Some experience but first flip questions

12 Replies

so I own a couple long term rental properties but I am working with a partner in my first flip.  Are experienced flippers borrowing money to buy and renovate the properties?  I'm in a situation where I have money or could borrow and I'm struggling to see the benefits of borrowing cash for this process.. Isn't one of the biggest dangers and expenses the potential to not sell in the time frame you planned for and end up paying high interest on borrowed money?  Besides underestimating your repair costs or overestimating your sale price, is this not the biggest danger?  If someone has the cash to do it without borrowing are there any good reasons to borrow?  Especially being new to flips it seems using cash helps give some wiggle room for other mistakes?

Borrowing works if you price it into the deal. Means you have to get better deals. Borrowing always adds risk but also increases the cash-on-cash return. I've got 12 flips going on here in Seattle and our goal is to do 100 next year. Borrowing from hard money lenders I believe is the way to go and I'll tell you why from my perspective.

I actually have cash but prefer to buy cash flow rentals, tax lien certificates and life insurance with the cash. The problem with flipping is the taxes. You cannot 1031 or claim capital gains on a flip. Without an s-corp election, you have to pay self-employment tax on the flip. If your in a high tax bracket, the flip can put you into an even higher tax bracket.

So I take advantage of being a "real estate professional" tax designation using rental depreciation "active losses" to off-set my "active profits" from flipping. In a nutshell, I prefer to buy cash flow rentals with my cash rather than use it for flips. Just my opinion. Ask your CPA. 

For me, flipping is just a job. Cash flow properties are a better investment with cash.

It reduces your personal risk in the deal. Also another deal might come along or you might need reserves to get long term financing if you change exit strategies for some reason. It helps you build a track record with the lender. Creating a win for a private lender will build trust and help increase your likelihood of getting another loan where you don't have your own cash in future.
But you can certainly go it alone if you have the means to do so.

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Originally posted by @Ryland Taniguchi :

Borrowing works if you price it into the deal. Means you have to get better deals. Borrowing always adds risk but also increases the cash-on-cash return. I've got 12 flips going on here in Seattle and our goal is to do 100 next year. Borrowing from hard money lenders I believe is the way to go and I'll tell you why from my perspective.

I actually have cash but prefer to buy cash flow rentals, tax lien certificates and life insurance with the cash. The problem with flipping is the taxes. You cannot 1031 or claim capital gains on a flip. Without an s-corp election, you have to pay self-employment tax on the flip. If your in a high tax bracket, the flip can put you into an even higher tax bracket.

So I take advantage of being a "real estate professional" tax designation using rental depreciation "active losses" to off-set my "active profits" from flipping. In a nutshell, I prefer to buy cash flow rentals with my cash rather than use it for flips. Just my opinion. Ask your CPA. 

For me, flipping is just a job. Cash flow properties are a better investment with cash.

 I guess I'm just not understanding the thinking that cash is better used for cash flow rentals.. Granted my experience is nowhere near yours but doesn't using cash to buy rentals defeat one of the best things rentals have going for them? The fact that someone else is paying off the borrowed money for you.. If your buying your rentals in cash your losing perhaps the greatest thing about them?  It seems cash is far better used in something that returns your cash quickly like a flip than locking up cash in a rental someone else could be paying for?? What am I missing on this maybe I'm not understanding your strategy right? The taxes I can understand depending on a personal situation..

I do agree that I think I prefer the style of cash flow rentals but in my area it seems like flips are just far easier to find.. 

Originally posted by @Richard Slade :
Originally posted by @Ryland Taniguchi:

Borrowing works if you price it into the deal. Means you have to get better deals. Borrowing always adds risk but also increases the cash-on-cash return. I've got 12 flips going on here in Seattle and our goal is to do 100 next year. Borrowing from hard money lenders I believe is the way to go and I'll tell you why from my perspective.

I actually have cash but prefer to buy cash flow rentals, tax lien certificates and life insurance with the cash. The problem with flipping is the taxes. You cannot 1031 or claim capital gains on a flip. Without an s-corp election, you have to pay self-employment tax on the flip. If your in a high tax bracket, the flip can put you into an even higher tax bracket.

So I take advantage of being a "real estate professional" tax designation using rental depreciation "active losses" to off-set my "active profits" from flipping. In a nutshell, I prefer to buy cash flow rentals with my cash rather than use it for flips. Just my opinion. Ask your CPA. 

