Don’t "Flip Out" and Quit Your Day Job

NEWS FLASH: Flipping houses is a lot harder than you think.

Not just because Florida home loan rates have been on the rise for months on end, but because you need considerable cash flow, time and experience to do it right.

MSN Real Estate and Bankrate.com set out to debunk the get-rich-quick myths of flipping in a recent feature. Many of us have seen one or more of the real estate reality TV shows out there that make it look so easy. Buy a run-down house, fix it up quick and sell it for a profit before the first loan payment is due. Oh, and that profit is as much as your year’s salary. For a second (or maybe longer), you consider a career change.

Slow down.

It’s not as easy as it looks, in part because of your competition. Big-time price appreciations of the past five years have led a lot of people to consider the same thing, and as a result, the obvious deals are long gone. The pros make money on the front end by buying properties for at least 30 percent below market value. Finding such value takes time and once you find it, you need to move fast. Forget about the no down payment options, too. It hardly ever works that way. You’ll need considerable capital to close the deal, not to mention to do the renovations.

“The masses believe in the dream that’s been promised to them, that they’ll be making a fortune in the next six months. They don’t have the basic know-how. If it were as easy as they make it seem, 286 million people would be flipping real estate,” said Manuel Iraola, Homekeys.net, an online real estate company based in Miami.

Richard C. Davis is the owner of Trademark Properties, based in Charleston, S.C., as well as the creator and star of A&E’s reality show, “Flip This House.” Davis believes no one can watch his program and reasonably get the impression that this is an easy way to make a living.

“In our original video, we had a warning. ‘Do not try this at home. It’s for trained professionals. You will lose money,’” he said. “I got two guys following me around with a camera. There’s no script. If I lose $100,000, you see it.”

While he understands the desire to get in on the action, he doesn’t have a lot of sympathy for those who don’t want to invest the time and effort one needs in order to really learn the business.

“Right now, you have people jumping in on frenzy and it will bankrupt a lot of Joes and Susies who have no business doing this. I mean, my wife is a doctor, you don’t see me going out doing heart surgery,” Davis said.

What’s the catch? What is there really to learn? Bill Kring, a financial advisor in Atlanta, wishes more people understood that they need to have adequate savings in place to pay the bills while money is flying out the door. After all, even if the potential for profit is there, you have to finance cabinetry, plumbers and plants, etc., up front.

“This is a business with zero income until liquidation. So what are your resources? What are your abilities to borrow? Without that, you’ll never make it,” he said.

Access to large amounts of cash is the hardest part of the business, and a great misperception, according to Raphael Isaac, who’s rehabbed and resold houses in the metro New York area for 14 years. Most of the time, he puts at least 10 percent down and then has a month to close his deals.

“If you don’t close in 30 days, they keep your money. Then you need more cash to carry the house, the insurance, the utilities and the maintenance,” Isaac said. “You won’t get a contractor to renovate a house for no money. People go to trade shows and buy these books and tapes on how to buy a house with no money down. I’ve never seen someone actually do that.”

Another reason access to cash is so important is that you probably need to hold on to the house for at least three months. Why is this? The FHA anti-flipping regulations stating that homes sold in under 90 days after their purchased aren’t eligible for mortgage insurance from the FHA. In addition, those sold in 91-180 days are okay, but require an independent appraisal to make sure the price is fair.

What that means for the owner is additional carrying costs. Every day you own a house costs you money in interest, property taxes, insurance, and utilities.

If you’re taking out a home loan to buy the house, you will also want to talk to your banker about prepayment penalties.

“We make money when people hold loans, we lose money when they pre-pay,” said St. Petersburg, Fla.-based banker Mark Dannenmiller.

A typical prepayment penalty is 80 percent of the Florida home loan balance, times the interest rate, divided by 2. If you borrow $100,000 at a rate of 5.75 percent, your penalty would be $2,300 — $80,000, multiplied by .0575, divided by 2. Dannenmiller’s advice to those thinking about this business is to keep your job, make a little bit of money on the side and pay yourself back, building up cash reserves.

“Hopefully, by the fifth or sixth house, you don’t need me anymore and you’re buying houses for cash. That’s important because as soon as you (quit) your job, you can’t get a loan,” he said.

Joseph Patton, an investor and rehabber who buys primarily in Philadelphia, getting cash is the easy part. The hard part is finding the properties.

“These properties are not for sale through Realtors and they’re barely available through auctions. Finding them is very time-intensive. You have to be out there on the street. It’s almost banging on doors. It’s not an insider’s game but you need to put in time to build the network,” he said.

Another point to consider is that as far as the IRS is concerned, buying and selling real estate as an investment strategy is markedly different than doing it as an occupation. If you buy, fix up and resell a home while you have another full-time job that provides the bulk of your income, it’s considered an investment and will be taxed as short-term capital gains.

NOTE: If you own it for a year or less, it is considered a short-term gain, while it’s considered a long-term capital gain if you own it for more than a year. Short-term capital gains are taxed at the same rate as ordinary income, whereas long-term capital gains are currently taxed at 15 percent of the actual gain.

On the flip side (no pun intended) to flipping is that if you do this year-round and it pays the bills, that’s considered a business. Your gains will be taxed the same as ordinary income no matter how long you own a property, while the taxes and interest are regarded as expenses.

You’ll have to pay self-employment tax of 15.3 percent, and you won’t be able to take advantage of a like-kind or 1031 exchange, which helps with taxes when a property sells for a lot more than you paid for it. Only an investment property qualifies for this tax break, and case law suggests you need to hold it for a year.

So does it make any sense at all to do this?

For the right individuals and the right reasons, sure. Ralph R. Roberts, a real estate broker and investor in Detroit, recommends learning everything you can about the industry and not to consider making it a career until you can make double the amount of money annually that you do in your current job.

“One person I went to high school with bought a house every year for 30 years. He’s flipped about 10 of them. Now he’s building a mammoth house. But he never did it to get rich; he did it to have financial independence. You can’t go into it for the hype. You do it for financial security down the road,” Roberts said.

Well there you go. Maybe you don’t need to quit your day job after all. It gives you your health insurance anyway. Maybe moonlighting as a flipper is the next best thing. Who needs sleep?