Beware of the Flip

Before the Great Recession of 2008, housing prices climbed dramatically, and homes sold faster than buyers could gush, “I love that spa bathroom.” Contractors and even handy DIYers got in on the uptick by buying fixer-uppers and improving them in the quickest ways possible, selling them, and reaping the profits. Enter the real estate phenomenon of flipping.

The trend waned a bit as the housing market hit the skids, but then returned with some significant differences. Today’s flippers are more often professional investors with access to cash as banks tightened mortgage loan guidelines and available work crews, says Seth Captain, managing broker of Captain Realty in Chicago.

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A new generation of house flippers is facing losses from properties that are taking too long to sell.

But now, Captain notes changes: “Low inventory and many buyers’ eagerness for new construction and remodeled homes has caused some buyers not to do enough checking,” at least in Chicago, he says. And some buyers don’t insist on an inspection if sellers won’t permit it as a contingency, adds Frank Lesh, owner of Home Sweet Home Inspection Company in Indian Head Park, Ill., and executive director of the American Society of Home Inspectors (ASHI), a national organization based in Des Plaines, Ill.

Your job is to guide buyers through this rough terrain. The first thing to do with a remodel is to look at the public record and see when the property your buyers are interested in last changed hands. If it’s less than a year ago, the property may require a more thorough examination. While not every flip represents a potential landmine, you can help clients by asking for information about who completed the work, says broker Mark Ferguson with Pro Realty Inc. in North Greeley, Colo. Ferguson, also a real estate investor and blogger at InvestFourMore, says most problems arise with work done by DIY owner-flippers, who lack the skills of licensed contractors.

Here are more ways you can be an advocate for buyers who plan to purchase a house that’s being flipped. Many of the caveats reflect the same type of thoroughness that should be undertaken with any sale.

1. See it yourself

Don’t buy at auction or without seeing a house in person, says Eric Workman, senior vice president of marketing at Chicago-based Renovo Financial, a private lender. Buyers should inspect the structure so they see firsthand if visible problems exist that may be red flags for deeper trouble. This is the first step before they call in experts.

2. Learn the history of a home

Workman suggests asking officials in your community and real estate salespeople if they know how long a home may have been vacant. The number of seasons a property goes through while being empty of occupants can help predict whether its plumbing and other mechanical systems may have been neglected or damaged.

One of the most important reasons to trace a home’s lineage is that if no one has lived in the remodeled house yet, it’s hard to know how well the systems work, Captain says. “There may never have been a heavy rain to know if the home’s drainage system will stand up, or if termites are chewing away at support joists and not visible,” he says. He suggests buyers ask for names of others who’ve bought from the same flipper to learn how well their houses have fared over time.

A buyer can also request to see the permits that the flipper pulled to perform work, especially important in cases where the floor plan was changed or a load-bearing wall was removed, Ferguson says. Or, if mold was a problem, a buyer can ask if the work was done by someone licensed to handle mold remediation, he says. They can also check the area’s Better Business Bureau to see if complaints or lawsuits have been brought against the seller by a prior buyer or real estate commission.

3. Understand the flipping process

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Mark Ferguson, a real estate broker at Pro Realty Inc. in Greeley, Colo., cautions wannabe flippers about the difficulty of making a sizable profit. “You may see flippers on TV shows appear to make a lot of money, but it is extremely rare to make $100,000 or even $50,000 unless you are dealing in high-value, high-risk properties.” Most shows leave out the costs associated with a flip such as financing, real estate sales commissions, closing costs, homeowners’ insurance, property maintenance, taxes, and possibly homeowners’ association dues. These additional costs can be 15 to 20 percent of the sales price. “A $100,000 profit on TV may only be a $50,000 profit in real life,” he says. Ferguson, an experienced flipper, has found his average profit ranges between $20,000 and $40,000 on a purchase that cost him between $75,000 and $150,000. In addition, many buyers don’t understand the time frame, he says. “It can often take me six months or more to sell a flip once I buy it,” he says. But it may be worth it if you’re motivated by more than money, he adds: “It can be fun, done on a part-time basis if you do the repairs yourself, and you can make money with realistic ideas of costs and profit margins.”

