Tuesday, October 29, 2019

Should You Buy A Flipped House? (Revisited)

Should you buy a flipped house?  It depends...

House flipping is all the rage, at least on television.  For some reason, people like to watch home improvement shows, often rather than improving their own homes.  And people love to watch the property twins remodel a house - among a plethora of others as well.   It seems every channel, even ESPN, has a house-flipping show these days.

What is a flipped house?  Well, in my definition, it is a distressed or outdated property that was bought for below market value, and then remodeled to bring it up to modern tastes and standards, and then re-sold within a short period of time.

Ideally, if you are a house-flipper, you want to unload the house within a year or so.   You may have a high-interest loan with the bank, and every day it sits on the market, you are making less money and making more interest payments to the bank.   It is not a risk-free enterprise, no matter how easy the television makes it look.   Markets can go down, and costs can escalate.  You may overpay for the home and overestimate what it will sell for.  You could lose your shirt - or maybe make a few thousand or tens of thousands of dollars.   And despite what the television shows, it is a lot of work - not just picking out tile and countertop colors.

And the best way to make money by flipping a house is to do some work yourself - if you have the skills.   If you went to work for someone as a painter, for example, they might pay you $15 an hour, and you'd have to pay income tax and social security tax on that.   If you hired a painter, they might charge $30 an hour - or more, which while that is deductible, is an expense you have to pay.  If you paint a room yourself, your labor is essentially free, and the money you make (or save by not paying a painter) is taxable as a capital gain - which you might not even have to pay, if you roll over the equity in the house to a new investment property in a Starker deferred exchange.

House flipping is not for everyone - it is a risk-taking venture, and you have to be prepared to do some work yourself, or have a list of inexpensive contractors you can trust and use to do much of the work.   It also pays to incorporate as a business, so you can have access to wholesale pricing on materials and supplies.

House flipping, in theory, is an example of wealth creation.  You are taking a raw material (a house) and adding materials and labor to produce a product (remodeled house) that is worth more than the sum of the parts.   In theory, at least, that is how it should work.  In reality, it is hard to do.  As I noted in should you remodel or move? the problem with remodeling is that in terms of cost per square foot, it is costlier in many instances than building anew.  Remodeling a bathroom, for example, can be more time-consuming than simply building a new one in new construction.   In a new house, you don't have to work with existing plumbing, electrical, sheetrock, etc. - and you don't have to worry about hidden nightmares presenting themselves and increasing your costs.

But as a home buyer, should you buy a flipped house?  Yes and no.  There are some issues you should be aware of.
1. Corners may be cut:   In order to eke out a profit, the flipper will hire the cheapest labor (often illegal aliens picked up at the local 7-11, or at least that was the way it was done, back in the day).  The flipper hires contractors he knows work fast and cheap, and they may do a job that looks good but down the road may cause problems. 
2.  Lots of Cosmetics:  Selling a house is a matter of curb appeal and wow factor.  If you throw some shrubs on the lawn (often literally, as I noted before) and toss some grass seed around (realtor grass, they call it), put in granite countertops and stainless steel appliances, the buyers will swoon over your house and make an offer over asking.   But things like a new furnace, replacement windows, or a new roof, might be neglected. 
3.  Overpaying:  The house that sold for $250,000 a year ago at an estate sale, is now listed for $400,00 after $80,000 of renovations have been done.   Is this a good deal for you?   Arguably it would be better for you to buy the $250,000 house, and over time, do these repairs and upgrades.  If you can so some of the work yourself, so much the better.   But then again, see my comment about remodeling.
What brought this up is that we are in phase II (out of III) of our flooring and painting project.  The person we bought the house from had it in the rental pool for decades, and it was pretty worn out.  They did a lot of upgrades, and a lot of cosmetic "wow factor" improvements as well - such as raising the ceilings in the dining/living room and the master suite (which they created from two bedrooms).   And while they did put in new appliances (except the refrigerator, which we had to buy) and a new roof and A/C unit, 13 years later, these things are starting to wear out.

