House-flipping still offers opportunity

By Scott Bernard Nelson

updated 9:48 a.m. ET April 9, 2007

Has the house flipping bloom finally fallen off the rose? HomeSmart LLC in San Juan Capistrano, California, which tracks real estate deals in 150 metro areas coast to coast, found that in every region, the proportion of home sales for properties owned six months or less has fallen dramatically since hitting a peak in 2005.

HomeSmart President Mike Ela says he assumes most of that quick buying and selling was intentional, which fits his definition of "flipping." Not only are flips becoming less prevalent, but they're also becoming riskier.

In Florida, for example, only 2.6 percent of home sales were for flipped properties in the third quarter of 2003. But that percentage had more than doubled to 5.8 percent by the third quarter of 2005. As the real estate market cooled, the percentage dropped, hitting 2.4 percent in the final three months of last year.

When flipping was at its peak in 2005, only 12 percent of deals resulted in a loss, according to HomeSmart. If they did dip into the red, it was for an average of $8,775. More recently, one in four deals lost money at an average of $23,250 per transaction.

That's not to suggest, however, that short-term real estate investing is a dog whose day is past. In fact, with foreclosures rising this spring in the subprime market, there will be an increasing number of opportunities for entrepreneurs in some markets. Ela says there are bargain properties coming available at this point in the real estate cycle, but that buyers shouldn't assume one is a deal just because it's in foreclosure.

"The previous buyer may have overpaid for it, and the lender may have loaned too much money on it," he says. "Lenders sometimes make bad choices. Don't make their mistake your mistake."

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Before you start looking for properties, there are some basics you should keep in mind. Ela assumes buyers spend an average of 5 percent of the purchase price for things like Realtor commissions and rehab work, so a "profitable" sale is one that goes for at least 105 percent of the amount originally paid.

The goal usually is to find a property selling for 70 percent or less than its intrinsic value, make a series of cosmetic repairs and then put it back on the market. One popular strategy is to look for rundown houses in otherwise nice areas, on the assumption that the neighborhood's value will rub off on your ugly duckling if you can make it a little less ugly.

Now that the froth is off the market and you can't count on rapid price appreciation, how do you find these gems and beat other investors to them? Know that it can be done, but don't expect it to be easy.

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