You’ve seen all the shows on A&E, Bravo or HGTV about getting filthy rich by flipping houses, but ask yourself, would you buy one of these houses? Many do, unfortunately, before fully recognizing and understanding that buying a flipped house requires the utmost caution.
“There’s nothing wrong with buying a flipped house, in fact, a rehabbed or renovated home will raise property values in a neighborhood,” said Ted Rood, a national mortgage planner based in St. Louis, Mo. “But you have to do your due diligence. When buying a flipped house, it’s not just ‘buyer beware,’ but ‘buyer prepare.’
“You have to prepare physically, emotionally and financially for every eventuality that a flipped house represents, which requires that you always approach it with the utmost care and caution.”
Flipped house caution signs
By trade, Rood is naturally conservative and cautious about protecting his clients’ interests and money, so he’s on to many of the quick-buck flipped housing scams that continue to surface. Shady or sketchy house flippers know how to gloss over, cut corners, and cover their tracks better than an esthetician working the cosmetics counter at Bloomingdale’s. Water-damaged hardwood floors? No problem. Nothing that a little wall-to-wall carpeting can’t conceal. Think Hurricane Sandy or Katrina. Did you ever wonder what happened to all those flooded-out cars? Many, after being polished and primed, were sold as near-new when their metal frames underneath were rusting and corroding away.
Even well-intentioned flippers face the same time/money squeeze. The longer it takes them to fix and flip a house, the less profit they make. They often use hard-money loans to finance their flip projects, so each day of delay can involve costly carrying charges.
Similarly, the more money they pour into rehab, there’s less money for them to take home, which is why they often use the cheapest materials to complete their handiwork. It’s better for their bottom line, but not necessarily for the consumer. Any so-called improvements that look good on the outside might be ready to break, blow up or go on the blink on the inside as soon as the new buyer of a flipped house moves in.
Unsuspecting buyers who have been burned by unscrupulous flippers aren’t the only ones expressing caution about buying a flipped house.
“The FHA doesn’t much like them, either,” Rood said. “If you want to buy an FHA-insured house that was flipped within 90 days, you need two appraisals and an inspection. The seller is responsible for fixing every defect.”
Rood has seen instances where a flipper has come in and dressed up a $100,000 house and relisted it a few short weeks later for $200,000. “And all they did was install a couple of doors and paint the mailbox,” he said.
Fortunately, before the FHA will sign off on a deal, the seller has to produce records and receipts of the completed repairs, justifying the dramatic price increase. “The burden of proof is very high,” Rood added.
Tactics for buying a flipped house
Given all the caution signals and warning signs that a flipped house seems to scream out, Rood still thinks they can be good buys for educated consumers who know how to skillfully negotiate and protect their financial interests.
1. Find out if the house has been flipped
First and foremost, you need to know if the house you’re interested in has been flipped. A knowledgeable real estate agent in your neighborhood should know. The agent can also ask a title representative to run the title as to when the property last changed hands. Another tip-off that a house could be a flip is everything about the home looks new on a block of older homes.
2. Get a real estate agent
Second, Rood recommends being overly cautious about a for-sale-by-owner or FSBO. “By trying to cut out the real estate agent, the FSBO owner has removed an important layer of protection from the buyer,” Rood said. “Without the agent, there’s really nobody looking out for you. In some of these cases, the lender will step in, but we’re not real estate agents. We may end up doing the work of two or three people, and that’s never an ideal situation.”
3. Buget extra for any unforseen repairs
Third, Rood suggests using the 20 percent rule, which simply means that the buyer should add about 20 percent to whatever estimate or budget the buyer thinks the house and unexpected repairs will total. Rood noted that he had one client of a flipped house who got stuck with $10,000 in repairs after finding water damage under the carpet. “The buyer wanted to reverse the sale, but it was too late. Suing the seller didn’t do much good because the seller didn’t have any money,” Rood recalled.
Because the buyer knows he has to factor in these unexpected costs, the buyer should reduce his offer accordingly. If the seller doesn’t accept, the buyer should simply move on to another house. If an inspection turns up additional problems and the seller doesn’t want to fix the problem, the prospective buyer can ask for a credit toward the purchase. If further investigations turn up uncoded or unpermitted work, that’s cause for more negotiations.
The 20 Percent Rule
- $500,000 Asking price
- $100,000 20 percent rule ($500,000 x 20 percent)
- $600,000 Realistic buyer purchase and repair costs ($500,000 + $100,000 in fixes)
- $400,000 Price of offer that buyer should make ($500,000 – $100,000)
5. Use a mortgage calculator
Fourth, Rood advises running different mortgage calculations, a gamut of scenarios that will include the seller’s top asking price, down to the buyer’s hoped-for sales price based on the 20 percent factor and what further inspections turn up. Use the handy MyBankTracker mortgage calculator to find the payment sweet spot that you can afford.
6. Give yourself a financial buffer
For an added financial buffer, buyers of flipped houses will be well served if they ask for a home warranty service to protect the flipped home’s major systems and appliances. “That’ll give the flipped house buyer a little more protection,” Rood said. Furthermore, the buyer or buyer’s agent can ask the seller to pay for closing costs, leaving more money in the buyer’s pocket.
Lastly, Rood suggests limiting the size of the down payment, leaving enough of a cushion to cover the unexpected.
“If all you have left in your savings account is $500 when your water heater goes out, then you’re going to end up financing a bunch of stuff on credit cards,” Rood said. “You never want to put down such a large down payment that it’s going to impede your liquidity.”
Final words of caution
No house is trouble-free, which goes double for flipped homes. The hazards and warning signs may be obvious like a crooked wall or a cockeyed chandelier or they may be silent like plumbing dangers lurking just below those new granite countertops, in what you thought was a fabulously remodeled kitchen.
With a combination of caution, patience, and hard work, you can find your way home.
“Know what you’re buying, know your budget and what you can afford, on top of that, build in a cushion for the unexpected and be prepared to negotiate hard.
If it doesn’t work out, you keep searching until you get what you want.”
Peter is a staff writer at MyBankTracker.com who covers banking, personal finance, investing and homeownership.