For me, flipping is just a job. Cash flow properties are a better investment with cash.

 I guess I'm just not understanding the thinking that cash is better used for cash flow rentals.. Granted my experience is nowhere near yours but doesn't using cash to buy rentals defeat one of the best things rentals have going for them? The fact that someone else is paying off the borrowed money for you.. If your buying your rentals in cash your losing perhaps the greatest thing about them?  It seems cash is far better used in something that returns your cash quickly like a flip than locking up cash in a rental someone else could be paying for?? What am I missing on this maybe I'm not understanding your strategy right? The taxes I can understand depending on a personal situation..

I do agree that I think I prefer the style of cash flow rentals but in my area it seems like flips are just far easier to find.. 

 The same logic applies to rentals as it does flips. Why use your own cash, when the property can pay for your borrowing costs. In the rental, the tenant pays for your loan. In the flip, the equity created by the improvement pays for the loan.

To clarify, I don't pay 100% cash on rentals. I use the cash as a 20% downpayment on rental property with 9% or 10% caps and 18% to 21% cash on cash with the leverage. I rarely find these numbers here in Seattle and so I've bought rentals in Phoenix, Houston, Memphis, Kansas City and Birmingham. 

We live in the same area. (Seattle) and we are in the top 10% of flippers by volume locally and I can tell you that it is very difficult to find a flip. I look at 50 deals from our internal marketing and wholesalers a couple days ago and another 40 last night and maybe there are two possible deals out of 90. I have three people helping me make 30 to 40 offers a week on the mls. We spend over $12,000 a month in marketing and have 2 negotiators working with motivated sellers. I am working with at least half of the wholesalers out there. With all this effort, we are lucky to find 1 solid flip a week. With all this effort finding deals, we only have 12 flips going right now.

I agree that flips are great for velocity of money. When we JV with private money on a deal, we look for deals that pencil out at a 25%+ IRR per six month project (50%+ annualized) for the JV partner. The returns are a lot lower however if you use 100% cash without HML or private money leverage.

I guess what I am trying to say is that Other People's Money increases your returns (while increasing your risk) in both rentals and flips.

But on flips, be careful about the taxes. According to IRS code 1221, a capital asset is something used in trade or as "inventory" in business. As a dealer status (versus an investor status), you cannot 1031 or receive capital gains status. The flip income counts as ordinary income.

If you have rentals here in Seattle, you need to make sure that flipping doesn't put you in a "dealer" status that affects your ability to 1031 or receive capital gain treatment on your rentals. This can usually easy be done through a CPA that structures your flips and rentals in separate LLCs, with your flip LLC receiving an S-corp election.

The point that I was making in the last point was why I personally don't use 100% cash in flips. Not only am I getting a lower cash-on-cash return, but under my tax circumstances I am better off using the cash (that could have been used to flip with 100% cash) as the downpayment on 18% cash-on-cash rental properties as this builds my depreciation that can be used as "active losses" to off-set my "active gains".  In addition, I can buy one flip with 100% cash or buy 8 flips using hard money or private money at a 85% loan-to-cost loan (both acquisition and rehab). If you have great velocity of money with one flip, you'll have even better velocity with 8. But again, the bottleneck is finding the deals.

I think the part of hard money that you don't like is the high interest rate at 12% and 3 pts. That's totally understandable. It doesn't have to be that expensive. We're going through the SEC/DFI paperwork now on a rule 506 private placement to raise $10 million (already have the investors) at 5.5%. The money on flips doesn't have to be that expensive. However, I will still pay 20% and 5 pts to 2nd position gap fund (private money pays for the downpayment) for flips if I can flip zero down.

Originally posted by @Richard Slade :

so I own a couple long term rental properties but I am working with a partner in my first flip.  Are experienced flippers borrowing money to buy and renovate the properties?  I'm in a situation where I have money or could borrow and I'm struggling to see the benefits of borrowing cash for this process.. Isn't one of the biggest dangers and expenses the potential to not sell in the time frame you planned for and end up paying high interest on borrowed money?  Besides underestimating your repair costs or overestimating your sale price, is this not the biggest danger?  If someone has the cash to do it without borrowing are there any good reasons to borrow?  Especially being new to flips it seems using cash helps give some wiggle room for other mistakes?