Because a flipper’s goal is to make a profit in a relatively short period, many changes are cosmetic, such as refinishing hardwood floors and painting kitchen cabinets. Captain notes flippers often replace countertops, appliances, and fixtures in what tend to be buyers’ favorite rooms: the kitchen and bathrooms. They may forgo fixing the more expensive, time-consuming, and less visible problems. For example, a rotted subfloor may be deemed not worth fixing if it’s underneath gleaming boards, and dated plumbing may be left as long as faucets work and water pressure seems okay, Captain says: “They don’t want to kill the deal, but won’t go above and beyond. They also know that most buyers reach a point where they want to be done looking and are happy to focus just on what’s new and pretty.”

4. Hire a certified home inspector

Even if the flipper says the home was preinspected, advise buyers to bring in their own expert to avoid surprises later. But even home inspectors can miss signs of problems beyond the surface, Lesh says. “Perhaps water wasn’t run long enough during the inspection to find out that pipes hidden behind newly tiled walls are corroded,” he says. A good inspector will follow up on possible trouble spots — say, a wall that sounds hollow and may be lacking solid backer board and studs — with requests for more information. “We might ask, ‘What’s going on here?’ We won’t rip off the wall, but will request receipts to show work was done properly.”

Inspection fees typically vary by a home’s price, size, and age. Lesh charges between $650 and $700 for a 15-year-old $500,000 house. Cultivate a list of inspectors you trust, and give it to buyers so they can choose the one they want to work with.

5. Bring in additional specialists

Certain systems warrant calling in a skilled expert. Glen Gallas, vice president of operations for the Mr. Rooter franchise based in Waco, Tex., advises having a plumbing inspection even if all seems perfect. “With today’s technology, a licensed plumber can do a video camera inspection of the main sewer line to see if there are mechanical defects in the pipe, which most home inspectors don’t see,” he says. “There might be a small leak in the line from roots growing, but it could take several seasons for them to be large enough to cause problems, and that could be long after the purchase. By then, [repairs would] also be more expensive,” he says. An average plumbing inspection ranges from $150 to $400.

In the case of electrical work, a new junction box may suggest all’s well, but that doesn’t mean wiring was brought up to code, says Keith Pinkerton, owner of a Mr. Electric franchise in Huntsville, Ala. “Houses built in the late 1960s and early ’70s often were wired with aluminum, which was outlawed, and copper was required. But some might not know because they’re behind walls. We pull off the panel cover and look,” he says.

Some buyers may be content waiting to hire an expert only if the general home inspector picks up on problems such as foundation cracks that could reflect structural defects. At that point, a structural engineer can determine the seriousness of the problem. And many home owners find that it helps to bring in a structural engineer in cases where a house is very old since more problems may lurk beneath floors, below floors, between walls, and above ceilings.

6. Avoid legal glitches

Before buyers sign on the dotted line, be sure a lawyer has checked that there are no legal problems with the transfer of ownership, advises Alan Doran, executive vice president and general counsel with OneTitle National Guaranty in New York. All kinds of issues may arise when buying a property that has been flipped, he warns: “For example, if sellers acquired a property through a short sale, they need to obtain detailed information on the short sale to ensure that both transactions comply with state regulations and the original lender’s short-sale requirements,” Doran says. There may also be a requirement that the flipper owned the property for a minimum amount of time before selling, and proofs of payment of liens must be verified, he says.

With all this information in hand, your buyers can decide whether a flip is still worth buying, particularly if the seller won’t deduct estimated repair costs or fix problems. But, as Captain notes, if a flip passes muster, it may be just as desirable as any other purchase: “What difference does it make if a flipper made money in a short time if the buyer finds a wonderful home?”