Monday, March 14, 2005

Buy. Sell. Profit. Repeat. Investors are flipping houses to build wealth. Here's what you can learn.

They call them flippers

By Jon Birger, MONEY Magazine

NEW YORK (MONEY Magazine) - In the 1990s, Flippers were stock jockeys who finagled their way into initial public offerings, only to flip them days or hours later for big profits.

These days the go-go market is homes, not stocks. In hot spots like Las Vegas and Florida, real estate flippers have discovered that a modest down payment and a little patience can net them tens (even hundreds) of thousands of dollars in profits, sometimes tax-free.

The most aggressive of them figure that some combo of paint, new flooring and kitchen upgrades can turn the dumpy house they bought for $300,000 in February into a $400,000 property they can unload in July. And in the most sizzling markets, they're absolutely right.

Ask Angel Cooley, 54, a retired judge who moved to Las Vegas three years ago and has since flipped eight houses. Even with the Vegas market cooling somewhat in recent months, Cooley expects her real-estate-related net worth to reach seven figures this year.

"A year ago you could buy something in Vegas for $200,000, and in less than four months you could gain $150,000," she marvels. "It was a crazy kind of hysteria here, like people running after a Brink's truck."

Sound tempting? Absolutely. While quick-hit real estate investing is nothing new, the confluence of new tax breaks, low interest rates and exploding prices has created a perfect storm for flipping opportunities (at least in some markets) and has made legions of instant moguls.

Problem is, the playing field is getting crowded. In Las Vegas, 7 percent of all homes sold last year had been owned for less than six months, according to DataQuick Information Systems. Nationally, 14 percent of all new mortgages these days are for second homes or investment properties, up from 8 percent in 1999, reports mortgage tracker Loan Performance.

If you've been considering putting in your application for that real estate mogul position, statistics like these should give you pause. So should the example of veteran flippers like Jeff Bliven, who, after 20-plus years in the game, says he's dropping out.

"With some of these mortgage companies, if you can fog in a mirror they'll make you a loan," says the 42-year-old resident of Newtown, Conn. "When everyone's doing it, it's time to liquidate."

Some facts to keep in mind.

Speculation makes markets riskier. That's what concerns David Berson, the chief economist at Fannie Mae. He's still bullish on home prices but worries that speculators may overinflate white-hot markets.

Historically, home prices have declined very infrequently in the U.S., in part because typical homeowners don't treat their houses like stock investments. They don't sell in a panic just because their neighbor fetched only 90 percent of his asking price.

"But the nature of speculators," Berson notes, "is that they do pull out when prices stop going up."

Even a small downturn could wipe you out. Vegas or Miami or San Diego real estate surely won't lose all of its value like an eToys, but the potential risks for investors are just as dire.

A flipper who puts down $40,000 to buy a $400,000 home would lose the entire down payment should the market decline just 10 percent; throw in closing costs, 12 months of mortgage payments and a 6 percent realtor commission to sell, and the flipper could easily be out $80,000 on a $40,000 investment.

Hard-core flipping is obviously not for everyone. If the market chills, you'll face the ignominy of making monthly mortgage payments on a property you can only sell at a loss. That said, the risks are mitigated when you live in your investment for at least two years. Not only are the potential tax benefits terrific, but your mortgage payments cover an all-important cost of living: shelter.

So what's the best way to get started? MONEY sounded out two dozen experienced renovators and real estate investors around the country for suggestions. Here are the highlights.

Lesson 1: There's a reason it's called sweat equity.

Flippers who do put down roots -- perhaps they're more aptly described as serial renovators than as flippers -- typically buy unattractive or underappreciated houses in good or up-and-coming areas. They live there while making key renovations and then sell after two years, all the while looking for their next two-year home improvement project.

Why wait two years? Under current tax law, the first $250,000 of profit from a home sale is tax-free if the seller has lived in the house for at least two years. The tax break is even bigger for married couples: The first $500,000 in capital gains is tax-exempt.

"For the typical American, it's the best and most generous tax break in the entire tax code," says Douglas Duncan, chief economist for the Mortgage Bankers Association.

Turning a profit may seem easy in a flippers' market, but getting from point A to point B can be a lot of work, particularly if the brand of investing you're used to is of the point-and-click variety. Scouting out properties, negotiating financing and final prices, and overseeing renovations can be a full-time job.