One more thing here. If a flipper is less experienced, they are less likely to know the markets as well. I know several markets well enough so I know what will sell at what price point with pretty decent predictability. The only thing you can't predict is slowdowns in the market like 2000-2001 and 2008-2009. I was flipping houses before, during and after the 2008 crash. But historically slowdowns have always come after stock market crashes and so nowadays if the stock market crashes I will sit on the sidelines (and that's when I'll wholesale all my good deals) until the volatility evens out. Some areas like Ballard, Queen Anne, Magnolia, Wallingford, Fremont, Greenlake, Bellevue, and Kirkland always remained solid for flipping even in 2008 and 2009. You just have to adjust your strategy to the market. 

I have been investing in Seattle since 2000 and have now experienced that it is easier to flip in a buyer's market like 2010 to 2013 and harder to flip in a seller's market like 2014 and 2015. 

If you stay conservative, you should underestimating your sales price and over-estimating your rehab. 

We run our projects with detailed scope of works for each of the 16 CSI divisions. I used to be a general contractor and measure every linear foot and square foot to put together a detailed scope of work. So when our subcontractor bid, they have a all the contract documents such as detailed material list with SKUs, specifications, detailed scope of work, invitation to bid instructions, etc.

@Ryland Taniguchi  how are you going to double your flip production based on your comments that one a week is hard to find?  are you going to look at other markets ?

the PDX market is much the same  uber competitive.. It dawn on me the other day that trying to do this one infill at a time was very difficult and expensive sounds like you burn thourgh 250k a year in overhead just finding your deals.

I was always being pitched smaller 2 to 5 lots deals.. and now I made up my mind to keep my minimum at 10 and preferable at 20 to 30.. now we don't get the big hits building these kind of subdivision like you can on a remodel if you smoke it on the buy

But we also spend no money on marketing.. So we have one 27 lot project going now and we can really get mass there I have 7 vertical with a very organized 2 starts a month until built out.. I have another 24 lot right behind it and am now looking for later part of 2016 deals.. plus much less competition on these deals.. Have you thought of looking at this end of the business ?

from 2002 to 2007 I was a high volume courthouse steps rehabber in PDX  we achieved the goals your trying to shoot for.. but as you state it was a ton of work.. Lending became much more productive for us in that market. 

As for tax's if your making a lot of money in the home flipping or building business your going to pay tax... the C corp gets you out of the AMT.. but you also lose your ability to get  loss carry backs.. which for me is a nice insurance policy.. Sure came in handy in 2009 through 2011  when things went so crappy for most of us who had been bigshots pre 08.

On another topic a bunch of you Seattle guys have invaded our PDX market.. I am sure yoiur aware.. and created some pretty stiff competition for the local folks.. East Side funding Vestus etc.

Originally posted by @Jay Hinrichs :

@Ryland Taniguchi  how are you going to double your flip production based on your comments that one a week is hard to find?  are you going to look at other markets ?

the PDX market is much the same  uber competitive.. It dawn on me the other day that trying to do this one infill at a time was very difficult and expensive sounds like you burn thourgh 250k a year in overhead just finding your deals.

I was always being pitched smaller 2 to 5 lots deals.. and now I made up my mind to keep my minimum at 10 and preferable at 20 to 30.. now we don't get the big hits building these kind of subdivision like you can on a remodel if you smoke it on the buy

But we also spend no money on marketing.. So we have one 27 lot project going now and we can really get mass there I have 7 vertical with a very organized 2 starts a month until built out.. I have another 24 lot right behind it and am now looking for later part of 2016 deals.. plus much less competition on these deals.. Have you thought of looking at this end of the business ?

from 2002 to 2007 I was a high volume courthouse steps rehabber in PDX  we achieved the goals your trying to shoot for.. but as you state it was a ton of work.. Lending became much more productive for us in that market. 

As for tax's if your making a lot of money in the home flipping or building business your going to pay tax... the C corp gets you out of the AMT.. but you also lose your ability to get  loss carry backs.. which for me is a nice insurance policy.. Sure came in handy in 2009 through 2011  when things went so crappy for most of us who had been bigshots pre 08.

On another topic a bunch of you Seattle guys have invaded our PDX market.. I am sure yoiur aware.. and created some pretty stiff competition for the local folks.. East Side funding Vestus etc.

