Real Estate… Answered

Of all the investing strategies available to beginners, flipping houses is probably the most exciting. You buy a real estate investment well under market value and then resell it to another investor for a small but fast profit. So, instead of waiting six months or longer to sell to an average homebuyer, you make money in a matter of days or weeks. It sounds great, but how much money do flippers really make?

There’s a huge range. One highly knowledgeable but unmotivated friend of mine makes about $50,000 per year flipping houses. Another highly networked friend makes over $50,000 per month. Then there are the big dogs, like my father, that make upwards of $10 million per year flipping commercial properties. I’ve studied each of them closely and found four S’s that affect their income:

The Spread

Professional investors don’t care how much money you make from a property, as long as they are making their desired profit. For example, let’s say you find a landlord that will buy one house at 20% below market value. Searching for appropriate deal, you find two possibilities:

• A house worth $100,000 that you can buy for $70,000 (30% below FMV)
• A house worth $100,000 that you can buy for $60,000 (40% below FMV)

Which one do you offer to the landlord? The second one, obviously. The landlord will buy either of them for $80,000 (20% below FMV). You’ll make $10,000 more from the property with the larger spread.

The Size

Your profit also increases proportionally to the size of the deal. For example, let’s say you have a luxury home investor that will buy one property at 30% below fair market value. You find and buy a property that is worth $1 million for $600,000. A few days later, you flip to the investor for $700,000, netting $100,000. Because the numbers for the investment are larger, you make more money.

Seed Capital

Of course, it’s difficult to buy a house for $600,000 if you can’t afford it. Successful flippers depend on a large reserve of cash that they use to buy and resell houses quickly. Having a large pool of cash available gives you several key advantages:

• You are able to move faster than investors that depend on conventional financing, making your offer more powerful to motivated sellers
• You can close on and resell a property quickly, minimizing the chance that your investor will buy from another flipper before you can close
• You can buy more than one house at once, allowing you to dominate a particular market

Unless you have an unlimited source of capital, it’s better to make a small amount of money in a short amount of time than a large amount of money over a long time period. For example, let’s say you invest $100,000 in a property with a fair market value of $150,000. You have two choices:

• Within a month, you can sell the property to another investor for $110,000, netting a quick $10,000
• In six months, you can sell the property to a retail buyer for $140,000, netting $40,000 

When deciding between the two options, a professional flipper will assume they can perform a similar deal every month, allowing them to turn over the same $100,000 real estate investment 12 times in one year. So, if you take the first option, the annualized return on investment is:

$10,000 Profit / $100,000 Purchase Price * 12 X 100 = 120% Return on Investment

If you choose the second option, on the other hand, you can only turn over your money twice per year, giving you an annualized rate of return of:

$40,000 Profit / $100,000 Purchase Price * 2 X 100 = 80% Return on Investment

Both returns are excellent, but assuming you can perform a similar deal every month, the first option is superior. It shows the advantage of moving your money quickly.