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Copyright by John T Reed
Flipping seems to be the latest subset of the nothing-down movement.
First, as I have stated elsewhere, you should know that the purpose of the nothing-down movement is to overcome the objection, “But I don’t have any money to invest in real estate.” When gurus try to sell real estate information, they encounter that objection and need a way to overcome it in order to make a sale.
Real real estate investors generally do not use any nothing-down techniques. Rather, nothing down is a creature of book, tape, “boot camp,” and “mentoring” salesmen which has taken on a life of its own among beginners who have fallen for that sales ploy and think it’s a real way of investing in real estate. The typical successful real estate investor has done one nothing-down purchase in his career—invariably because of some unusual situation that popped up with no prompting by the investor.
Nothing down also appeals to those who believe that somewhere you can get something for nothing. When I appeared on the 60 Minutes segment titled “Nothing Down” in 1986, Morley Safer began the piece by saying, “Americans have always wanted to get something for nothing. Now they want to get something for nothing down.” Well put.
The nothing-down movement now includes the following techniques:
• borrowing 100% of the purchase price
• promises by gurus that they will put up the cash for deals you bring them (See the discussion of Michael R. Enelow at my guru rating page)
• lease options
• partners
• flipping
See my nothing down article for information on the other techniques.
I like the idea of flipping. However, it appears to be extremely difficult and risky in the real world.
Many title and escrow companies now have policies refusing to handle double escrows. Those are transactions where the property is bought then immediately sold at the same closing. Double escrows enrage sellers and their agents. Also, many double escrows have involved resale at phony inflated prices. HUD adopted policies against financing any property that had changed hands twice in a short period of time.
In 2001, I interviewed two different successful flippers and wrote articles about them in my newsletter Real Estate Investor’s Monthly. I was surprised by a number of things. For one, they had to sell for much bigger discounts than I had assumed: 65% to 85% of fair market value. Jeez! At those prices, it seems you would be better off just buying from those guys rather than trying to imitate them.
Why do they need to give such big discounts? Flip properties are vacant. Vacant properties dramatically change the profit picture. Speed becomes paramount. How fast you get the property sold and closed determines the amount of your profit and whether you make any profit at all. Builders have this same dynamic. Once they buy the land, they frantically try to get the houses built and closed as fast as possible because their profit is determined by their speed. Every day you own the property it is a big financial drain.
The flippers to whom I spoke had big staffs. Makes sense when you realize they are almost simultaneously buying and selling—each of which is very laborious and time consuming. One guy was running many property-wanted ads and putting property-wanted signs on every telephone pole in town. He said he spent about $500 putting up signs for every purchase he made. He also used many other methods like going door to door looking for sellers.
I had thought that flippers look for a buyer before they close the purchase. That would make the deal nothing down because you could use the buyer’s money to pay for your purchase. In fact, you can’t do that in the real world. Why? Because sometimes the seller does not sell. He may refuse because he is outraged that you are reselling for a profit. He may be trying to extort a higher price out of you knowing you are over a barrel with the new buyer you found. Maybe there is a problem with title or some such. Maybe there is a tenant who refuses to move. There could be a lot of reasons.
In the real world, buyers are real people with real families. When they buy a home from you, they expect to move in on closing day. They and their family give notice at their old apartment or sell their old home in anticipation of moving into the home you are selling them. They make arrangements with a moving company. If they are from out of town, they are enrolling their kids in the local schools, etc. Moving is a big deal. Some flaky investor selling them a home he doesn’t own, then saying, “There’s a problem,” is likely to cause the whole situation to explode in lawsuits, if not assault and battery. You’re messing with people’s live when you sell them a property. You’d better have your act together.
Bottom line is you really cannot sign a contract to sell to a new buyer until you are sure you are going to be able to perform on that contract. And the only way to be sure is to wait until after you close the purchase. Real world flippers go into instant frantic efforts to sell the moment they close the purchase—but not before. That’s part of why they need a big staff. One sends a blast fax to 3,500 buyers who have asked to be on his fax list. Costs him $250 just to send the faxes.
Also, you would probably have trouble showing a property you did not own to prospective buyers. For one, the seller would be displeased that you are even trying to do such a thing. Same with the listing agent. It also makes them look the fool if you succeed. Arguably, the agent could be legally liable to the seller for not advising him how to capture the profit taken by the flipper.
When I was an agent, I rarely saw properties that could be profitably flipped. But there was one: a side-by-side duplex that I advised the client would sell for more if she legally subdivided it into two separate homes. I was not advising any physical separation of the building, just the ability to own each half on a separate deed. She applied, got approval, and made exactly the extra money I said she would as a result. Had I allowed a sharp real estate investor to subdivide it after he bought it, my client might have had a basis for suing me.
It is very difficult to insure vacant property. It tends to get vandalized by neighborhood kids or taken over by drug dealers. Flips are vacant.
The reality of financing in the flip business is the opposite of what the nothing-down people preach. Flipping requires all cash. You cannot get a normal mortgage because the transaction costs would be astronomical considering you are only going to own the property for a matter of days—you hope. You cannot use the buyer’s cash because you really cannot look for a buyer until after you have closed. So the fact is you need all cash to buy—the opposite of nothing down. This is usually done with lines of credit that are far larger than the average nothing-down wannabe could obtain—hundreds of thousands of dollars.
Real flippers lose money on some deals or make too little profit on others. But they are OK in the end because they do lots of deals and make extraordinary profits on others. However, a beginner doing this is trying to make a profit on every deal because he only has one deal at a time. The flipping business does not lend itself to such highly predictable outcomes.
A lot of “real estate investment” techniques I hear about sound suspiciously like brokerage. This is one of them. One guru said he was “just a middleman” when he does flips. That kind of talk would make good evidence against you in an unlicensed-practice-of-brokerage prosecution.
To do a brokerage deal, you must have a brokers license or be a licensed salesman and be affiliated with a licensed broker. Laymen tend to believe that they can finesse that by simply not calling themselves brokers. Not true. The law has a doctrine called “substance over form.” It says that the courts will look at what you do, not what you call it. If what you do looks more like brokerage than investing, they will demand to see your license and hold you to the standards of behavior of brokers—most notably a fiduciary duty to the client. Flipping looks a lot like bringing a buyer and seller together for a commission. That’s brokerage.
Furthermore, it not only looks like unlicensed brokerage. It looks like a “net listing.” A net listing is one where the seller says, “Just get me X dollars. You can keep any amount above that.” Net listings were illegal in New Jersey when I was licensed there. They are ethically questionable everywhere because of the powerful conflict of interest regarding the setting of the asking price. Normally, the broker has a fiduciary duty to recommend no less than market price to the seller. But in a net listing, the broker has a strong temptation to recommend less than market so he can increase his take.
Doing one real estate deal—either buying or selling—is extremely stressful. The stakes are very high. There are many opportunities to screw up. When I was an agent, I recall several women customers or clients crying hysterically as the deal progressed. I once advised a couple on a tax-free exchange, which also involves buying and selling at the same time. They swore they would never do an exchange again, but when I questioned them about why, it turned out it was just the strain of doing a purchase and a sale simultaneously that bothered them. Note that exchanges are much easier than flips.
For more information, see my Web review of the Discovery Home Channel TV program Flip That House.
Click here to see a review I wrote of the book Flipping Properties.