We noticed an interesting headline it today’s Wall Street Journal. “House Flipping Makes a Comeback”. That brought back fond memories of easy equity during the days of “irrational exuberance” in real estate. Of course, there’s a dark side to irrational exuberance which we’re sure you don’t need to be reminded of.
So why did this article catch our interest?
The star of the article is a real estate “investor” in Phoenix…really? Phoenix? We thought Phoenix was a train wreck. Or, is their opportunity in chaos?
Anyway, this guy in Phoenix went to an auction and bought a house that was formerly worth $1.3 million. He paid just under $489,000. He then sold it to a woman for $699,000. That’s about $210,000 in quick profit. In The Real Estate Guys’ world, we call this “found” equity. It’s “found” because he didn’t do anything to the property to make it worth more. It was worth more than what he paid for it at the time he bought it. The bank left money on the table. He found it.
Sounds easy, right? How many of those would you like to to do in a year?
The article goes on to talk about different markets and statistics. It provides some insight into bank motives. Blah, blah, blah. This isn’t to be critical of the Wall Street Journal. But they write for a different reason than we do. We’re thankful they brought the topic up. Now we have something to build on.
What we’re interested in is HOW to do it. Though we’re not experts in purchasing foreclosures, we have certainly done our share of “found equity” deals. Based on our experience, here are some tips if you decide to play this game (which can be very fun and profitable!):
ALWAYS know your exit before you get into the deal. And ideally, you want more than one. The article doesn’t say if the Phoenix guy had his buyer identified BEFORE he bought the property, but that’s the way we would have played it. With a buyer in hand, you show up at the auction (or go into the open market) and look for a property that your buyer wants. If you know what they’re willing to pay and you can buy it for less, then you have margin and a quick and known exit.
Make sure your buyer is real. That is, he’s ready, willing and able (as in financially capable of buying). If you’re a real estate agent, this is basic. If you’re a newbie flipper, it’s gold. You don’t want to be stuck holding the property.
Make sure your margin is more than 6%. Even though 6% on a $300,000 deal is $18,000 and it sounds like doing that 10 times a year might be a decent living, it’s the same as if you were a real estate agent. The difference is a real estate agent isn’t putting his own capital at risk. If you’re going to take more risk, you need to receive more reward.
Don’t put all your money into one deal. It will be SO tempting when the “no miss” deal comes along. But remember, this is real estate. Something ALWAYS goes wrong. It doesn’t necessarily mean you lose money, but it might be tied up for awhile, so you lose opportunity. Side note: If you don’t happen to have $500K sitting around like our friend from Phoenix apparently did, go find 10 friends who have $50K and do a small syndication. Now no one has all their money in one deal. And if this whole process takes 90 days, $200K on $500K is a 40% return in 3 months. That’s 160% annualized. We’re betting there are some investors out there who would want to get in on that. If you decide to go this route, make sure you visit with your attorney first. Syndicating isn’t something for the newbie do-it-yourselfer.
Did we mention to have a plan B? And C and D? If your buyer falls through, have 2 or 3 more lined up. If possible, be prepared to “Flip and Hold”. This is what we call buying a property for cash, then refinancing it to get most of the money (or if you bought it low enough and wait a bit, you can sometimes get ALL your money back out). Then rent the property for enough to float the mortgage and expenses. Obviously, this is more complex and there’s some math to do to make sure it all makes sense. And we know that getting loans on certain types of properties (and cash out loans in general) is harder to do today than in the past. We recommend knowing your financing options BEFORE you buy, even if you don’t plan to hold. You never know how it’s going to work out. The more options you have the safer you are.
We obviously could go on and on (we’re experts at that). This topic is too deep for a simple blog post. But it should get your brain whirring (which is always a good thing). Our recurring theme is that there is a lot of money to be made in real estate right now simply because most people still aren’t ready to play. This guy in Phoenix made 200 grand because other people weren’t there bidding. And what a great service he provided for his buyer!
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