Passively flipping houses out of state does not work
Passively flipping houses out of state does not work.
This is a pretty bold statement. Is it true? Yes it is.
In real estate like anything else, I am sure that there are going to be exceptions to the rule, but in general the answer is usually going to be that passively flipping houses out of state does not work.
Let's first look at what I mean by passive. Let me tell you a story about an investor who we will call "Greg". Greg grew up in a town that we will call "Cleveland".
- Greg has lots of ties to Cleveland. Greg has invested in real estate in the past. He knows real estate agents, general contractors, laborers, plumbers, roofers, painters, and electricians.
- Greg moved across the country for a new job. He still keeps up with the Cleveland real estate market and stays in touch with all of his Cleveland contacts.
- When Greg sees a good deal, he has his agent take a look at it for him. If the agent thinks it's promising Greg will then arrange so that his contractors can take a look at the house and give him a estimate for the work that needs done. Greg then has his agent assist him in buying the house. He then has his contactors perform the work on the house. Then lastly he has his agent sell the house for him and he makes a profit.
Is Greg flipping houses out of state? Yes he is.
Is he passively flipping houses out of state? No not he is not.
Putting this deal together is like putting together a puzzle. Every team member is a different piece of the puzzle. The agent is one piece. The plumber is another. As are the general contractor, electrician, roofer, painter, and laborers.
Greg has to take all of the pieces and put them together in order to complete the puzzle.
Now that we have heard Greg's story, lets talk about another investor's story. We will call this investor "Frank".
Frank also lives across the country from Cleveland. Frank has always wanted to flip houses but he doesn't have the experience to go it alone. Frank wants to partner with another investor to have them show him the ropes. Frank can't afford to flip where he lives as his neighborhood is to expensive. He has read online that Cleveland has really cheap houses. He decides to research turnkey operators who can flip houses for him in Cleveland.
Frank reaches out to a local Cleveland real estate brokerage that builds rental property portfolios for out of state investors. They are a brokerage that also has contractors on staff with the ability to handle repairs and renovations. We will call the owner of this brokerage "Roger".
Frank explains to Roger that he would like to flip houses. Frank is looking to purchase a house that has an ARV of $180k. He will only be interested in properties that meet the 70% rule.
Wait slow down there Roger. What the heck is the 70% rule?
The 70% rule is an investment strategy where as the house flippers max offer is 70% of the ARV minus the repair costs.
Frank also wants Roger to handle the all the renovations for him seeing as Roger has a renovation company as well.
So with the information in hand Roger knows that in order for this to work, he will need to find Frank a property with numbers similar to this:
- ARV: $180,000.00
- Repairs: $30,000.00
- Purchase price: $96,000.00
- Gross profit before closing costs: $54,000.00
- Roger's commission when Frank purchased the property: $2,880.00
- Roger's commission when Frank sold the property: $5,400.00
- Frank's gross profit after Roger's selling commission: $48,600.00
Note, There are closing and holding costs as well. These have not been accounted for in this example.
Now looking at those numbers Frank is pretty excited. He wants Roger to get started right away, so that he can make his $48,600.00. Frank tells Roger that he will continue to use Roger's services and would like to flip 10 houses a year.
Roger then explains to Frank that unfortunately this is not going to be a feasible strategy.
Roger explains to Frank that deals like this are rare. In the event that Roger did find one of these deals, he would be doing all the work. He had to locate the deal, rehab the deal, and then sell the deal. There would really be no need for Franks involvement.
If Roger is doing $48,600.00 worth of work then there is no reason for him to give that to Frank and only get paid $5,400.00 by Frank for his efforts.
Frank is confused by this. Frank was under the impression that Roger and his company do this for rental property investors all of the time. What is the difference between this and a rental property rehab?
Why would a real estate agent or company be able to pass rental property deals to out of state investors but not flips?
Does this mean that all of the rental properties are terrible deals?
Here is the difference.
When you are investing in rental properties money is finite not infinite. Roger is unable to purchase every property he comes across and keep it as a rental. His pockets, much like everyone else, (except maybe Warren Buffet or Bill Gates) just are not deep enough.
He can buy properties but his capital will be tied up in the properties he purchases. Eventually he will run out of capital.
When it comes to flipping though, the money and the profit is pulled back out of the deal in short order. It is ready to be used almost immediately for the next deal. Money also changes from finite to infinite if the deal is good enough. Even if Roger, or any other local, did not have the money available at that time to purchase it. With the numbers being as good as they are he would simply contact a hard money source to fund the deal.
Of course this capital would have a cost to it, but it will always be there if the deal is this good.
For these reasons Frank will never be able to find a quality contact on the ground in Cleveland to flip houses for him. Anyone with the wherewithal to put together all of the puzzle pieces will have done the deal themselves.
Sure there may be people offering to do this for Frank, but it's not because they are nicer than Roger. It is because they don't know any better or are not smart or sophisticated enough to understand that they are doing themselves a gigantic disservice.
Would Frank be in a good position with an investment of over $100,000.00 across the country with a person who is not smart or sophisticated enough to realize they left almost $50,000.00 on the table?
OF COURSE NOT!
This is why passively flipping houses out of state does not work.
About the author:
James Wise is the Broker and Owner of The Holton Wise Property Group, a real estate brokerage and property management company operating one of the largest scattered site rental property portfolios in the greater Cleveland, Ohio area. He has been a guest speaker on several real estate internet radio shows and podcasts. He regularly writes blogs and articles for multiple real estate related websites. He is an active member of the National Association of Realtors® and the Akron Cleveland Association of Realtors®.