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House flipping is a big craze. People say you can make a fortune. Should you flip houses?
For most people, the answer is a resounding NO. (See exception - residence flipping link below) Flipping a house is a lot more dangerous than the TV real estate hucksters claim. First, the numbers they use are fictitious – they are not lying, they just happen to leave out a lot. It is kind of watching the sports news and getting half the score. Today against the Steeler's, the Patriots scored 27 points... and in other sports news...” - OK – did they win?? Maybe.
To flip, you have to be in an up-ticking, a stable or a stagnant market. A declining market will be very dangerous. How do you know what kind of market you are in? You can never be sure.
FLIPPING – NOT FOR THE LITTLE GUY
Lets use an example of a stable market, where prices generally remain relatively constant for 6 months.
Here is an example of TV flip mathematics:
Buy house $400,000
Addition $50,000
Total Cost $450,000
Flip sale for $500,000
Profit $50,000
Great - right? - Is this accurate? Did we make $50,000 in six months part time managing a flipped house?
TIME VALUE OF MONEY OR MORTGAGE
Well, how long did it take? OK - lets say it took six months, that is a pretty good time, it would be very hard to do it in less time – three months to fix it up, and three more to find a buyer and close the deal. Six months of $400,000 at 5% is $10,000. So it cost you about $10,000 in opportunity cost of the money – or mortgage interest payments for the six months you held the property, either way it costs real money.
Your $50,000 profit is now reduced to $40,000 because of the opportunity or the direct cost of money used in the project.
REALTOR
How much did your Realtor cost? Lets say he charges 5%. Most Realtors charge at least that, so lets use 5%. 5% of $500,000 = $25,000. Maybe you didn’t use a Realtor, but most people do and will have this cost.
Your $40,000 profit is now reduced further to $15,000 due to Realtor commissions
INCOME TAXES
Flipping a house is ordinary business income. For most people that means that they will pay both income tax and social security tax on it. Lets say your tax bracket is 20%, add another 15% for social security tax and we have 35% tax rate. Lets use 33% as a total federal income tax and social security tax rate for simplicity. $15,000 / 3 = $5,000 in tax payable, not including any state income tax that might be due. I live in state-tax-free Florida, so I will ignore that.
Your $15,000 profit is now down to a net to you of $10,000. Is making $10,000 (less if you have to pay state income tax too) good enough for six months of work and the risk? Probably not. It could be worse, if the market declines slightly it would be worse.
Flipping property is for big business. If you do 10 a year, it could work well. But to flip a property here and there very likely will result in disappointing returns.
Now “Residence Flipping, great idea – for some.”