The roof was clearly a 15-year shingle job, as it is showing signs of wear, and perhaps a tiny leak.   The A/C unit was installed haphazardly, using existing refrigerant lines running underground often underwater when it rained.   It was not the most expensive A/C unit available, of course.   The windows - single pane wood windows - were merely sanded and painted.   We ended up replacing them with vinyl replacement windows, which reduced the amount of noise and dust, as well as saving considerably on our electric bill.   Replacement windows aren't glamorous, but nevertheless, more important than glitzy things.

I am also re-doing the bathroom toilet closet walls (again).   I replaced the toilet flange, which was installed improperly and cracked.  The sheetrocking on the walls was horrific - lots of seams and a corner gobbed with caulk, which wasn't that noticeable until we repainted the toilet closet with a semi-gloss paint, which showed every defect.   All of the trim had been painted flat white, which we think now was intended as a primer.  It attracted dirt like velcro.   After 13 years, of course, you generally have to repaint a house, but the paint job the flippers did, was, well, quick.

The toilet closet exhaust fan was installed poorly - venting to the attic, not outside, which I will have to fix.  Insulation is missing from the ceiling in the closet, which means it is always warm in the toilet closet in the summer.   I removed the bathroom exhaust fan and was chagrined to see that they installed the housing and then sprayed the ceiling with knock-down, not bothering to mask the housing.  As a result, the entire interior of the fan was filled with plaster.  Fortunately, it washed out, so I can at least re-use the exhaust fan.  By the way, you should take the cover off these and vacuum them once a year or so - they get filled with dust bunnies - gross!

The exhaust fan was tacked to a rafter with two screws, crooked, and the hole they cut was too large, meaning the fan was sucking in air from the attic as well as the bathroom.   It also meant that if you looked closely, you could see through into the attic on the far side of the fan (I didn't notice this for several years).   So I had to reinforce the hole and insert strips of sheetrock and knockdown the ceiling to match - now the hole is a square 9.75" x 9.75" instead of a crooked 12" x 11".   I will cut a hole in the soffit and install a vent to the outside, next.

Stupid stuff, to be sure, and it only took a few hours of plastering and sanding and working to fix it.  Now I have to repaint the room as well.   But this is the kind of stuff that might cause your house to fail a home inspection, so it pays to fix these things - you never know when you want to sell your house.

The flooring in the house was redone with engineered hardwood, which I wrote about before.  Not expensive engineered hardwood, either, and after 13 years, it is showing its age, with scratches, dents, and water stains where the dog's dish used to be (I weep softly as I walk by).  I have some extra pieces, and I can repair parts of it.  But engineered hardwood in a kitchen is never a good idea - use tile.

Speaking of tile, that is the new trendy thing these days.  And houses shouldn't be trendy - they cost too much to be style statements.  When we bought the house, 13 years ago, engineered hardwood floors and oatmeal walls were a thing.  Corian countertops were already going out of style, and white appliances were, well, dated.  Today, it is plank tile that looks like wood, gray walls, and granite countertops - and stainless appliances.   So these trendy makeovers are nice and all, but bear in mind that the hot look of today is yesterday's news in a hurry.  The gray paint we are putting up today is probably already dated.   Should have gone with purple - that's the next big thing!  (Just kidding).

While the main part of the house was engineered hardwood, they skimped in the bedrooms with carpet so cheap it looked like a wrinkled terrycloth bathrobe, or perhaps some sort of carpet padding. Replacing it with newer carpet would have been a cheap upgrade, but we got a deal on an entire pallet of engineered hardwood flooring, and it does look nice when finished.  In a humid, mildew-prone environment with lots of allergens, carpet is just a bad idea.   No wonder tile is so popular in the South - particularly in Florida.  Survives a flood, too!

I noted before, when we re-did the laundry room, that the pipes in these houses go through the slab - and after 50 years, they are likely to leak or burst.  So far, we have not had to replace them yet.  But when I re-did the laundry room, I made provision for access to the attic to run new pipes there.  It will involve some sheetrock work in some rooms, when the time comes.   Again, something structural and functional and fundamental, but no "wow" factor in new plumbing, is there?   There is a fancy, useless bathtub, of course, that we have used only once.   It is a laundry hamper and dust collector.  We may remove it and install a roll-in handicapped shower instead - something that older people can actually use.

