Soft market teaches flippers an ever-so-humble lesson

Flipping a home

Here is an interesting article on flipping real estate and how the soft market (in areas other than Austin) is affecting those who practice that particular form of real estate investing. The website referenced in the article doesn’t have stats for Austin, but even in our rising market of the past year, one has to be very careful buying homes with the intention of selling quickly for a profiit.

Noelle Knox, USA TODAY
Thu Sep 21, 6:56 AM ET

Investing in real estate looked so sexy. Like the tech-stock bubble that turned college kids and housewives into day traders, the real estate boom turned insurance brokers, doctors and bicycle mechanics into real estate flippers, who would buy and then quickly sell homes for easy profits.

Now those profits are shrinking fast. Nearly one in five flippers who sold from April to June actually lost money on the deal, the highest level in 2½ years, according to HomeSmartReports.com, which today will release a report on flipping activity in 147 metro areas.

The vanishing act of speculators is accelerating the decline in home sales this year. That’s making life hard for home sellers but giving buyers a bonanza of choices. It’s also a stark reminder of the cyclical nature of real estate.

Though it’s too early to say how far the market will fall, short-term real estate investors are learning how hard it is to make money – any money – once For Sale signs begin hanging in yards for months. Sellers cut prices, and builders hand out swimming pools to entice hesitant buyers.

Take Jeffrey Epstein, an insurance broker in Florida. When Epstein put deposits down on a condo and a town house under construction in Miami in 2004, he never actually planned to live in them – or even buy them outright.

“My strategy was just to put down a deposit and try to flip the contracts when they built the properties, which I was able to do on a couple others,” says Epstein, 49. “But then I ran into a couple of problems.”

Namely, a local real estate market with a 17-month supply of condos for sale and prices 11% below last year’s median. In June and July, Epstein had to come up with the money to close on the condo and the town house. Now, to get them off his hands, he’s offering to pay the buyers’ closing costs and homeowner’s association fees for a year.

“I’ll have a small profit … but less than I thought,” says Epstein, who’s through with real estate investing.

Thousands of real estate investors across the country are saying the same thing. Investors bought about one out of every four homes sold last year, according to the National Association of Realtors. They focused on the hottest markets, such as California, Florida, Arizona and Nevada – the very markets that are now feeling the sharpest reversals of fortune.

“We’re nervous about what’s going on in the market,” says David Kloth, a doctor in Danbury, Conn., who started a real estate development firm with a lawyer a few years ago in hopes of one day changing jobs. They put down deposits on three luxury condos in Las Vegas that will be completed in November. Their hope is to flip them for a profit of 25% to 30%.

“We’ve got two months to close” on the property, says Kloth, 44. “Until we sell, who knows? I don’t think we’ll lose money, but we won’t make as much as we thought.”

The sharp drop in sales suggests that real estate speculators have fled the market, says Edward Leamer, director of the UCLA Anderson Forecast, a national economic prognosticator. Yet the fact that prices remain stubbornly high in most markets shows that many investors are still holding onto their properties with dreams of making a profit.

“It’s different from the stock markets,” Leamer says. “When things get bad, there’s a mad dash for the door, and prices can drop rapidly.

“In the home market, the investors, rather than rushing for the door, are holding onto homes imagining the market will turn around.”

It reminds him of the last real estate bust in California. “In the late ’80s, here in California, you couldn’t go to a cocktail party without somebody admiring their own intelligence about the latest home they just bought,” he recalls. Then, in the ’90s, deep layoffs in the aerospace and defense industries sent the market into a tailspin.

“What happened in California is a good lesson” for investors. Leamer says. “We had speculators out of the market for at least a decade.”

Flippers make money, but profits shrinking
Some investors are already bailing out. The number of homes for sale in the USA has hit a record. That bulging inventory both makes it hard for homeowners to sell and creates eye-catching bargains for buyers.

In Las Vegas, for example, the market was infested with real estate flippers during the recent real estate heyday. Roughly one out of every 10 homes sold there over the past five years was owned for just nine months or less, according to HomeSmartReports.com.