In fact, real estate is as much a lifestyle choice as it is an investment strategy.

Serial renovators Bob and Christine Miller of Phoenix, for instance, spend most of their free time working on their homes, doing everything from repainting walls to rummaging through junkyards for vintage doors and sinks. For 44-year-old Chris, home improvement is in the blood: Her dad was a weekend tool-belt warrior. But Bob, a 41-year-old baseball executive with the Arizona Diamondbacks, didn't know Bob Vila from Bob Uecker before he met Chris.

Soon enough, though, he was tiling floors and installing cabinets like a pro. He says that fixing up a neighborhood eyesore is almost as rewarding as turning a big profit. "You have to enjoy doing the work. And we do."

Lesson 2: You can't sell high if you don't buy low.

Even a world-class do-it-yourselfer with a keen eye for design can't turn a bad house in a bad school district (or a good house purchased for too much) into a winning flip. That's why most flippers focus their searches on ugly ducklings that can be turned into swans with a few cosmetic changes.

"I look for the house that the neighbors hate because it's not kept up," says Joyce Grimes Bone, 37, of Norcross, Ga., who has flipped 10 homes in four years.

Her rehabs typically cost about $10,000 per house and are what she calls "cosmetic light," meaning carpets, roofs, paint and landscaping. The goal is to make $20,000 in profit per deal. For the math to work, she must buy 30 to 40 percent below a home's post-rehab market value.

Bone takes a Peter Lynch-ian, buy-what-you-know approach. "My niche is suburbia," she explains. "If it's on the way to Costco, I've checked it out."

Before bidding, she runs through a mental checklist: "Do the neighbors have pride of ownership? Are the schools good? How close is it to shopping and the highway?" It all boils down to whether she'd want to live there.

The thing is, not every neighborhood has a "Boo" Radley house in dire need of a makeover. And if you're looking for bargains, real estate agents aren't likely to be much help because their job is to get top dollar for sellers, not steals for buyers.

Bone, like many flippers, looks to the foreclosure and pre-foreclosure market to find motivated sellers willing to cut a deal. Locating these folks isn't easy (Bone goes so far as to post "We Buy Houses" fliers at the county courthouse), but the Internet does help.

Check out foreclosure and pre-foreclosure Web sites such as RealtyTrac.com for leads to investors looking for off-price real estate.

Lesson 3 Practice makes perfect.

Celestino Mastrangelo, 42, of Willoughby Hills, Ohio, has been investing in real estate for a decade. His first deal was a clunker. After making only cosmetic repairs, he and brother-in-law Dino Scalzo put the house back on the market, only to have it go unsold for months. The problem? Dingy kitchen cabinets and a prehistoric furnace turned off buyers.

"With our second house," he says, "we did everything: new kitchen cabinets, new furnace, hot-water tank, and we finished the basement." After putting $25,000 into the $80,000 house, they soon sold it for $155,000. "You have to spend money to make money," he says.

Mastrangelo also learned to line up financing early. If you're selling one house to buy another, you'll probably need a bridge loan. For hard-core flippers hunting for quick scores, traditional mortgages may not do the trick.

The best bargains come from people who need cash and are in a hurry to sell. That's why many flippers finance purchases either with personal savings or home-equity loans.

Says Mastrangelo, "Sellers are motivated to sell to you when you don't have to qualify for a loan."

Lesson 4: You don't need to flip to add value.

The tricks of wise flippers can be applied to your home, even if you've no plans to sell. When they buy, they look for places that are underpriced because of cosmetic problems that most house hunters don't realize can be easily fixed.

When they renovate, they choose styles, patterns and fixtures with broad appeal: no purple kitchens, no heart-shaped Jacuzzis. Installing an ultra-efficient furnace or carving out an attic bedroom is nice but unlikely to enhance a home's curb appeal.

That's why the most fruitful fixes are the most visible ones: floors, siding replacement (in colder climes), outdoor decks (in warmer regions), bathrooms and all things kitchen -- cabinets, counters and appliances.

And when it comes time to sell, the first thing they do is paint. "Exterior, interior walls, trim, ceilings, everything," says Bone. "The greatest payback is things people see." Top of page

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