Speaking of laundry room, well, I already covered that nightmare.  A lot of sketchy plumbing and downright unsafe electrical work, covered over with paneling.  It looked great, and now it is great - but only after months of backbreaking work.   And the ceiling in the garage - what kind of paint did they spray on there?  I ended up re-sheetrocking the ceiling, entirely.

And the sewer line seems to be working well - for the time being, at least.  Regular roto-rooting (and putting dollar tree Drano down the drain occasionally - it kills tree roots, supposedly) seems to keep it all flowing.

And the electric panel - I didn't realize the Federal-Pacific panels were such fire hazards.  Again, something that would spike a home inspection, if we hadn't fixed it.  But $1000 later, we have a nice Square-D box, with lots of extra spaces for additional breakers for future use.  Of course, I had to replace the service drop as well - unexpectedly.

The list goes on and on.  There are structural things that will need to be replaced that the house-flipper didn't address because such items don't add to the wow factor or resale value.  The driveway, for example, was cracked and now is even more cracked.  That will be an issue, now, as a potential buyer might balk at it.  And those "brand new" appliances that were installed before we bought the house?  Well, that was 13 years ago, and already we've replaced the disposal, the ice maker, and the washer and dryer.

Are we unhappy with the house?  No, not at all.  We knew going in that a lot of the improvements were superficial in nature, and that as with any home, repairs and maintenance were a regular thing.  In fact, you can schedule this stuff, like clockwork, about ever 15 years or so - roofs, HVAC units, hot water heaters, appliances, flooring, paint jobs, etc.  Houses are not like anvils!  They require constant work to keep them from going back to nature.

Should you buy a flipped house?  That depends on a lot of factors, including the house itself, and the price, above all else.  In a heated market, you might end up bidding against other people - and the chance to consider the house carefully might not be in the cards.  But in a normal market, a home inspection is a good idea, if you are not familiar with how houses are put together.  Pay attention to the structural things and basic systems.  Fancy appliances and trendy treatments are fine and all, but they don't cost much and can be installed in a day. Things like foundations, roofs, plumbing, electrical systems, and the like, are often more costly and difficult to repair - and affect your bottom line a lot more than paint color.

Say you are looking at two comparable houses.  The first one is being sold by an owner/occupier who has maintained it for many years.  It has a new or newer roof, plumbing, electrical, replacement windows, HVAC, and a new concrete driveway.  But the appliances are white and the countertops are Formica and the wall colors are not to your liking.  The second house - a flipped house - has new countertops and appliances, and a fresh coat of paint, and is painted in trendy colors.  But the second house has older plumbing, electrical, roof, a cracked driveway and a leaky foundation.   Which is the better value?   It all depends on price, of course, but in general, the "flipped" house probably commands a higher price, as it has better curb appeal (those throw-away plants that will be dead in a year) and wow factor.   Some people pay extra for this.

You can replace the appliances in the first house (and you will have to, down the road, anyway).  Granite countertops - if that's your thing - are not as expensive as  you might imagine.  Paint can be done in a weekend - by yourself, or a painter.  These are superficial things, easy to change, inexpensive to fix.

Like I said, it depends on a number of factors - price being the biggest one.  And some flipped houses may have many of these structural items replaced, particularly if it was an entire gut-and-remodel job.  Others, well, less so.   Here on our island, two flipped houses were sold recently.  Both were redone and looked like showplaces, with all the trendy colors and appliances and countertops and bathroom vanities and tile flooring.  Walls were removed to give that modern "open" look.   But within a few months of sale, the new owners of each house had a dumpster in their driveways.   The first house needed replacement windows and a new guest bath.  The second a new roof and windows.  The new owners, far from getting a "turn key" solution, bought a fixer-upper, instead.

You can dress up a pig, but it's still a pig!