Flip, Hold or Fold?

Ryan Hartman works for a company that has been investing in foreclosures in Southern California since 1975 but recently decided to exit the residential market because of the region’s slumping home prices. Now the company is hastily unloading its inventory of rental properties — most of them purchased as foreclosures.

“We didn’t flip. We held, and we don’t like to be in markets where there isn’t appreciation,” said Hartman, adding that he is still considering a foreclosure purchase for a personal residence. “We’re looking around maybe for our own use. But not for investing purposes.

“The guys who are flipping, they can make some money,” he conceded.

But in areas of the country where home prices have risen more slowly and steadily over the past five years, and soaring home prices haven’t driven monthly mortgage payments far above average rental rates, foreclosure investors have a different perspective.

“Right now the market is slowing down,” said Craig Rhodes, a North Carolina investor who has purchased and resold four foreclosure properties in the last two years. “The next two, just looking at the market, I will purchase with the purpose of renting out. And then once the market turns around I may sell. It’s just like the stock market, you buy when you can buy low and sell when you can sell high.”

Frank Corpuz owns a rental property in Las Vegas, but he’s leery about purchasing another because of the disparity between average monthly mortgage payments and rental rates. The city’s home prices have skyrocketed more than 100 percent over the past five years, but were down on a quarterly and annual basis in the first quarter of 2007, according to Freddie Mac’s Conventional Mortgage Home Price Index.

“It’s a buyer’s market, yes. You can buy it very, very cheap. You can go through the banks and buy it,” he said. “But try to get it rented at a decent amount and that’s another issue. That’s another headache.”

Corpuz thinks the abundance of foreclosures in Las Vegas — which had the nation’s fourth highest metro foreclosure rate in May, according to RealtyTrac — will drive home prices there down to a more reasonable level by the end of the year. He blames overly greedy flippers for contributing to the sharp housing downturn in the city.

“Your strategy (should be) to rent it right away and not flip it. You can’t do that here in Las Vegas because people are not buying,” he said. “This is the place to buy, then just hold it for five years or so. That’s when your money is going to be made. You have to hold it. Not flip.”

But Southern California real estate guru Bruce Norris believes buying and holding is not the best strategy in his market, which also has seen price appreciation fizzle recently after doubling and tripling in the past five years.

“Buying and holding will someday make sense again in California. If it were me, the only way I would buy and hold a property in California right now is if I wanted to keep the property for a very long time and it already cash flowed from the very start,” he said.

Norris believes that a flood of foreclosure inventory in California will force banks to begin lowering prices en masse by the end of 2007, and he points to evidence that is already beginning to happen.

“These lenders are about to drop prices and put a lot of inventory on ‘sale,'” he said. “When they do, California investors will be back in business.”

According to Norris, California investors won’t need to wait until the market hits bottom — he’s estimating that will be around 2011 — to start profiting from foreclosures. He said investors should “learn to buy ‘wholesale’ and create a margin of equity by closing a transaction in 10 days when the normal marketing time is 10 months.”

“During the last downturn, between 1991 and 1997, the best deals for investors came from buying lender-owned properties and short sales,” he added.  

Hartman, the Southern California investor who is exiting the foreclosure market, also compared the current housing climate to the mid 1990s, when there were “a bunch of properties in foreclosure and no equity.” His advice for prospective foreclosure investors: “Don’t buy before the (trustee’s) sale. If you’ve got cash, do it at the sale. … You’re not going to get the deal before the sale because the owners are so loaded” with debt.

“”If you get a foreclosure with an 80-20 loan, you might be able to get in there if you knock out the second,” he continued, agreeing with Norris that bank-owned properties may soon translate into bargain buys. “I don’t think the bank’s inventory is high enough to start a fire sale right now. … But it’s coming.”

Chicago-based real estate investor, trainer and author Doug Crowe said that both fix-and-flip and buy-and-hold strategies are viable in the current housing market.

“Buying and flipping a property can work. It works especially well in a market where values are rising,” he said. “With the slowing market in most areas of the country, it is still possible to make a profit by this strategy.

Buying and holding, however, creates a larger margin for error and a significant opportunity for wealth creation,” he continued. “Talk to any investor with gray hair and you’ll learn that the majority of their wealth came from buying and holding for the long term.”

Crowe cautioned that both strategies — fix-and-flip and buy-and-hold — require investors to engage in careful evaluation of each prospective deal. For fix-and-flip, he recommends building “loads of margin” into deals, especially in cooling markets where home prices are declining and the average time to sell is increasing. To come up with a maximum offer amount, flippers have traditionally used the simple formula of subtracting 30 percent, plus projected rehab costs, from the estimated “after-repair value” of the home. But that formula is changing in some markets, according to Crowe.

“With slight dips in home values and market times measured in months, not days, savvy investors are adding even more margin to their calculations, some not buying any property that isn’t at least 50 percent of the ARV,” he said.

Although investors who plan to buy and hold may not have to find such deep discounts upfront, they should still not ever pay full market value, according to Crowe, who said that every deal should give the investor instant equity from the start. Crowe also advised investors to carefully calculate monthly carrying costs and rental rates to make sure a prospective investment will bring in a positive cash flow.

Miami investor Harry Andrade is new to foreclosure investing, but he recently found a condo in foreclosure and was able to purchase it 20 percent below market value — giving him about $70,000 in instant equity. That margin may have been too thin had he planned to flip the property and try to resell it in the languishing Miami market. But his strategy is to buy and hold, at least for the near future.

“It’s a much better strategy simply because it’s a buyer’s market today and not a seller’s market,” said Andrade, noting that he already has a renter in the condo and is able to charge enough rent to cover his monthly carrying costs. He is continuing to mine the foreclosure market for more rental properties and already has another promising deal in the works.

If they do their homework, buy-and-hold investors like Andrade will come out ahead in the long run, according to Crowe.

“Landlords enjoy many more financial benefits over ‘flippers’ or anyone who simply buys and sells. As a landlord, you enjoy leveraged appreciation.  In many cases, buying, fixing, refinancing, and holding creates a situation where an investor has zero cash into the deal, after refinancing,” Crowe said. “With an appreciating asset, tax write-offs galore, and the ability to control the investment, any proactive landlord should realize measurable wealth into the millions of dollars in a handful of years.” 

Buying low is the common denominator that makes almost any investment strategy work. So whether investors plan to flip, hold or temporarily fold their real estate operation, they’re always on the lookout for a good deal.

“Right now I’m kind of taking it easy and just watching the market,” said Corpuz, the Las Vegas investor who said he scans RealtyTrac’s foreclosure list every day. “If I see something exceptional I might go get it.”

Buy and Hold Checklist

  • Right price? Profits are made when you buy and realized when you sell.  Make sure the property has some equity when you close
  • Positive cash flow? Honestly your expenses and income.  Plug in vacancy, management and reserves to ensure you can carry the all the property’s debt and expenses.
  • Upside potential? Buying in the path of progress naturally and fairly increases property value and equity. You reap the rewards of low supply and high demand.
  • Easy fixes? Look for simple improvements that will allow you to increase rents, while decreasing expenses and vacancy rates. 
  • Target market? Concentrating your investments in a geographic location makes for scalable management and less stress for you.

Source: Doug Crowe, host of “The Real Estate Coach” weekly radio talk show.

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