Flip and Grow Rich with Phoenix Real Estate

Long time readers know that I typically listen to sports radio while I’m in the car driving around town.  At least, when I’m not on the phone.  Often, radio ads peak my interest, and I feel compelled to comment, and today is one of those days.

There is a radio ad running right now by a Mr. M, where Mr. M is offering to provide a free DVD that will explain how to flip and grow rich in today’s real estate market.  Mr. M (a celebrity of sorts, with a “hit” TV show) reports that he started flipping and growing rich when he was broke, isn’t a handyman, and that anyone can be as successful as he has been.  His web site is offering his product for either $97 or $997, which seems to contradict the radio price, but we all know that when something on the radio is free, it’s never really free (unless Gambo and Ash are giving away free tickets to the DBacks…those really are free).

Honestly, I wouldn’t bother commenting on Mr. M’s campaign, except that on both Trulia Voices and PropertyQube have recently had questions from potential real estate investors asking whether you can indeed flip and grow rich.  The words in the questions seem to echo words in Mr. M’s advertisements, which suggests that his ads are getting out there, and there is indeed interest in getting rich by flipping houses.  Heck, who wouldn’t want to know how to buy something for nothing, fix it up (for nothing), sell it, and then get rich?

Can you indeed flip homes in the Phoenix real estate market and get rich quickly?  In my opinion:  Not likely.

Let’s consider a couple of principles that would be required to successfully flip a house.  First, you need to get a property that is at least 20% below current market comparables, in a market where homes are selling in under 3 months, to have enough profit potential in the property.  In nearly every case where a property is priced this low, you can expect the home you are buying will need a significant amount of repair/fix-up.

As well, if you can’t indeed “flip”, meaning sell the home quickly after it is fixed up, you can’t get rich quickly.  In Phoenix, are there sub-markets where homes sell in under 3 months?  Yes.  That sub-market is the foreclosure market of homes priced below $200K, where homes are priced very aggressively.  In order to compete in that market, you need to be priced similarly when you go to sell, and then you could expect to “flip”.

Ok, we found a market to sell in to, and we know the price for what we need to pay, how do we get a home 20% below the market we are selling in to?  That’s a lot tougher.  In this case, the best hope is to find an extremely distressed property, which ideally has a pool.  The property will probably require significant repair (ie, cash), to be enjoyable, such that a typical owner occupant would pass on making any type of offer.  That reduces the number of buyers for the property (likely to be bank owned), and hopefully allows the investor to get the home significantly below comparable values of other bank owned properties.  This is a true 1 in 100 scenario.  It does exist, but the investor needs to thoroughly understand the sub-market they are buying in to.

Buying a flipper with no money?

The next challenge, is how do we do this while being broke?  We use FHA financing, of course.  The big caveat to FHA is that there is a requirement to owner occupy the home, but you wanted to live in a construction zone, right?  Via FHA financing, along with AmeriDream (or any other down payment assistance program), you can buy a home with essentially no money down.  FHA financing will also allow you to get a special type of repair or construction loan via Streamlined 203(k), where you can borrow as much as an additional $35,000 extra to pay for the repairs that you are planning.

Now that you own a house for no money down, have it financed, and have some money to spend on repairs.  The next task is to manage all of those repairs.  Mr. M does this as his full time job, micro-managing the task so that it gets done as fast as possible, for as low a price as possible.  The loan carrying costs here eat into the bottom line, and he wants the home ready for sale in days, not weeks or months.  Being able to estimate what the repairs are likely to cost is equally critical.  To get it done quickly, you really need to have a complete list of contractors already lined up and ready to go, before you get into the deal.  A schedule, with daily supervision is also critical to minimize the loan carrying cost expense.  Finding out that a planned $1500 cabinet reface will actually cost $5000 for new cabinets, along with a 6 week delay, is likely to blow the entire deal out of the water.

Once the home is fixed up, the next step is selling it.  Priced aggressively, a home that has been professionally remodeled, with attention to detail, will indeed sell quickly, as long as the new buyer can use FHA financing, because that’s the #1 financing tool right now.  This means the home cannot be listed for more than $346,250, but under $200,000 will yield far quicker results.  With closing costs and commissions, as well as a potential seller contribution to the buyer’s closing costs, expect the sale of the home to cost anywhere from 6% to 12% of the home’s selling price.

Let’s look look at a specific example with numbers.

We need a straw man home, so we’ll envision a neighborhood where the average non-distressed home sells for $200,000 (in 6 months), and several bank owned properties recently sold for $180,000.  With our ear to the ground, we find a home for $145,000.  That’s perfect.  It needs a new AC unit (since the drug dealers are stealing copper from them to net $40 to support their habit), there are numerous holes in the walls, the carpet is trashed, the house needs to be painted, the yard is overgrown, the pool is empty, and there are 2 missing cabinet doors, along with a missing stove.

We take out a loan for $145,000 plus an additional $15,000 in repair expenses via 203(k) using a 1 year ARM at 5.25% (since we are flipping, we get an aggressive loan product).  That gives loan costs of $600 + taxes & insurance for a total of $800/month carrying costs.  Not bad.  We micro-manage the heck out of the repairs, (ignoring the fact we lived in a home in Phoenix in August without AC while the unit was being repaired), and get all of the repairs and remodel work done in just 45 days on schedule and on budget, for the low carrying cost of $1200.

We list the home aggressively at $190K, as we want to be the very next sale in the area.  Sure enough a buyer comes along the first weekend, and makes a full price offer to close in 35 days, but asks for a 3% seller contribution, resulting in an estimated 9% in closing costs and commissions, or $17,100.  As well, the payoff on our FHA loan is actually more than we paid, due to the 2% FHA mortgage insurance premium that was piled onto the loan, resulting in a loan payoff of $163,200.

Calculating the profits

So we sold the home for $190,000 minus $17,100 in commissions and expenses, minus $163,200 to pay off the loan, minus $1200 + $800 in loan carrying costs, resulting in a total profit of $7700.  Now, it’s true we turned nothing (if you call living in a construction site and managing the 45 day effort nothing) into something, but was it worth it?  If you could execute this plan once every 75 days, you would make $37,500/year in your efforts to flip and grow rich.  If you paid a real estate agent an average of 2.5% of the sale price (and nothing on the buy side), the real estate agent would make $23,000/year.  Honestly, I’d prefer to be the REALTOR, and avoid all of the risks associated with carrying the home.

Finally, the risks in this strategy should be obvious, but I’ll elaborate a few of them just the same.  There’s a serious risk in property values declining further, during the flip and sale period.  Every 1% in property value decline is $2,000 in lost profit potential.  Next, there’s significant risk that the fix-up will cost more than estimated.  When was the last time you watched a house flipping show where there wasn’t a crazy, unforeseen expense?  Sure, that’s why it’s on TV, but since the days of This Old House, with Bob Vila, this has been the norm, not the exception.  And finally, there’s the risk that the selling price you want, simply cannot be achieved, because you’ve overestimate the market.  With less than a 5% buffer on sales price, there’s not a lot of wiggle room in overestimating the sales price.

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