Now, in new neighborhoods in the Summerlin area of Las Vegas, about 40% of the single-family homes for sale are vacant, says Bruce Hiatt, owner of Luxury Realty Group. “It’s higher than we expected,” he says.

Homes that were selling for $535,000 last year are going for $460,000 today.

“It’s shocking to see, in a year’s time, the price’s ability to come down,” Hiatt says.

Falling prices have also hurt the traditional buyers who bought their homes with plans to live there and build equity the old-fashioned way. The sliding prices have made life miserable, too, for developers who are trying to sell the last homes in a project. To compete with investors on price, more builders have resorted to offers of free kitchen upgrades, landscaping, swimming pools and the like.

Despite the cut-throat competition, flippers remain active in Las Vegas. About 6% of the homes sold in the gambling mecca from April to June had been owned for nine months or less. That put Las Vegas in seventh place for flipping activity in the second quarter.

Nationally, the level of real estate flipping declined to 4.7% in the quarter, down from a high of 6.4% in the first quarter of 2005.

Those estimates would be even higher, but they include only homes owned for nine months or less. In reality, many investors buy during the construction phase (when developers offer the best deals to generate a buzz) and wait a year or two for the project to be completed before selling.

In the second quarter, flippers who lost money lost a median sum of about $39,000, according to the study. Gainers, on the other hand, made a median of $42,500 – illustrating that it’s still possible for quick-turn investors to make money in soggy real estate markets.

Other highlights from the second quarter:

• Ocala, Fla., and Hagerstown, Md., tied for the most flipped properties, 6.7% of home sales.

• In Truckee, Calif., about 15 miles north of Lake Tahoe, 67% of flippers lost money on their sales, the largest percentage of any metro area. Last winter’s snowfall was nearly 40 feet, which may have caused some investors to think twice about the market.

• Flippers in Gainesville, Fla., lost the most money, a median of $63,948. Florida had three of the top four biggest median losers in the country. Gainesville, situated in the north-central part of the state, holds less appeal for investors than do coastal cities in Florida.

• Flippers in Napa Valley, Calif., made the most money: $85,400. The fact that Napa is a small area and a premier wine destination helps explain the big gains.

Since the beginning of 2000, far more flippers have made money than lost money. But even in a frenzied market, amid bidding wars and escalation clauses in contracts, it’s easy for some people to lose money – a lot of money – by flipping real estate.

“In all but four of the last 23 quarters, the flippers who lost money lost a greater amount than the flippers who made money,” says Mike Ela, president of HomeSmartReports.com, which studies flipping trends and other factors to evaluate the stability of local real estate markets.

“We’re bombarded with ‘Get Rich Through Real Estate’ ads and infomercials that promise get-rich-quick opportunities,” Ela says. “So much work needs to go into proper research to buy and sell.”

Part of the art of investing in real estate is being able to ride the cycles. One way of making a big return on your money is to put down as little cash as possible. But then, should you have to hang on to your property through a downturn, you might have to watch your monthly mortgage drain away your profit.

“Buy the best location and have holding power, and you’ll never lose,” says Seth Okun, 50, a podiatrist in Tampa who has investment properties in Florida, New York and Nevada.

In 2004, he put down the first deposit on a unit in the MGM Grand Residences in Las Vegas, and he closed on the condo this summer for a total of $630,000. “I have it up for sale, but I’m not under any pressure. … If somebody wants to pay the ($815,888) price for the MGM Grand Residences, fine. Otherwise, I’ll keep it.”

Sweat-equity can pay off

One of the most reliable ways to make money in real estate has been to add value to a property. Put some sweat-equity into the property by remodeling or repairing the home or landscape.

Page Musgrove, a 33-year-old bicycle mechanic in San Diego, has bought and sold several homes since 1999. He bought a duplex last September for $560,000, fixed it up and flipped it in April for $655,000.

He looks for homes that need work or have moisture problems. “I look for mold,” he says. “That’s my best friend. It will drop the price.”

