Flipping homes in a down market

Peter Coy at Business Week's Hot Property is wondering whether Flipping is still a good business.


Here's the news Peter: Flipping, well executed, can indeed still be a great opportunity, even in this market. (When we say "flip" we'll generally mean fixer-uppers where the investor adds value by improving the property. This is different from pure speculative flipping where you just buy and hold for a few months because the market is roaring. I'm a huge fan of the former and don't have nearly the huevos required to participate in the latter.)

Consider these stats and some simple math that we measured this week for the Palo Alto real estate market:

• The median price per square foot is over $800.
• A diligent fix-and-flipper can knock down some walls, add square footage at maybe $300 per. In a few months you can literally double your investment with some room to cushion against market risk.
• Properties at the low end of the market in Palo Alto this week are around $1 million and about 45 years old. These are your fix-and-flip candidates depending of course on lots of variables, like neighborhood.
• We classify about 8% of the properties on the market in Palo Alto this week as Flips.

So this is a no-brainer right? Not so fast. In a market like Palo Alto, your primary challenge is that a zillion spec developers know these economics already and they're likely to beat you to the property. The best opportunities are gone in a flash, even in this market. (Maybe especially in this market.) In most markets of course the opportunity is less evident because prices are closer to construction costs.

We look at other factors too, for example, what percentage of a property values in a local market is tied to the lot size (which you're stuck with)? Look further south in Morgan Hill and you'll notice that price per square foot is just over $400. Still room to profit. However, is there room to take a bottom of the market property, improve it, and sell it as top-of-the-market prices?

You can get into a property in Morgan Hill for around $650k. The top quartile of homes for sale in Morgan Hill are $1.5 million. Notice though that the lot size in Morgan Hill is a compelling influence on the price. Flipping opportunities in Morgan Hill are significantly more scarce than Palo Alto.

How long can it last?

In fact the gaping difference between construction costs and sales prices is one of the most compelling arguments supporting the Housing Bubble. In many areas it is still incredibly profitable to build. Economic nature abhors an arbitrage gap. So build we shall, until the gap is no more. Either prices fall or construction costs rise. Or Both.

We're confident that the value of the fix and flip will always be an important part of the real estate cycle though profitability of the the flip may ebb and flow. What we know for sure is that there continue to be flip opportunities to the diligent, the clever, and the lucky.