Is there money to be made in home flips?
A look at 3 San Diego real estate investor types trying to buy cheap, turn a profit
By Lily Leung
(Flipping is) not for the weak of heart. It looks easy … but it could be disastrous for someone who doesn’t know what they’re doing.
–Chief Denney, a Rancho Santa Fe investor whose company Compass Real Estate Capital will flip 100 homes this year
Home flipping follows an assembly-line process.
Investors who work in teams scout for bargains, close quickly with cash, gut and beautify, and market the homes to agents — all while the timer’s ticking. If everything goes right, their money and muscle will yield enough profit to keep that machine churning.
“It’s not for the weak of heart,” said Chief Denney, a Rancho Santa Fe investor whose company Compass Real Estate Capital will flip 100 homes this year. “It looks easy … but it could be disastrous for someone who doesn’t know what they’re doing.”
Flipping during the housing boom generally required little skill or effort because soaring home values did most of the work. Flippers today must rely on research, persistence, and in some cases, hard-money lending — as median values are almost 37.3 percent below their 2005 peak and most of the buying opportunities are in distressed homes.
Despite the usual risks of flipping — from hidden building flaws to costly missed deadlines — competition for deals in San Diego County and nationwide has heated up in the past two years.
Local research company DataQuick said a little more than one in four San Diego home sales in May had no record of a mortgage, a likely sign of cash investing. Sales with no recorded loan typically make up 13.3 percent of total transactions, DataQuick’s 10-year average for the county.
Who are they?
Real estate investors vary by portfolio size, financing and motivation.
But they share several similarities. They seek profits, face risks, scout for bank-owned homes and foreclosures, and are more discerning than ever in what they’re buying.
Type one: big-timers
These investor teams are typically of 30 to 40 people, including contract workers, and they rehab about 100 homes a year.
Denney, of Compass Real Estate Capital, is among them. He and business partner Bob Pabian are former developers who have switched to rehabs because that’s where the money is, they say.
Compass’ niche is “really abused homes” with everything from cracked slabs to structural problems. They gut the insides, replace flooring and cabinets, and resell.
Today’s flips require more effort than those in the past. In the mid-2000s, an investor could get away with doing little to a property yet find a buyer easily. Many called it the “greater fool” theory because the idea was to find someone who knew less about real estate but would pay more.
“The market is doing zero lifting for you,” Denney said. “Now you buy cheap and you add value.”
Their approach: Buy below $500,000, rehab with quality features within 30 days and coordinate several projects at once.
Type two: mid-sizers
Roger Faulkner, Brian Kendrick and Dustin Trotter run RBD Ventures, a La Mesa-based company that plans to flip 52 homes this year. Unlike Compass, this group has no prior real estate experience and has learned to flip through how-to seminars and investor social hours.
“We met as individuals and wanted to get into investing for cash flow,” said Faulkner, who was previously in the hospitality industry.
The guys at RBD Ventures only consider properties listed on the Multiple Listing Service, also known as the MLS, over foreclosure auctions, which tend to be riskier and require big teams.
Like the partners at Compass, Faulkner, Kendrick and Trotter also tend to buy homes that need extensive work. They’ll sometimes salvage parts that are of value, from granite countertops to wood cabinets.
Their approach: Buy in the $200,000 range, put in features that “add value” and aim for a 90- to 120-day turnaround, from purchase date to sell date.
Type three: small-time buyer/holder
Patrice Butcher and her partner, Claye Moore, want to make money in real estate. But unlike RBD and Compass, they prefer slow and steady.
The couple, who currently own 15 properties, recently closed on a South Bay condo for $120,000 and are seeking a renter.
Moore, an engineer, and Butcher, a utilities employee, bought their first home in 1987 and only planned to be in the real estate market for the short term.
“But then none of the tenants wanted to leave the houses and it would’ve cost me 25 percent to get out of everything,” Butcher said.
They eventually decided investing would be “a good, slow way to ensure you’re going to have income when you’re ready to retire.”
Their most recent purchase, like many of the others, was a traditional listing.
Their approach: Buy cheap, pay attention to details (such as avoid homes near power lines) and find places that need little rehab work.
How does it work?
Every deal starts with research and ends with a profit or loss.
