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A sun-room in a home on Overlook Drive that was bought by HomeVestors to resell.

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The art of the flip

When real-estate investor Crawford K. McDonald takes on a new property, there's almost always an affecting story about the homeowner's reason to sell. McDonald specializes in a niche market of real estate that uses cash offers and quick turnarounds to buy residential homes that can be easily flipped to use as rentals or resold for a profit.

In many cases, owners have inherited a house they don't want, or they can't afford the repairs necessary to sell for top dollar, or they simply need fast cash. "There are as many reasons as there are houses," says McDonald, of ECM Real Estate, which works primarily in Chattanooga and North Georgia.

Sometimes, the better story is about the life of the house, like the historic residence McDonald bought that contained a player piano and red velvet curtains, among other atypical amenities.

"I told my friend I'd bought this older home that had been used as a brothel. He said, 'Back in the 1800s?' and I said, 'No, back in February.'"

Left-behind finds are not uncommon for house flippers, who are often dealing with homes or homeowners — or both — in distress. There can be a lot of literal and emotional baggage to unload as the sale goes through.

Often it's a secondary property an owner is trying to sell, but McDonald says he has bought the occasional primary residence. One client, who'd always dreamed of living in Alaska, showed up to get his check with his car stuffed full of belongings.

"Picking up the check was literally his last stop," says McDonald. "He was getting money to start his new life."

Chattanooga investor Mark Kessel says the promise of fast freedom likewise leads clients to his company, HomeVestors, a national network of real-estate franchises known by the tagline "We Buy Ugly Houses."

Kessel says the deal is not for every homeowner, but the arrangement has advantages for some. Investors like Kessel make no-obligation offers on the spot for a house "as is," meaning the homeowner is not obligated to make whatever repairs may be needed. "They don't even need to clean it," Kessel says.

The seller pays no closing costs or Realtor listing fees, and they get paid in cash, typically within a week.

If it sounds like a win-win proposition, it can be: A homeowner unloads an unwanted property; an investor buys low and sells higher.

But there are caveats, says Grace Frank of Grace Frank Group with Real Estate Partners Chattanooga.

"In a strong [housing] market like this, if a seller goes out and gets pricing evaluations from a real-estate agent or gets an appraisal, they're going to see the wholesaler is undervaluing where the market is considerably," says Frank, who works with investors from across the country on real-estate investments in Chattanooga. "That's what a wholesaler wants to do, buy at 30 to 40 percent under market value so they can turn around and make a profit. That's their whole strategy."

Unless a seller is in a distressed situation and has to get out quickly, Frank says the seller will almost always do better by selling the property to the end user.

The Wall Street Journal recently reported that house flipping is back to nearly the same level it was around the 2006 peak of the housing boom, "when it became a symbol of the rampant speculation that soared before the bubble burst."

The difference now, according to trend analysts from CoreLogic Inc., is that most of the current flips are less risky than those more than a decade ago. These days, "short-term investors [are] focusing more on adding value than speculating on prices," writes Ralph McLaughlin in a CoreLogic special report.

According to CoreLogic data, by the fourth quarter of 2018, the flipping rate in the U.S. reached 10.9% of all home sales — the fourth-highest rate since the company started keeping track in 2002.

Another study found a higher rate of home flips in Chattanooga than the country as a whole. In the first quarter of 2019, ATTOM Data Solutions estimates 8.8% of sales were in flipped homes in metropolitan Chattanooga, compared to 7.2% nationwide. In the first three months of 2019, 167 homes were flipped in Chattanooga, according to estimates by the property database.

 

Benefit and risks of "flipping"

The business model for buying a house, fixing it up and reselling it for a profit can be lucrative for investors. But the rewards today are being driven not by rampant speculation but through remodeling and updating older homes. CoreLogic's research shows that the profitability of house flipping, while down from peak levels, is still far greater than in the period that led to the burst of the housing bubble more than a decade ago.

The profitability of house flipping peaked in 2011 at almost 40%, according to CoreLogic. Current rates have fallen by half since that peak, though the 20% percent range is still double to triple the profitability experienced by flippers in the pre-housing-bubble days of the early to mid-2000s.

"Back in the day, you could easily hit those numbers [40% profitability]," says Randy Shelley, of First Property Management in Chattanooga. "Now there's so much competition and there's a much shorter supply."

When the housing bubble burst, "there were so many foreclosures that hit the market," Shelley says. "Foreclosures are at a 20-year low right now."

In a strong [housing] market like this, if a seller goes out and gets pricing evaluations from a real-estate agent or gets an appraisal, they're going to see the wholesaler is undervaluing where the market is considerably. That's what a wholesaler wants to do, buy at 30 to 40 percent under market value so they can turn around and make a profit. That's their whole strategy.

While home flippers can bring in more profit with each sale, he says, "it's harder to find a lot of houses."

For those looking to break into the business, analysts caution about the so-called HGTV effect, in which investors enter the market because TV makes flipping appear relatively easy.

Kessel recently bought a house in Brainerd from a disillusioned first-time flipper who lives in Maryville, Tennessee. The woman had purchased new kitchen cabinets and laminate flooring and hired a contractor, who had completed part of the work, but all of it inferior, Kessel says. Once the contractor got paid, he was gone.

"My offer was going to be less than what she paid for it," he says. "I didn't know what she paid for it, but I knew what it was going to take from me."

At that point, though, the homeowner "just wanted out," Kessel says.

 

Assessing home conditions

Still, there are homes Kessel won't accept, sometimes because it's a bad deal for him, sometimes because it's a bad deal for the homeowner.

When the situation warrants, "we actually try to talk people out of our service," Kessel says. "It's not going to be the best service for everybody. I certainly don't want to take advantage of anybody. We are discount home buyers. Where we are helpful is for someone who is trying get out from under property quickly. They don't want the hassles [of selling]. They don't want the real-estate fees. We offer a flat price, and we pay all the closing costs."

Kessel says he tries to make sure "when the call first comes in" that the potential seller fully understands how the deal works "so they don't waste our time and we don't waste their time."

"It's a very emotional business," adds McDonald. "Homes are such a personal item."

Often homeowners are surprised, even insulted, that they're not being offered the full market value of their house. But that's not how the business works.

Kessel says a distressed property may need tens of thousands of dollars of repairs to make it suitable for selling in today's market. Sometimes updates are all that's needed; sometimes he'll change the whole floor plan to modernize the space. It's just a matter of finding the sweet spot in the cost-benefit analysis, no matter what he originally paid for the house.

McDonald says his typical outlay to purchase a house falls within the $20,000 to $25,000 range, though he has paid as little as $500 and as much as $80,000. The latter was in a gated community.

"There was a dispute over a will, lots of infighting in the family and they were just ready to be done with it," he says.

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