls his first property investment, one of the few he still
owns. Purchased in Daly City, south of San Francisco in 1970 for about
$40,000, the property's value now approaches $1 million.
"It's paid off, free and clear and tenants are paying $2,000 in
rent. If I had sold it for $50,000 and made $10,000, would I have been
able to parlay that into $1 million?" Eckerman asks.
It's could be a good time to invest in flipping, provided you learn
the ropes and hedge your bets.
"Keep your regular day job. Don't just flip. Buy the houses you
can afford. Flip one or two. Hold onto the others," says Eckerman.
There's little doubt that 2005 was a banner year for new home construction. According to the National Association of Home Builders, single-family home sales reached a record 1.282 million units last year, up 6.6 percent from the record set in 2004.
But if the full-page ads in my local paper are to be believed, new home demand has begun to flag. The issue is not how many units will be sold, rather it's the way they'll be priced. Recent ads have offered new home discounts ranging from $70,000 to as much as $100,000.
These new homes are being sold by major builders in one of the best markets in the U.S. The Washington, DC region includes some of the richest areas in the nation by income: Fairfax County, VA (#2), Loudoun County, VA (#3), Falls Church, VA (#8), Howard County, MD (#10) and Montgomery County, MD (#13). If builders are cutting prices in a region known for high household incomes, you have to wonder what's happening in other population centers.
In many areas across the country it's often paid to buy new homes at the earliest point in the construction cycle because as projects are built out prices tend to rise -- sometimes by hundreds of thousands of dollars.
As an example, last Fall the New York Times Magazine said at one New Jersey development, houses "that were selling for $560,000 when they first hit the market 24 months earlier were now going for at least $935,000." (See: Chasing Ground, October, 16, 2005)
But if builders are now offering discounts, then several thoughts emerge.
First, why offer price cuts unless demand is weakening? This is not a hideous thing to admit, it makes no sense to believe that each and every year will set a new sales record. What we have to this point is not a pricing collapse or evidence of a broken bubble, but rather moderation in the marketplace. On Wall Street they would call this a "correction" or "profit taking."
Second, price reductions do not mean builders are losing money. The basic cost to construct a house remains largely unchanged as projects are built out -- even though asking prices may increase substantially. Thus builders can drop prices and still profit, especially with established projects.
Third, if you're a builder you want to maintain unit volume because continuing sales allow you to retain skilled construction crews, a prized commodity.
If builders are openly discounting prices, it means they're competing with recent buyers who now wish to sell. While most owner-occupants tend to hold homes for a number of years, short-term owners include a large percentage of investors hoping to buy-and-sell as soon as possible.
The growing number of new-home contract cancellations may well be evidence of entrepreneurial discontent. Speculators may prefer to lose a deposit than to close on a home that costs money to hold each month and can only be re-sold in the short term with a minimal profit or no profit at all.
The appearance of builder discounts drives a fat wooden stake into the hearts of short-term speculators, but reduced speculation is not necessarily good for builders. If fewer short-term investors are looking for new homes, then discounts become a self-fulfilling prophecy -- discounts lead to fewer investors, there's less buzz, fewer investors result in less demand, less overall demand requires additional price cutting and so forth.
Traditionally builders have avoided price discounts because they wanted to maintain their pricing structure to protect past buyers and themselves. Rather than a reduced price, builders would rather throw in a finished basement, gourmet kitchen, fancy bathroom or some other upgrade that does not show up in price reports. Other approaches including paying some or all closing costs, buying down the mortgage and paying points.
Now that price reductions are appearing publicly, only builders with the most demand will be able to resist the discount trend. Just look at what happened with U.S. auto manufacturers: When one offered employee discounts to the public, others were forced to follow.
Someone buying socks from Wal-Mart and Target doesn't care about the price next week because the purchase is being made for reasons of comfort and utility and not much is at stake. With real estate the deal is different: Speculators in the past few years have routinely thought of new homes as sure-fire investments. If discounts mean the flames have gone out, then a lot of builders -- and a lot of speculators -- will have a tough time ahead.
