The Pitfalls of House Flipping

An axiom of business is “Buy low, sell high.” One of the ways this rule is applied in the real estate market is the practice of house flipping: buying a house, doing some work on it, and then selling it for a much higher price. It has become a hot practice in real estate, and it is possible to make a large profit with the practice.

But it is not without risks. It is easy to get involved in house flipping and then have one of the pitfalls that make the process risky open up right under your own feet. Each year, many investors involved in house flipping fall victim to these traps, and lose money to them.

One of the worst pitfalls is to be in the wrong place at the wrong time. The once-booming real estate markets of Nevada, California and Florida, which were fueled by house flipping and speculation, are now awash with foreclosures and upside down mortgages. They were great markets where they were hot, but the last ones to hold a flipper there are now paying a huge price for their greed. It is easy to fall prey to this trap. People forget that bubbles must burst.

Another related pitfall is to buy into the wrong location. It is hard to flip a house when no one wants to buy a house in that neighborhood. Just a couple of doors from where I live, there is a house sitting vacant because the current owner thought he could pretty the place up and flip it. The neighborhood is in decline, or at least this section of it-the house next door to the flip has become condemned recently. It is ok for a person like me who is living in his house until the market recovers, but to have a house sit vacant just chews up money.

The way around these two traps is to know your market and economic cycles. Learn where the houses are actually being occupied by the people buying them, and not just being flipped. If the cycle looks too hot, think twice before stepping into it.

Consider how likely it is that you could rent out the house if you can’t sell it. This is an oversight that many do not look at. On one hand, renting out a house means that your renovations are depreciating fast; on the other hand, if the bottom of the market falls out, it might mean the difference between saving part of your investment and losing it all.

Both my next door flipper and the person I brought my current house from failed to account for being able to rent out the houses they were trying to flip. The previous owner of my house thought he could fix it up and flip it before he ran out of money, he was wrong. I closed on the house a mere two weeks before the bank was scheduled to take it in foreclosure. The previous owner could have brought more time if he would have rented it out. Same is true of the house being flipped down the street; it is just sitting there chewing up mortgage payments. In its case, I suspect that it is too small for potential renters, not a good sign for a house that you want to flip.

A question to ask oneself when looking for a house to flip is “Will anyone actually want to live here?” While a house can be brought and flipped several times-one a half-mile from my house has been brought and flipped a dozen time during the past four years before the market cooled (now it sits vacant, just as it has been for the four years I have watched it)-when the economic cycle cools off your only chance of selling it is to actually find someone who wants to live there. The ultimate buyer of houses are people who plan on living in them-don’t just buy a house that only value is to sell to another house flipper.

Besides location and cyclic pitfalls, there are the costs of buying and fixing up a house that you want to flip. You need enough money to pay both the mortgage on it, and to do the repairs or cosmetic changes which are going to make someone more likely to buy it from you. Resist buying a place that needs more than simple cosmetic changes. Major structural repairs will be out of view of the buyer and do not give a large return for your investment.

And beware that costs can be much greater than you estimated. Discovering hidden damage in your gem in the rough, or having to hire a different contractor because the first one turned out to be a hindrance will drain your budget fast.

Remember, if you are prepared for the possible pitfalls, flipping a house can be a profitable undertaking; if you are not prepared, then the pitfalls can cost you much more than you can afford to invest.