Musgrove puts the savings toward remodeling the bathroom, kitchen and yard but spends “no more than $40,000” on each property. He favors properties with tenants and rents that will cover the mortgage.

But Musgrove is done flipping in San Diego, where home prices are now falling and there’s nearly a nine-month supply of single-family homes for sale.

“I don’t trust the California market anymore,” he says.

Posted by Steve
10 years ago
Steve

Steve is a Real Estate Blogger, Husband and Dad, UT Austin Grad, Runner, Real Estate Broker and owner of Crossland Team and Crossland Real Estate in Austin TX.

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john - 10 years ago

It’s interesting how you post all of these different articles, but not the one in the New York Times that talks about how more and more home buyers are rebelling against the price-fixing real estate industry. This is the article I’m talking about – it specifically mentions, as I have in past postings with you, how the 6% custom is not in the consumer’s best economic interest and only benefits those few real estate agents that are the top in the field.
http://www.nytimes.com/2006/09/03/business/yourmoney/03real.html?ex=1159329600&en=6dbbe8548d7ddf9f&ei=5070

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Steve - 10 years ago

Hi John,

Thanks for your comments.

The NYT article is more of the same anti-Realtor stuff. I did post the Wall Street Journal article more than a year ago that says the same thing. http://crosslandteam.com/blog/2005/08/15/wall-street-journal-delivers-scathing-attack-on-real-estate-commissions/

If you search past blog articles you’ll find several discussions of Discount Realtors and the issue of commissions. I believe consumers have more choices and options today than they ever have before and I simply disagree with what the opponents of the current compensation system try to hold forth.

I’m curious, and I have a few questions for you or anyone else who would care to respond:

1) If you wanted to sell your home today, in what way are your choices limited with regard to the commission structure or level of service available to you in the Realtor marketplace?

2) What product is it that you want to purchase from a Realtor and at what price? (within reason – i.e. nobody will list and sell your home for $100) In other words, what is your perception of the amount of income needed to carry on a successful and profitable real estate business such that the practitioner can thrive and remain in the business for more than 15 years, as we have?

2) Do you believe the government should tell me what I can charge for the services I provide, or should that be dictated by market forces, my level of experience, competition from other agents, and ultimately, the decision made by the Seller or Buyer who hires me?

Steve

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bill - 10 years ago

I want a full service agent that I can use who’s willing to sell my house and provide a decent service (but I will be equally involved to reduce his work load) at 3% of total selling price. That is, he and the buyer’s agent will each gets 1.5% each. Let’s assume that my house is going to be sold at 300,000. Both him (seller’s agent) and buyer’s agent will get $4,500 each.

For how much work? Well, listing it on MLS, hosting a couple of open house sessions, giving me some pointers on how to get the house dressed up, and at last, when the contract is in, he will be responsible to help me prep the documentations. I guess if you add all his work together, it’s about 40 hours of total working time, and that translate sinto about $112/hr of wage. He will pay his due to his agency, but I think the agency shouldn’t ask him for more than half a percent ($1500). Even after broker share, he still has about $75/hr. wage level. I think it’s pretty high already.

I don’t care if some hot agent who can sell million dollar houses in a heart beat. He can charge 10% or even 20% of the selling price if he’s that good. That’s how some hot shot lawyers charge their clients. Even with high fees, they still got plenty clients.

Let the agents compete. Starter/juior agents should charge less than senior agents. Government doesn’t have to step in, as long as the real estate trade associations let the market decides the commission level, rather than a rigid 6% rule with full service agents.

Again, the key is fairness and reward of hard work. I am not jealous of those high power attorneys or real estate agents. I am mad that those imcompetent agents that make pretty much the same amount of commission while wasting my time.

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Jim - 10 years ago

Bill,

We already had this discussion. Even a top performing agent selling a good number of homes a year will only make average income selling at 1% or 1.5%.

