Despite all the advantages and the ease of finding and buying flipper properties, there are possible disadvantages to buying such homes. Luckily, there are ways to overcome them.
Financing your flipper acquisitions might be a problem unless you plan ahead. But large amounts of cash and good credit are not needed to acquire and flip real estate for fast cash profits. The reason is you won’t be applying for new mortgage financing at a bank. If you need cash, such as for the down payment or improvements, borrow on your bank credit line, credit cards, and/or from an equity credit lender.
Purchase Bob Bruss reports online.
Yes, the interest rate will be higher than the prime rate, but you will only need the borrowed cash for less than a year until you fix-up, flip, or refinance the property. If you are going to be living in the house, a bank home equity line of credit can be especially easy to obtain and economical (usually at the prime rate or even lower).
- Your quick resale flipper profit will be taxable at ordinary income tax rates. When you resell your flipper property after less than 12 months of ownership, Uncle Sam will be waiting to tax your profit at ordinary income tax rates. However, if you can wait to sell your flipper property until after you have held title more than 12 months, then you qualify for the new low federal long-term capital gains tax rates.
If paying profit taxes, especially at ordinary income tax rates rather than the lower capital gains tax rate, bothers you, why not completely eliminate income tax on your real estate profits? You can do that by limiting your property purchases to single-family houses (or condos, although I don’t recommend condos for flipper profits because they usually don’t appreciate in market value as fast as houses, primarily due to lower buyer demand), live in the house at least 24 months as your principal residence, and then resell for up to $250,000 completely tax-free profits (up to $500,000 for a qualified married couple filing jointly), thanks to Internal Revenue Code 121.
The only eligibility test is the house or condo must have been your principal residence an “aggregate” two of the five years before its sale. In other words, you can be a “slow flipper” every 24 months. Your tax adviser has full details.
- Most bargain-priced properties need at least minimal fix-up work. My experience has been there is a very good reason a property can be bought below the market value of comparable nearby properties. At the very least, virtually every such property needs a coat of paint. But paint is the most profitable improvement you can make.
For this reason, you will need to anticipate how to pay for the fix-up work – create your credit lines and other money sources in advance so you’ll be ready to roll as soon as you gain title or control of the property. As suggested earlier, buy only properties that have “the right things wrong” so you won’t get into major renovation work or room additions that usually do not meet the criteria of adding at least $2 in market value for each $1 spent on improvements.
- If in doubt about property condition, include a professional inspection escape clause. Unless you have extensive construction experience, be sure to negotiate a professional inspection contingency clause in the purchase contract. It’s also known as a “weasel clause” which allows escape from the purchase if your professional inspector and/or termite inspection report reveals surprise structural problems.
- Plan your exit strategy. The smartest real estate investors plan their exit strategy before they acquire a property. To illustrate, if you are a long-term “buy and hold” investor, your exit strategy might be to hold the property for many years, perhaps refinancing every five years to take out tax-free cash, before selling and carrying back mortgage financing for your retirement income. However, if you want to flip properties for almost immediate cash flow, you’ll need a quicker exit strategy.
In many parts of the nation, as I write this, the local home sales situation is a “buyer’s market.” That means there are far more homes for sale than there are qualified home buyers. This is good for you when you are a buyer, but not so good when you are ready to sell.
EXAMPLE: Suppose you buy a bargain-priced house for $200,000, spend $20,000 fixing it up and it should be worth $275,000 after fix-up (based on comparable recent sales prices of similar homes in the neighborhood). But there is a glut of similar nearby homes for sale. What will be your exit strategy? Please don’t panic! You have several excellent choices. One is to hold the house as a long-term rental investment. However, suppose the local rental market is weak because there are too many similar rentals and houses for sale. Your next exit strategy might be to offer the house on a lease with option to purchase. Even in the softest buyer’s markets, there are usually many lease-option buyers. Good times or bad, I’ve never had problems finding lease-option home buyers. But it might take two or three years for your lease-option buyer to exercise their purchase option so be sure you don’t have any balloon mortgage payments coming due shortly. Another less desirable exit strategy is to offer your fixed-up house at a below-market price, perhaps $250,000 in this example, if you must sell now for cash. But that method leaves part of your potential profit on the table.
- Avoid low-income, high-crime neighborhoods. Until now, I haven’t mentioned the topic of location when acquiring flipper properties. Although I’ve made handsome profits in low-income neighborhoods, I’ve tried to avoid high-crime neighborhoods. Longtime subscribers will recall my “drug house” REO (real estate owned) foreclosure property acquisition where, shortly after my tenant moved in, there was a murder on the street in front of the house. But she and her children remained tenants in that house for almost 14 years, and the neighborhood crime rate declined (primarily thanks to California’s tough “three strikes and you’re out” criminal sentencing law), so it turned out to be a great long-term investment. However, it wouldn’t have been a good immediate flipper profit property!
However, when I eventually sold that rental house at a handsome profit, it was bought by two brothers who spent about $50,000 fixing it up (far nicer than I would have done!). Their father later told me they netted about $75,000 “flipper profit” within six months.
But I recommend avoiding “management intense” locations. I must hasten to add some of the biggest real estate profits are made in low-income neighborhoods that are on the upswing. To illustrate, one day I got lost in Oakland, Calif. As I was driving around trying to find my way to the freeway, I observed the many fixer-upper property opportunities. I also noticed all the new construction, another positive sign. However, the risk is high in such areas so be sure you can handle the uncertainty of low-income neighborhood realty investments.
Flipper property investors usually must hold for at least a year before earning profits in rapidly improving neighborhoods. Often, many years of holding are required to realize resale profits, if any.
If you can time your acquisition to buy from a highly-motivated “don’t wanter” property owner who wants to sell out of a low-income and/or high-crime area, and who will sell to you at a bargain-basement price and terms, it’s possible to earn quick flip profits. But please be aware of the potential risks.
(For more information on Bob Bruss publications, visit his
Real Estate Center).
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