People have been buying run down and dilapidated things, then fixing them up and reselling them for a profit for as long as there have been things that break. It has now taken on a style of it’s own when it comes to real estate. Some people might argue that flippers are just investors who take away supply from other potential buyers. But I can tell you from experience, that the majority of people who are in a position to buy a home they plan to live in prefer to have the home at least 90% complete and up to their standards before they move into it. The people who are ok with a home that requires a ton of work, or has been used as a hoarder home, or is a century home that’s half falling apart, are almost exclusively investors who are then competing with other investors. I think that investors and home flippers are doing a service by purchasing homes that no one else is willing to go near, then turning them into something that is liveable and will appeal to the mass market. If they make some money along the way, more power to them. Capitalism at work. Obviously, it has become clear that relying solely on the private market to manage the housing of an entire country is not the most ideal strategy, there are flaws in every system. That’s a discussion for another day.
For todays discussion I’ll focus on how flipping homes works and some things to consider if this sounds interesting to you. Firstly, you need to have a reasonable level of confidence in your abilities or your contractors abilities if you go the route of purchasing a run down home. With home prices where they are now in Toronto and the surrounding area, even a very poorly maintained home can fetch an absurd price because of the land value and other factors. If the move-in ready home is “only” 100,000 more, most people find it a very reasonable trade-off to pay a tad bit more and avoid the hassle of renovations. That leaves a select few people who are willing to pay the high price and take on the risk of doing renovations with the hope of possibly making some money on the sale. Over time as more and more people have learned about home flipping and the real estate market becomes more efficient, the “gaps” in the market become smaller and smaller which makes it more difficult to make a profit as an investor. You pile on a serious supply demand imbalance due to population and other factors and you find yourself in a bizarre situation where people will pay a premium just to simply get ANY home, regardless of condition. This is not an ideal market dynamic in my opinion for investors or end users.
When is a good time to flip homes?
People say that you can’t time the market, while there is some truth to this, I believe that you can absolutely make educated guesses about where the market will likely be headed. Let’s take a look at some recent examples. If you were considering flipping homes from 2020 to 2022 it would have been a good time to do so because the Bank of Canada cut interest rates at the fastest pace in recent history to prop up a potentially failing economy, and alongside the fed they effectively saved the stock market form complete collapse. This led to significant appreciation one year later. Real estate generally lags behind the stock market, and prices take a bit more time to move. But seeing the unprecedentedly low interest rates at which you could borrow money, locking in a 5-year fixed mortgage was a no brainer at the time. Even if your renovation took 1-2 years, with money being so unbelievably cheap, and so few people willing to put their homes on the market, it doesn’t take a rocket scientist to see how that equation would lead to increasing prices. After the development of a vaccine it provided people with the confidence they needed to be around others again and provided a visible pathway to the end of the pandemic. Around this time in late 2020 early 2021 all the stars were really aligning and they were pointing at the fact that the real estate market was going to get a little bit crazy.
Not every shockwave of the pandemic lockdowns could have been predicted. For example, tradespeople became very challenging to find, and this made home renovation projects more expensive and extended their timelines quite a lot. This is where having some backup plans for any risky investment is always a good idea. In the case of the covid real estate market, being willing to do some of the work yourself would have been a very useful backup plan if you were a home flipper as well as planning ahead and being flexible with the materials you used, since it was nearly impossible to find certain items in stores. A good majority of home renovations can be done DIY with YouTube and a small time investment you can learn how to do pretty much anything nowadays. I would only recommend the DIY strategy if you are willing to put a significant time investment into the home, and have some amount of prior experience, because even though it might be quick to learn it can take a lot of time to complete. It’s also important to factor in the carrying costs into your profitability equation and to budget at least 1.5x the amount of time you think it will take you to finish a project, and even then expect it might take longer than that. Hofstadter’s law states that a project always takes longer than expected, even when the law is taken into account. The best way to ensure that you come out ahead is to use a very conservative equation to manage your costs while also baking in some profit as a buffer.