An average income in real estate is not good enough, because it’s a very unstable job. It’s a business, and people expect to be rewarded with an above average income. That’s why all those 1% realty companies go through hundreds of agents a year. People burn out and go somewhere where you can make a decent living. It’s a matter of supply and demand. YES, commissions are negotiable, but NO, they’re not negotiable below a certain point. I for one will NOT work for anyone below 3%. However, I will give discounts to repeat clients or very good friends.

End of story. People bitch and moan about this for years, but the fact remains that the majority of folks realize this is a tough job and that’s why realtor commissions haven’t really gone down much.

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Jim - 10 years ago

Btw, all the anti-commission BS is being stirred by the online companies like Zillow and various discount brokers. Why? Because they are trying to sell you a competing service which is inferior. Discount listing agents are not there when you need to close the deal, so the buyers agent has to work twice as hard, which is why a lot of them boycott those listings. I wouldn’t do that, but I’ve had the misfortune of working with a listing from Texas Discount Realty. Same old crap, the listing agent is nowhere to be found.

And Zillow, those companies sell you on very useless and inaccurate home assesments so you give them their name and #, which they turn around and sell as a lead to a realtor so you can get a “more accurate” evaluation. The commission crap is all a marketing ploy by some companies to win over business.

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Jim - 10 years ago

>

Really, just 40 hours. How about the hours of prospecting and talking on the phone with “clients” who waste your time asking questions but never sign the listing agreement. How about the hours driving showing properties to people who never buy?

How about, Bill, your boss at work only pays you at the end of the month, and only if he decides your work is good enough? What if you wake up in the morning not knowing where your next paycheck is coming from?

I currently do 2 deals a month, my first year in business, and about $200k house. It takes ALOT of work to get here, and I’m only making $90k a year or so. Imagine if I got 1% instead and only made $30k? Would I be motivated to stay in this business. Try working as a realtor, Bill, and you’ll see.

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bill - 10 years ago

Jim, calm down. You can explain explain explain, I don’t care. No matter how “hard” this business is, it’s a business, it should follow the free market rules. This means, the magic hidden hand of market will decide how your labor should be compensated, not a strict 6% set and ENFORCED by a trade organization. What business is NOT hard, anyways? A healthy discussion should not be called “bitching”. Keep charging your 6%, I am not trying to get the government to lower your commission one bit. I have said, if you want to charge 20%, be my guest. Some lawyers do that, and they still drive Bentley and marry hot women their grand daughter’s age.

I just want to find an agent who charges less and doing just as good if not better job as yours. That’s what competition is all about. I end up saving money, the agent get paid according to the quality and amount of work he’s done. That’s all. Simple logic, and yet some 6% people just don’t want to get it.

Jim, your rhetoric is getting old. Really.

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Steve - 10 years ago

Hi Bill and Jim,

I appreciate your lively participation in the Crossland Team Blog, though you sometimes cause me to worry about how to maintain civility while still keeping an open forum. Please be kind and respectful to one another. 🙂

I think one of the toughest things to understand about the perceived value of anything we pay for in life is that the amount paid doesn’t always seem to match the effort or outcome we observe. Since a lot of the effort put forth by a Realtor is uncompensated, the gap has to be made up on paying customers, or “done deals”.

For every “easy” deal that a Buyer or Seller may think we got (where it looks like our efforts are disproportionately small compared to the money we earned), there can be 2 or 3 that were very difficult to complete, or that we worked hard on for months, only see see it all fall apart at the end due to circumstances beyond our control.

Steve

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bill - 10 years ago

“For every “easy” deal that a Buyer or Seller may think we got (where it looks like our efforts are disproportionately small compared to the money we earned), there can be 2 or 3 that were very difficult to complete…”

Steve, I perfectly understand the unevenness of the real estate deals. Some folks don’t do their own homework and cause tremendous hassles to all the parties involved. Some deals are much more complex than some others. That’s exactly why the 6% cross the board commission is not fair. These more troublesome customers ought to pay more because they used more services. By the same token, if I am such a good seller/buyer, I did much of the prep works myself and I made the entire process smooth and efficient, why should I be penalized for some other incompetent sellers/buyers pitfalls?