My son is teething and do I was up to 5 am last night carrying him in the ergo. Took a nap around 7 pm and now I can't sleep. What is your story for being up at 3 am? LOL.

I have always been a huge 10x person (Grant Cardon) and the answer is simple. You take 10 times more action than everyone else and that's how we double our volume. My goal is to do 100 flips in 2016 and so I am ramping up. Last year, my goal as a realtor was to sell 200 homes (in my 2nd year as a realtor and people thought I was crazy) and we sold 152 homes. 

Couple strategies

1) So, we are making 30 offers a week on the MLS. I will increase to 100 offers a week. I only think there are 400 properties in King, Snohomish and Pierce that would work.

2) Plan to ramp up on our online and direct mail marketing maybe by 400%.

3) Giving 33% equity partnerships with several of the top wholesalers in town. 

4) I am already pretty much a machine on the phone. I will call wholesalers, flippers, bankruptcy attorneys, lenders, agents, etc non-stop till I find more deals. 

5) I have a radio show on real estate on 1590 am the Answer with 12,000 listeners. We were invited onto KIRO 710 am which is the same channel as the seahawks. That would get us 120,000 listeners if we do it.

Any other ideas to get more deals? 

I think I am doing what everyone else does but with ten times more effort than everyone else.

Originally posted by @Jay Hinrichs :

@Ryland Taniguchi  I am in Singapore.. just chillin before dinner... :)  off to Thailand tomorrow .. Ya know living the life I Deserve because i am a RE investor.. at least thats what the gurus tell me

Some of the best food in the world is in Thailand. Perks to investing in real estate and making it through the roller coaster. 

Traveling to another country and posting on BiggerPockets sounds like something I would do. LOL

Originally posted by @Richard Slade :
Originally posted by @Ryland Taniguchi:

Borrowing works if you price it into the deal. Means you have to get better deals. Borrowing always adds risk but also increases the cash-on-cash return. I've got 12 flips going on here in Seattle and our goal is to do 100 next year. Borrowing from hard money lenders I believe is the way to go and I'll tell you why from my perspective.

I actually have cash but prefer to buy cash flow rentals, tax lien certificates and life insurance with the cash. The problem with flipping is the taxes. You cannot 1031 or claim capital gains on a flip. Without an s-corp election, you have to pay self-employment tax on the flip. If your in a high tax bracket, the flip can put you into an even higher tax bracket.

So I take advantage of being a "real estate professional" tax designation using rental depreciation "active losses" to off-set my "active profits" from flipping. In a nutshell, I prefer to buy cash flow rentals with my cash rather than use it for flips. Just my opinion. Ask your CPA. 

For me, flipping is just a job. Cash flow properties are a better investment with cash.

 I guess I'm just not understanding the thinking that cash is better used for cash flow rentals.. Granted my experience is nowhere near yours but doesn't using cash to buy rentals defeat one of the best things rentals have going for them? The fact that someone else is paying off the borrowed money for you.. If your buying your rentals in cash your losing perhaps the greatest thing about them?  It seems cash is far better used in something that returns your cash quickly like a flip than locking up cash in a rental someone else could be paying for?? What am I missing on this maybe I'm not understanding your strategy right? The taxes I can understand depending on a personal situation..

I do agree that I think I prefer the style of cash flow rentals but in my area it seems like flips are just far easier to find.. 

You will make more more money on your flip if you don't borrow money to do it.  If you have a lot of cash sitting in savings and not producing for you otherwise, using it the flip will make your flip more profitable.  The higher return on investment through borrowing others mention are higher based on the amount of cash invested, but the 'absolute' profit on the deal will be less when you pay the borrowing cost.  

So if you won't have multiple projects in parallel or other productive uses for your excess cash while your flip is in progress, I think it makes sense to use it in the flip as opposed to sitting in your savings account, collecting nothing but dust, while you pay points to take out a 12% loan.

Cliff, his comment was to use leverage for flips (HML), cash is used for down payment to leverage with bank mortgage money to buy rentals. Hard money to leverage flips.

The math is:  to jump up cash on cash performance, ramp up passive income, so one can stop the "job" of doing transaction income tactics like flipping.  

You might as work a day job vs do flips...  Flips (or day job) to buy rentals is the smart move... In other words, the only path to financial independence is via passive income (rent). 

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