Flip for Big Cash? Simple as 1,2,3… 03/09/12

I was having coffee again this week with some associates that I do a little work for from time to time and the discussion of market rate for a particular unit size in a particular area came up. Now, as a buyer’s advocate, my idea of what something is worth and what a selling agent thinks its worth are two very different things. I tend to build market instability and urgent resale options in to a price where they will talk about demonstrated growth and upswinging markets. Somewhere between the two views sits the truth and when we get there, in most cases, a deal is done.

This discussion wasn’t about doing a deal though. It was more about qualifying if a deal that had been done was any good. Let me explain. This associate had just penned 15 off the plan contracts for 15 separate apartments to one buyer, at what appeared to be 60% of their projected market value. In anyone’s terms 15 purchases in one hit is a big number, irrespective of the value represented. At the end of the day you have to settle all 15 contracts and banks and lenders get a little jittery when you pull stunts like this.

The thing is this associate has no intention of keeping all 15. Sure they intend to settle the contracts when the properties become available, however by the time the settlement happens they have every intention of having unloaded the properties on to the next buyer at a profit. This is commonly referred to as a “flip” in the property market and happens more often than you think. Let me give you an example.

You buy a 2 bedroom apartment for $200,000, that is valued at $300,000, and leave a very small deposit, say $5000. The property will take 12 months to be built so you have to fund the $5000 deposit for that time at 10 % interest. So it costs you $500 for the year. You then advertise the unit for sale off the plan 6 months later at $275,000, letting all of the buyer’s know that it is valued at $300,000. Someone decides saving $25,000 is a good thing and a deal is done. The property then comes through to settlement time and you and the second purchaser settle the property on the same day. You pay stamp duty and settlement costs, however because the purchase was really early off the plan, your costs total about $3000. So effectively you have spent $3500, and made$75,000. That’s about $71,500 profit, in 12 months, without having to get a loan or approach a bank or pay a mortgage.

Now, the first question I get here is why would a builder sell a unit for 60% of its value? This might happen if you bought 15 of them at once and he had 150 to sell before a bank would give him the money for the project. So if you bought 15, and it cost you $52,500 to service the deposits and settle the stamp duties and costs, you would stand to make approximately $1,072,500 gross in 12 months without ever really going to a bank for a house loan.

It sounds really easy, however the thing to remember with ALL real estate methodology is, the greater the reward, the greater the risk. It is ALWAYS a risk reward balance. With this situation, what if you don’t sell all the properties in time? What if the market shifts and the properties are valued at what you paid for them or, heaven forbid, less! When you sign a contract of sale, you are responsible and liable to settle the property for the agreed sum. If you fail to do so you lose your deposit and the seller can sue you for the difference between what they sell it for and what you promised to pay.

The reality of the flip is that in most cases the “discount” may only be as good as 10-15%. You would then factor in capital growth and the added dollars a project brings when a buyer can actually “touch” a property closer to finish. This may really only give you a 20% buffer. However if it pays off 20% of $500,000 is $100,000 and that’s a year’s wage to most. Get it wrong and you stand to lose that at a minimum, and it has the capacity to take your other investments with it. There is a time in the market to play this game, knowing when, as with all things, is the difference between success and failure, and this one is all about timing.  As always, negotiate hard, but fair. Have fun and buy well.

Garry McPherson

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