- Your profit can disappear in the time it takes to rehab and sell a home. Even if you get a property at what you think is a good value, you have to factor in all your costs. It's not just labor and materials. It's the time you hold the property. It could take months to fix up one property and find a buyer for it, and all that time you're paying mortgage interest, utilities, property tax, insurance and more. You really have to do the math.
Say you manage to pay $200,000 for a house worth $250,000. You plan to put in $10,000 worth of carpet and paint before clearing a nice profit. Not so fast. There's always more that needs to be done than you had expected, so say the rehab actually costs you $15,000. Closing costs add $12,500. Then, say it takes you six months to fix the house and find a buyer -- and each month you're paying $3,000 in expenses.The cost of flipping Selling price, once fixed:
$250,000
Purchase price:
$200,000
Gross profit:
$50,000
Expenses
Closing costs:
$12,500
Rehab:
$15,000
6 months of taxes, interest, etc.:
$18,000
Total expenses:
$45,500
Net profit:
$4,500
That's a pretty slim profit margin -- one that's completely wiped out if the previous owners trash the place. Or if there are any unknown major defects, such as a leaking roof, a severely cracked foundation or mold. Or if it takes longer than you think to rehab the house in your free time. Or if selling the house takes longer than you anticipated. Not to mention that it could take two to three times longer to complete than a traditional sale, tying up your time and money.
That's a lot of risk, and it could turn out even worse. There are other ways to invest in real estate without exposing yourself to so much risk.
- The owners or tenants may still live there. If you buy property at a foreclosure auction, you may have to be the one to evict the tenants. Do you have the stomach for that?
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- Vacant properties are a huge financial drain. Most foreclosures involve single-family homes. These homes feel like safer buys because they're what we know. But you're better off buying multifamily homes, with renters to cover the mortgage payments, taxes and utilities. "If you buy a quad, even if someone moves out, the other tenants cover your expenses," author Loftis says. "You rehab one unit at a time. You never have a property sitting empty that eats your lunch."
- The neighborhood may have underlying problems. You need to ask, "Why is this house in foreclosure?" If the owner lost his job, that's one thing. But if many jobs are being lost in the area, causing a glut of homes on the market, stay away.
- Financing a foreclosure can be complicated. At an auction, you have to bring a cashier's check for a down payment, and then you might have 24 hours to come up with the rest of the cash. Getting a traditional mortgage on a foreclosure would be extremely difficult. You would need to have different sources -- your own cash, access to trusts or hard-money lenders (which can charge exorbitant interest rates).
- You can get great deals now -- without buying foreclosures. One of the best reasons not to buy foreclosures: It's a buyer's market. Loftis recommends that you look for properties that have been on the market six months or longer. You'll find sellers who are willing to give you a good price.
Video on MSN Money
Buying at auctionHow to navigate a foreclosure auction, with CNBC's Carmen Wong Ulrich.
Still, buying a foreclosure might make sense.
If you're thinking of buying a foreclosure or pre-foreclosure for your own residence, it's an entirely different scenario. If you do your research, avoid occupied houses and never buy sight unseen, it could be worth the trouble. Georg Finder, an independent credit evaluator in Fullerton, Calif., bought a fixer-upper that way. He paid about half as much for his house as his neighbors had paid for theirs, and he used some of the savings to make cosmetic fixes. For Finder, the positives outweighed the negatives. He still lives there, 20 years later.
Published March 19, 2009
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