Everything in between just depends.
Investors will find prospective deals from a variety of sources, including online listings, agent referrals and foreclosure auctions.
As they’re looking, they have a clear criteria. They want lower priced homes (usually between $200,000 to $300,000) in neighborhoods that have seen drastic price drops since the height of the market (typically neighborhoods in the East and South counties.) They figure the lower they buy, the wider the profit margin.
If the math makes sense, investors will secure financing, which varies greatly.
Seventy percent of Compass’s financing is private capital and the rest is investor backing. RBD uses hard-money loans and private funds. Butcher, the small-time investor, found conventional investor financing.
Hard money lenders are sometimes preferred because they close loans within 10 days instead of 30 to 45 days with a bank. Another benefit: They focus less on credit scores and more on investment background, current projects and private capital.
Some prefer conventional loans because the interest rates are lower.
Butcher, the small-time investor, locked in a 5.125 percent interest rate with a 777 credit score and 25 percent down. Hard-money lenders, on the other hand, charge about 13 to 15 percent for loans that must be repaid within a shorter period of time, sometimes a year.
Windvest Corporation, who provided financing to RBD Ventures, also wants to see about $20,000 of capital for every $100,000 borrowed “to have some skin in the game,” said company vice president Andre Jimenez.
Since 100 percent financing is not available through hard-money loans, the market has seen a surge in use of private capital, said Reggie Lal, a real estate investment expert covering Southern California. People are dipping into savings, stocks, 401(k)s and IRAs.
“Liquidity has left the market … so they’ve been forced to get creative in finding alternative sources and pooling resources,” Lal said.
Conventional financing also is a possibility but has its limits. You can’t finance more than 10 properties,by Fannie Mae standards, and traditional lenders want stellar credit scores of 740 and higher.
Once financing is secured, investors submit multiple offers on different properties at once to increase their odds.
The rehabbing process starts and is on a strict timetable. For RBD, that timeframe varies, but at Compass, it’s 30 days max or they start to lose money, Denney said.
How is money made?
The goal for all investors is to make money.
A reasonable profit in today’s market is about 7 to 10 percent, as opposed to the 20 and 30 percent expected during the real estate boom.
Why has that margin for gain shrunken so much?
Factors include lower housing prices, high rehab costs for dumpy distressed homes and an array of fees that cover closing, tax and insurance.
Let’s take a deal by RBD.
The three partners bought a four-bedroom, three bath home in the Encanto area for $189,000 as a traditional sale.
They tacked on $79,500 in rehab costs, fees, property tax, agent commission and holding, bringing total expenses to $268,500.
The total went up again after paying off $12,000 in interest for a one-year $147,000 hard-money loan, bringing total expenses to $280,500.
The property, now in escrow, sold for $315,000, so the profit was roughly $34,500, or about 12.3 percent profit.
But not all deals yield profits in the teens.
Bill Tan, a San Diego hard-money lender, said a common pitfall is underestimating the cost of rehab, which could cost tens of thousands of dollars. Such extensive work often is required because many bank-owned homes are trashed by previous owners.
“Most (flippers) have never done it before, or they don’t use a professional,” Tan said.
Another common mistake is overestimating a rehabbed properties’ selling price.
Profits also depend on volume. Even though margins have decreased over the years, if you turn over enough rehabs in a year, it may be worthwhile, investors said.
What’s the community impact?
The infusion of flippers into the housing market has raised questions about their influence on the local economy.
Some qualified owner occupants have complained they’ve been edged out by investors because they can’t compete with cash offers, which are more attractive to sellers.
Companies such as RBD and Compass say they’re actually helping communities. They buy distressed sales that are in such bad shape the a typical buyer wouldn’t have the time or knowledge to rehab them.
“There are 30 hands that touch every home we have,” ranging from construction workers to escrow agents, said Denney, of Compass Real Estate Capital.
They say they rehab and sell at an affordable price to families that are able to afford a home through VA and FHA financing, the majority of their clients.
“After we’re done, the neighborhood is going to look a lot better,” Faulkner said. “And then, hopefully prices will go up.”
He added: “We’ve had people come up to us during rehabs saying, ‘Thank you for doing this.’ ”
First Published: July 7, 2011 6:00 AM PDT
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