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Tuesday, July 30, 2013

Secrets of the Home Flippers

Secrets of the Home Flippers: The Housing Boom Is Back

"Flip This House," "Flip That House" and other home-flipping reality-TV shows went dark when the housing boom went bust.

But home flippers--investors who buy a property, make some repairs and sell it quickly in hopes of a profit--never really left the scene.

Now the housing market is back and the flip is on. Sales of new homes in May rose to the highest level since July 2008, according to Commerce Department data. The Standard & Poor's national housing price index, which tracks existing home sales in 20 major markets, was up 12.1% in April compared with a year earlier. That's the biggest gain the index has recorded since it started in 2006.

We checked in with three experienced home flippers to find out how they got their start, why they do it--and what you need to know about the ins, outs (and ups and downs) of flipping.

Rule of Flipping #1: Find the Sweet Spot

No. 1 rule of thumb? "Never overimprove a house." He aims to find the "sweet spot," he says, "where you can get a good price on the sale, without overspending on the renovations."

It's sage piece of advice for any homeowner who's eventually looking to resell. Berger applies it to everything from the grade of carpet to the roof titles he chooses.

For example, in the process of a recent flip, he and his partners considered tearing down the house's carport and putting up a garage instead. But after driving around the neighborhood, he saw that most of the homes still had carports. "The improvement wouldn't stand out," he concluded, a decision that saved him and his partners thousands of dollars.

Of course, not every flip is a success: He had to hold onto four houses that didn't sell during the downturn. He rented them out to keep the cash flowing, a common way for flippers to bide their time while they're waiting, because, he says, "We knew that the market would eventually turn around."

House Flipping Rule #2: Crunch the Numbers
"When you're doing these deals, it's not about falling in love with the drapes--it's a math problem," she says. "If the numbers work, it seems less risky."

What's changed from the last housing boom is that most flippers are now unable to buy homes with 0% down. Banks will not finance a deal without 25% down, Pape says. She puts down 30% or more for her purchases.

Rule of Flipping #3: Have Plenty of Cash
 "If I get into a problem, it doesn't cost me anything to sit on a property," he says. "For example, if I have a mold issue, it might be two months late getting to market."

In the meantime, he has no mortgage to pay.
Plus, he adds, most banks typically won't lend money to buy a dilapidated property. If they do, a bank will charge higher interest rates than they would with a standard mortgage.

On his first deal, he bought a fixer-upper for $200,000 and spent $90,000 on repairs. He made sure he had enough cash on hand to pay for the property, plus the renovations, something he recommends for all first-time flippers. He then sold the house a few months later for $540,000, earning an 86% return on a $290,000 investment. He's been hooked ever since.
"[It's] probably the best thing I've ever done. It's satisfying to take something ugly and make it great," he says.

What to Know Before You Flip
While the flippers above have each employed their own strategies, and often met with success, home flipping is a risky business dependent on rising real estate prices and low mortgage rates. In short, it's not as easy as it looks.

Flippers must also be careful of the tax consequences in their quest for a quick buck. If you sell a property in less than a year, which most flippers do, profits are taxed as short-term capital gains, which are taxed at the same rates as regular income. (If you were to hold on to the property for a year or more, you would typically be taxed at a lower rate on those capital gains.) Plus, the Internal Revenue Service may consider you a real estate dealer, instead of an investor, if you are successful enough at flipping. That means your profits would be taxed at the same rates as ordinary income and you'll have to pay Social Security and Medicare taxes on those earnings. Plus, there is a real estate commission to pay as well.

So before you start a flipping empire--or decide to spring for even one investment property--make sure you have an adequate emergency fund and are maxing out your retirement account. It will make things easier if the red-hot real estate market starts to chill.

Please contact me if you have any questions about investing in this market.

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