Flipping versus buy and hold

By Bruce Firestone | Uncategorized

Feb 01

Why is it that people flip real estate ‘til they flop?

-they underestimate the cost of renos

-they underestimate the time it will take to do the renos

-they underestimate the cost of financing and holding
property while renos are underway and when they are trying to flip the property

-they don’t factor in the cost of their own time

-they don’t factor in the risk that they will not find a
buyer at a price that makes it even semi worthwhile to do this

-they don’t factor in market risks—interest rates going up,
political unrest, economic crashes, market bubble bursting…

-people are like gamblers—they only report (and sometimes
even remember) their winners

-the “setup” cost of each project is big—the cost of
completion (things like land transfer tax, legal fees, due diligence costs such
as building inspection, plumbing inspection, foundation inspection, structural
report, lease review, environmental assessment etc), the value of your time
spent searching and negotiating for a suitable property to purchase as well as
the time spent financing it plus organizing your team of contractors to
renovate the place, the cost of marketing including realtor fees, more legal
fees, staging costs, brochures, photography, website support, advertising…

-there is a hidden cost too just to get mindshare—you only
have limited bandwidth and a project like this will suck up a lot of your
creativity as well as time meaning there are other (possibly more profitable)
projects you don’t get to do

-it’s not that easy to buy undervalued property since the
internet has done a good job of providing more democratic information… even the
most motivated seller these days can learn approximately what his or her
property is worth in a few keystrokes

-lastly, there is this: say you renovate a property for
$100,000, which produces a great cap rate for you with a nice positive
cashflow. However, your appraiser only values the renos you did at $75,000. The
reason? The comparables he or she is using won’t support a higher value. Well,
if you are flipping it, maybe the market agrees with your appraiser, and you
take a hit on your flip; ie, you lose money. But if you are holding it for the
next 7, 10, 20 years, whatever, and then passing it on to your heirs, the only
thing that matters to you and your family is the positive cashflow (and great
cap rate).

The only caveat is this—you have to find ways to convince,
cajole, cadge a better appraisal from your appraiser if you are trying to
refinance to pay for your reno costs or to take money out of this project to do
another one. Low appraisals are a problem in that event.

It’s why, before we even allow a lender’s appraiser to set
foot on the property, we do our own realtor-provided CMA (comparative market
analysis) using not only comparables to establish FMV, fair market value, but
also cost to complete less depreciation and income basis.

I mean how is an appraiser going to know that you added
in-floor heating, extra insulation, cured drainage or structural issues or even
replaced your roof unless they look at your CMA and the list of work done (and
its cost) that you provide?

If your appraiser refuses to look at your CMA, put on your
best Donald Trump impression and say two words before they even get into the
building, “You’re fired!”

Bruce M Firestone, Real Estate Investment coach, Century 21
Explorer Realty Inc broker, Ottawa Senators founder 6137628884 bruce.firestone@century21.ca
“making impossible possible”

Postscript: you can download this spreadsheet, which shows
how we do CMAs based on three approaches—comps, cost to complete, income, https://www.dropbox.com/s/3zolbucldtms51o/QQ-abbeyhill-analysis-16-sept-2016-cap-rate-appraiser.xls?dl=0

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About the Author

Bruce is an entrepreneur/real estate broker/developer/coach/urban guru/keynote speaker/Sens founder/novelist/columnist/peerless husband/dad.