Purchasing in a depreciating market on the other hand can lead to losing money on the renovation, which is why I like to recommend investors have multiple workable strategies for each investment. You can actually come out ahead by making an educated guess during a falling market as to where you think the bottom or near bottom might be. If you take this approach you need to have multiple strategies and be willing to weather a storm if it turns out you were wrong. If you were banking on the appreciating to get you out of a flip profitability and it doesn’t happen there are a few other options. For example you could turn the property into a long-term or short-term rental, you could get creative with the renovation by including a basement suite to turn the property into two units instead of one, which generally increases your potential rent and final sale price. If you do use the rental method as a backup, it’s important to understand that you will likely be leaving equity in the property which might prevent you from doing another deal in the short term and you also have to be ok with the risks and responsibilities of being a landlord. Making sure that a property has multiple workable strategies is very important to prevent you from completely losing your shirt, especially if it’s your first investment and if you’re unsure what the market will do in the short to medium term. It is also important to actively try and avoid risk. With the amount of information out there today it doesn’t take a genius to figure out that eventually the gravy train of appreciation in 2021 was going to come to an end. The actual end date was up for discussion at the time and I think many people assumed the fed and BoC would increase rates sooner than they actually did. This is where being cautious comes into play. It can be hard to think clearly when you get swept up in the FOMO of real estate news stories talking about people making crazy amounts of money. Getting swept up in the hype and not understanding your own risk tolerance (i.e. how you’ll feel deep down if you happen to lose the majority or all of your investment) is often what leads people to making mistakes and losing money. Ensuring that you are thinking clearly, understanding your own tolerance for risk (there’s nothing wrong with the slow and steady approach), and making sure than an investment will work on multiple levels are all great ways to hedge your bets as an investor.
What does the flipping market look like today?
In our current market there are still opportunities to renovate homes and be profitable, you just have to be more certain about your purchase + improvements price than maybe you needed to be in 2020. I’d consider our current market stable with respect to prices and appreciation. The next move from the Bank of Canada is largely anticipated to be an interest rate cut. So if you buy today I would say there is a reasonable probability that interest rates are lower a year from now which means that prices at the very least are likely to stay stable and more likely to appreciate a small amount from today. Don’t expect anything crazy, but if you buy at a great price there is still room out there to make money as an investor. I would say the biggest difference in this market is that carrying costs have increase significantly thanks to the increased mortgage rates. This means that if your project goes over time, it can cause a significant dent in your profitability. So I would highly recommend being even more conservative with timelines or baking in a higher percentage of profitability to make sure that you still come out ahead.
Many professional investors use various marketing strategies to find off-market properties to purchase (i.e. properties that are not listed on the MLS). A common one is sending out mail to houses in a particular area and offering a quick closing to a distressed home owner. There are companies out there who “wholesale” homes. Basically signing a contract with someone with the option to assign the contract to another person, or even with the option to list their home on the MLS. Sometimes these companies will act unethically and a homeowner will sign something without understanding that there is an option to assign in the contract or that this person will be listing their home and doing showings. Without saying too much on this topic, I want to make it clear that I find this approach to business deplorable. Honesty is extremely important with whoever you are doing business with even if that is the only time you will do business with that person. Your reputation is everything, so if you promise a potential homeowner something the expectation is that you follow through with the promise. There are people who wholesale homes and run their business in a very honest and upfront fashion, I have absolutely no problem with that if the homeowner knows all the facts and decides that is their best option. As a homeowner it is important that you read the contract you are signing, and ask around your network for a trusted lawyer to look at the contract if you are doing an off market transaction. To be blunt a big reason people end up working with Realtors is because it is their full-time job to make sure they have your back, and if they mess up you have someone to blame (and sue). But if you’re doing everything yourself you don’t have the level of regulation, expertise, or insurance that Realtors have in order to protect consumers when dealing with what is usually their largest asset. Of course you can just as well come across an unethical Realtor who is only looking out for themselves and does a poor job looking out for you. But at the very least you have some amount of recourse and consumer protections when working with them.
