We’ve all seen the flipping shows on TV, who hasn’t? Shows like “Flip or Flop” or “Flip This House” present a watered down glamorized view of flipping. According to the experts, flipping is easy! Plus, you make great money, it’s easy to find great deals, and you don’t have to worry about much. If only it were that easy…
For those that aren’t as familiar with the lingo, “flipping” a house simply means to buy a property (preferably with no money down), usually one that is distressed and in need of repair, fix it up, and sell it quickly for a higher price than the price you paid for the property plus the repairs you made.
Myth: Get Rich Quick Formula = Buy with no money down -> Flip –> Sell at a higher price –> Use the proceed to buy the second property
It seems rather intuitive, doesn’t it? Buy low and sell high. How hard is it to follow that formula? Flipping is certainly a viable way to make money and there are people that successfully do it, but it’s an extremely risky strategy more akin to day trading. There are a few people out there making money by day trading, but most lose and lose big.
In addition to the inherent risk involved with flipping properties, there are a few issues with the formula itself.
First, buying a property with no money down means that the property is 100% financed. While you may not have paid any money out of pocket, these deals are seen as risky from a lending standpoint, so anyone loaning 100% on a property is going to charge a much higher interest rate. Because of this and the amount financed, your holding cost is extremely high. Oftentimes this is enough to eat most of the potential profit in a flip deal.
Second, appreciation from a property comes from either improving the property (“forced appreciation”) OR favorable market conditions. To achieve forced appreciation and still make a profit, a flipper has to have precise rehab numbers. A slight miscalculation can be the difference between a winner and a loser. Betting on favorable market conditions is a risky bet as market conditions are out of your control. This kind of exit strategy is like trying to time the stock market - sometimes it works, but often it doesn’t. Holding a property for longer allows you more time to make up for any errors and gives you the flexibility to exit a property at the most advantageous time.
Third, when selling a flipped property, the profit is subject to short term capital gains taxes, which are taxed at the same rate as regular W2 income. A lot of the benefit of investing in real estate is realized in the form of tax benefits that flippers are unable to benefit from.
Fourth, at the end of the day, flipping is a job. The moment you stop flipping, you stop making money. Someone looking for investments that will build over time and eventually provide them with passive income won’t find what they’re seeking in flipping.
The Right Wealth Growth Formula:
When building wealth in real estate, there are a few basic tips to remember.
#1 Don’t over-leverage at acquisition. When purchasing investment property, make sure you’re not over-leveraged. 60-80% Loan-to-Value is a good range to hold to depending on the asset type you are holding.
#2 Hold for an appropriate amount of time. A lot of the value of real estate comes from time. To fully gain the benefit of both forced appreciation and favourable market conditions, hold property for a longer period of time. This has the benefit of not only allowing your to fully absorb all of a properties appreciation, but also bumps your profits into a lower tax bracket if you hold for longer than one year.
#3 Refinance instead of selling. Instead of selling a property, look to refinance at an appropriate time. As I mentioned above, a lot of the value in real estate comes from time. Because real estate typically appreciates, the longer you hold a property, the more it’s value will be. Refinancing a property allows you to access this increased value while still keeping the property.
Invest with Confidence.
Yan Yan and Andrew Brewer
Sharpe Investor Group www.sharpeinvestorgroup.com
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