Should I try to 'flip' some real estate?

John W. Schoen Senior Producer • Profile • E-mail

June 13, 2005 — Jan in Alabama recently went shopping for a condo and found they had already been sold to "flippers" — before they were built. She wants to know just how that works — and if she ought to give it a try. Gregory in South Carolina, meanwhile, is going into business as a consultant. He wants to know whether he has to pay taxes on the "per diem" portion of his new paycheck.

A FLIP ANSWER
… My questions are: What exactly is flipping [real estate]? How can you do it without losing your shirt (when you don't have much of a shirt to begin with)? and Can you make money do it, whether it is pre-construction or existing — with little or no money down?
-- Jan H. – Birmingham, Ala.

A: Flipping is just a term for speculative real estate investing — when the buyer has no intention of occupying (or even renting) the property. The idea is to buy at a price that gives you the opportunity to profit by holding that property for only a short period of time.

Flipping has become popular in overheated housing markets lately because prices are rising so quickly. In fact, strong buying by flippers is now a major cause of overheating in many markets. Yes, some people are making lots of money. Most flippers use a lot of leverage (little or no money down, interest only loans, etc.) to get even more bang for their buck. If you already own a home, and you’re willing to pledge your equity in that property against a new loan, it’s not hard to borrow with no money down. (That "easy money" is another reason housing markets are overheating.)

But this is a very risky form of real estate investment for beginners. A lot of things can go wrong. "Pre-construction" sales happen when a builder wants to raise cash and sells contracts for planned units, sometimes at below-market prices, usually to professional investors, before anything has been built. Many developers operate with very tight cash flows. If that cash flow gets too tight and the development doesn’t get built, you’re stuck with a loan on a condo that doesn’t exist.

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Flipping existing properties can also be risky. It’s pretty difficult these days to find a property that’s “under priced.” With rates low and demand still strong, most sellers are asking for — and getting — top dollar. That means you’ll have to hold the property for awhile to see any serious price rise (your profit). While you’re holding that property (with no rental income), you’re gambling that your eventual profit will exceed the carrying costs you’ll be paying out until you sell. Those costs are mostly just mortgage interest and taxes, but you’ll have to spend some money on upkeep or the property won’t list very well when you decide to sell it.

The main risk of flipping — especially in a market like this that’s already risen a lot, very quickly — is that you’re stuck with an “illiquid” asset when the music stops. We’re not big believers in housing bubbles bursting like stock market bubbles. But hot housing markets eventually cool off —and they can do so quickly. If that happens while you’re still holding your “flipper” property — you could wind up selling at a loss just to get out from under those carrying costs.

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