That was a bit of a tangent so let me wrap up here by discussing how to increase the chances of an investment working out. As I mentioned above, trying to find off market deals can be a serious win when it comes to purchasing a property at a great price. There are a myriad of strategies to find people who are willing to sell, whether that’s flyers, door hangers, door knocking and pitching your proposition to them, online marketing methods, networking with friends, family and co-workers. You do have to be somewhat cautious if/when you do find someone willing to sell and I would recommend asking the homeowners if they would be opposed to a home inspection or at the very least doing an inspection yourself. Sometimes the homeowner might be willing to sell you the home, but doesn’t want to have strangers coming through their home. This does make it a bit more challenging from the investors perspective and if you choose to go through with a purchase you have to be ready for pretty much any problem on the books since you couldn’t get an inspector in to see the property. Depending on how many properties you’ve invested in before or how much experience you have with home building or home inspection you may have enough personal expertise or a friend whom you really trust that can give you a reasonable idea of the condition of the home and if it’s worth offering something to the homeowner.
This is again where risk tolerance comes in, making sure your profitability equation bakes in some of these risks, and preparing multiple viable strategies for the end use of the home (e.g. flip, rent, wholesale). You can find potential homes on the MLS to purchase as well, many investors are quite successful through simply purchasing homes that are on the market and negotiating a strategy that works for them. If you are looking for a deal on a publicly listed home here are some tips. First, look for homes that have been on the market for a long time or have been badly mispriced. Beyond 30-60 days is when sellers tend to realize they may have mispriced their home and this can open them up to negotiations.
Second, find out what the sellers situation is. This is where I would recommend getting a Realtor you trust and are willing to work with to call up the listing agent and try to get as much information as they can about the sellers reason for selling, urgency, and what types of things would make the seller more likely to accept an offer or what kinds of offers they might consider. For example, maybe they have to close by a certain date due to starting a new job. Maybe they will only sell if there is a firm cash offer and are just “testing the market” (these types are generally very hard to negotiate with, since they have no urgency and only care about getting their price). Maybe they are willing to consider a Seller-Financing mortgage at a lower rate than the banks can give you. This can serve as an annuity for the seller (e.g. monthly income) and allows you to give them the final higher price they are looking for since the financing could be cheaper than the banks offerings. You would have to coordinate with your agent and have them work with the listing agent to call up a lawyer and write up a contract for the seller to become a lender. The seller would likely be well advised to do some due diligence on your ability to pay the loan, as well as including the usual provisions in a mortgage such as the right to repossess the home if you default. This can be a challenge to pull off, but working with the right partners can make it a possibility. The seller might be ok with an extended closing which gives you time to find more funds or research development or rezoning opportunities that add more value to the property than a simple renovation thereby making the deal possible.
Lastly, the seller might even be willing to come in as a joint venture partner (if you have a proven track record) and allow you to renovate the home while retaining most of the equity and provide a 50/50 split on any profits made on the renovation and sale of the home beyond a certain price after factoring in costs. As you can see there are almost limitless ways to structure an investment that works for both the buyer and the seller, much of it depends on your risk tolerance, skill set, and your team. Which brings me to my final point, regardless of the approach you take it’s important to assemble a team of people that you trust in order to be successful in your investing endeavours, that includes people such as a real estate agent, mortgage broker, lawyer, home inspector, city planner, and various tradespeople that you trust. Having a strong team of advisors can make or break an investment, especially when dealing with one that has so many moving parts. I would highly recommend if you are thinking of getting into real estate as an investment and are considering any of the more complicated strategies that you find an investor who has done what you are thinking about doing and see if they are willing to spend some time talking with you about their experience. Research online, listen to investing podcasts, and most importantly just get started. You can easily overwhelm yourself with information and prepare until your eyes bleed out but nothing beats real world experience. Be prepared that it may not go completely as planned, start small with something just outside your comfort zone then build on your experiences and improve each time.
Hope that you found this information useful or interesting, feel free to leave a comment with your thoughts on this topic. I’ll see you back here in two weeks with another post.
All the best,
Oliver Foote