Flipping Properties Is Speculating, Not Investing
Posted on December 15, 2006
When you’ve been a real estate investor as long as I have, you get exposed to dozens of schemes that promise quick cash from real estate. During periods of rising prices and strong demand, many people flip properties to generate fast cash. Flipping involves finding properties that can be bought cheap, touched up a bit cosmetically and then flipped to another buyer for a quick profit. It sounds good and works well when real estate sales are booming. Advocates of flipping invariably refer to it as investing, but you only need to read the definition of “speculate” to know otherwise.
Webster defines “speculate” as “to buy or sell stocks, commodities, land, etc. usually in the face of higher than ordinary risk, hoping to take advantage of an expected rise or fall in price; also, to take part in any risky venture on the chance of making huge profits.” Doesn’t that description fit flipping to a tee? One thing you can bet on, at seminars on flipping, you’ll be told you can soon become financially independent and quit your job. It sounds too good to be true�and in most cases it is.
In order to minimize risk, flippers often get a property under contract, with an extended closing date, and then try to sell the contract to a third party for a few thousand dollars profit without ever actually taking title to the property. If they aren’t able to turn the property, their risk is usually limited to the earnest money deposit they put up when they signed the contract. Occasionally they will perform needed repairs or do cosmetic improvements such as paint or carpet to make the property more appealing. This added expense may also be at risk unless the flipper intends to take title to the property.
Granted, profits can be made flipping properties and you might be able to earn enough to quit your job, but all you’re doing is replacing one job with another�one without a steady income and one filled with risk. When you flip a property for a profit, that’s it; you have to find another property and do it all over again to bring in additional money. Compare this with investing, where properties are purchased to hold for the long-term rental income they can produce. Unlike with flipping that produces one time profits, the labor that goes into finding and acquiring income producing properties is invested labor that pays dividends for years to come. As rents go up and mortgage balances go down the income grows bigger and bigger.
An acquaintance of mine bought 14 houses between May 2004 and July 2006. By mid November 2006, he had sold 11 of them and made a nice profit on each one. Recently he called to see if I would be interested in buying the other three and this led to a fascinating discussion. In the fall of 2003, just after my book The Weekend Millionaire’s Secrets to Investing in Real Estate was released, he called to let me know he had purchased and read it. Like many other people, he had also attended a seminar on flipping properties and he wanted to let me know that while he liked the idea of long-term investing, he felt like he needed to turn a few deals first to raise some cash before he started buying income properties.
Having had that earlier discussion, I asked him why he didn’t just keep the properties and rent them. That’s when I got an ear full. He said that he made enough on the first four deals that he quit his job to devote full time to real estate “investing.” Things had gone well for several months and he had made more money than he had ever made on his job. Then he had his tax return prepared and discovered that the profits he made were taxed at ordinary income rates and it took most of his cash to pay the taxes. As a result, he said he devoted even more time and energy to looking for deals and the rapidly escalating prices in late 2005 and early 2006 led him to pay too much for the last three houses he purchased. Now most of his cash was tied up in the properties and he was worried the rising interest rates and falling prices may cause him real financial troubles. Welcome to the world of flipping�or should I say speculating.
Here’s a tip! Buying and selling real estate is not a lot different from buying and selling stocks, bonds or commodities. Unless you know what you’re doing, you may lose your shirt. If your income depends on making a profit from each transaction, you’re skating on thin ice. Investment markets, whether its stocks, bonds, commodities or real estate, ebb and flow. Understanding this is critical to long term success. During strong bull markets, you can almost throw a dart blindfolded and hit a winner, but when markets turn bearish, only the most knowledgeable and sophisticated investors are able to survive.
If you want to speculate in real estate, fine, but don’t do it to build cash like my friend was trying to do. As long as you know and understand the risk you’ll protect yourself. If you treat it like casino gambling and never put more at risk than you can comfortably afford to lose you can enjoy it when you win and although disappointed you won’t be broke if you lose. My friend is now grappling with the possibility of losing his three remaining houses in foreclosure and ruining his credit in the process. To me that’s speculating, not investing.
» Filed Under Success Tips Articles
Comments
Leave a Reply