“…though you sometimes cause me to worry about how to maintain civility while still keeping an open forum”

I almost never attacked Jim directly, nor did I ever make any uncivil remarks. However, I respect that this is your blog and you are the owner of this domain. So I apologize for your concern. I will refrain myself from making comments from this point forward.

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Steve - 10 years ago

> These more troublesome customers ought to pay more because they used more services.

But the more “toublesome” customers are difficult to identify prior to entering into a listing or buyer rep contract, so it would be hard to tell someone “geez, you seem to me like you’re going to be tough to deal with so I’m going to have to charge you extra”. Or “you seem like such nice people, I’m going to be able to sell your home for less than my usual fee”.

There is no way that could work and it would open the door to potential problems, such as being accused of discrimination. Now, if an agent wants to let his or her fee be determined by the negotiating skill of the client prospect, that’s up to that agent to decide.

And I don’t like to think of any customer as being “troublesome”. Every customer is an opportunity for an agent to help someone and to provide the best service they can. Not every buyer will purchase a home. That doesn’t make them troublesome, or a waste of time. We know that about 70% of all buyers that sign a Buyer Rep Agreement with us eventually buy a home. The other 30% are just as appreciated and valued because at least they gave us an opportunity to help them. People change their minds and that’s ok.

> I will refrain myself from making comments from this point forward.
I hope you’ll reconsider.

Steve

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john - 10 years ago

Why not bill by the hour then. This 6% across the board charge is monopoly pricing and price-fixing. If you don’t understand that, then you don’t understand plain economics. Bill is right and I just think you real estate agents are either too blind to simple economics or you just want to try and uphold the price-fixing environment as long as you can. It is very simple – like every other service industry – charge market prices for the service (amount or quality of) delivered and charge accordingly. Let various service providers compete. It doesn’t matter that real estate is “hard”? What kind of argument is that? Show me a job or industry that isin’t “hard” and you can make any money at, and I’ll say it doesn’t last like that for long or the industry has government protection of some kind.

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Jim - 10 years ago

John and others that claim price fixing: where are you getting this from? There is NO price fixing. You are welcome to use a 1% broker, or a flat fee MLS broker, or even negotiate with a full service borker. Most are willing to give some discounts to you if you do several deals with them.

The law of economics here is telling you that most agents can’t make a decent living unless they charge on average about 3% a deal. If I figured out a way to sell 300 homes a year by myself by working reasonable hours then I’d consider doing it at 1%, but that’s impossible. But that’s unlikely, so 3% is what allows me to make a confortable living, and I’m not budging from this fee. go use discount brokers if you want, but don’t complain about poor service. You DO have a choice.

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Paul Skellenger - 9 years ago

I have no problem paying a good commission to an agent who brings me a buyer and my net is where I want it. The point is, how much should I (the seller) pay you (the agent) to bring me a buyer and I net x dollars. To me, the equation should look more like a graduated commission where seller and agent both win. Agents may be able to the charge a rate for their expertise when a sale does not happen.

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Paul - 9 years ago

Interesting topic. Running a successful real estate business takes hours of work and a significant amount of money. When the real estate market was good, everybody was an expert. What I’ve noticed with discount firms is they spend more money advertising low commissions then the homes they are selling. What most people fail to realize is that the discount brokerages have set up their business to list as many homes as possible simply to attract buyers so they can sell other listings and receive 3% commissions from the sellers who are paying full price. Anybody who has been in real estate should know that listings are the key to attracting more business and that is precisely the business model of the discount firms that I know of. Anyways — I don’t know of any home seller that can’t use a discount brokerage, I think the real complaint is why full service agencies do not offer all of their services at discount prices. HMMMM… our Brokerage spends tens of thousands of dollars on advertising our actual clients homes and the discount brokerage spends thousands of dollars telling you how much money you can save if you list your home with them. Good Luck in a Buyers Market.

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