Flipping Houses Is Dead. Today’s Hot New Investing Strategy: ‘House Hacking’
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Declining prices, increasing interest rates, contractor shortages, and a totally unpredictable supply chain have made flipping houses a risky proposition where it’s next to impossible to make a profit. An exciting new twist on a proven investment approach called “house hacking” offers both new and experienced investors a way to continue to profit in today’s challenging market.
I recently interviewed Chris Naugle, “America’s #1 Money Mentor” about flipping houses in today’s current environment. Chris and his wife Lorissa starred in HGTV’s “Risky Builders.” To date, they have flipped over 275 houses. Before getting into real estate, Naugle was a professional snowboarder and skateboarder, he worked at a very high level on Wall Street, and now he focuses on helping people understand how money works to create financial freedom by “becoming the bank.”
Flipping houses: The truth about what really happens
Naugle’s first piece of advice is that what the TV shows is not the truth.
“When it comes to flipping, the truth is the opposite of what you see on TV,” he said. “I had a show and the really, really bad things that were happening in the background got shot down.”
The profit in a flip is in the buy
When it comes to flipping houses or almost any other type of real estate investment, where you make money is buying the property at the right price. This is the most important fundamental of real estate investing.
For any flipper, you need to find the diamond in the rough. The money in a flip is not made in the sell — it’s made on the buy, Naugle advises.
Avoid making this common mistake
In today’s market, flippers are not going to find their diamond in the rough by searching the MLS.
“If you’re flipping, you can’t be competing with homeowners or with hedge funds that are buying up the same properties you want to buy,” he said. “Instead, you have to solve a problem that is different from (the problem that) the average person looking for a house is trying to solve. You need to find people who may be losing their house or can’t list their house on the market. You must be willing to do what everyone else is unwilling to do, which is pounding the pavement to locate properties and taking the time to build relationships.”
Naugle shared that he had the most success working with estate brokers and companies, plus attorneys who handle divorces, estates and foreclosures.
“I built a relationship with estate brokers because they are selling all the belongings. Then, I would ask, ‘Do you think they want to sell the house?’ The answer was usually, yes,” Naugel said. “I would follow up by asking, ‘Would they be open for a cash offer?’ If so, I would make a really low cash offer that they would usually shoot down.
Next, he would tell the owners that he’d close in 30 days, and that they could leave all their stuff there. They didn’t have to clean it up.
“I don’t care what’s broken, I know the roof is leaking, but don’t worry about it. I’ll take care of it. I’ll take it exactly how it is, but this the best I can do from a cash standpoint,” Naugle said. “If they’re going to accept those terms, then I’m going to get my price.”
Naugle explained that the seller must decide which matters more — price or terms. They’re not going to get both in this type of situation.
The second challenge is how the market has shifted.
For the better part of 14 years, we’ve been in an appreciating bull market, Naugle said. For the first time in many people’s professional lives, we’re in a deflationary period where the price of real estate is going to start to come down.
“Although the stock market reflects what’s happening now, real estate is a lagging indicator meaning that even when the stock market is decreasing, real estate isn’t feeling the pinch yet,” he said. “If you bought a house today and took six months to renovate that house and get it ready to market, it’s possible it could have lost (as much as) 10 percent in value. So, you’re fighting the market going the wrong way.”
Supply chain, contractor and inflation issues
In addition to the prices going in the wrong direction, issues with the supply chain, locating contractors who will show up, plus high inflation rates are making it almost impossible for flippers to turn a profit. Here are Naugle’s thoughts on today’s market issues:
“You’ve got major supply problems. Good luck getting windows or a new fridge. My wife designs houses, and there’s a three-month wait to get black handles for kitchen cabinets.
“And good luck finding contractors. If you are fortunate enough to find contractors who actually show up to work and do a halfway decent job acceptable by today’s standards, and show up every day until your job’s done, be thankful. Today contractors are like ants — they’re scattered on so many jobs because there’s so much demand.
“The other thing people must understand is inflation. The Feds have done a damaging job by raising interest rates faster than they ever have in history, and at least one more rate increase is predicted. So, your dollars are getting weaker by the day, and that means they can purchase less. They (the Feds) are talking about a $2 billion to $3 billion bailout package for the banks. That puts $2 billion to $3 billion into circulation out of thin air that steals value from your current dollars again, making your dollars worth even less.”
In terms of the investor doing a flip, this means the buyer who could afford to purchase the house you’re going to flip may be unable to purchase that house six months from now.
Naugle said, when it comes to flipping in today’s market, “flippers are fighting a battle when everything is going in the wrong direction. This is particularly difficult for new investors who haven’t been involved in flipping before because they don’t have established reputations, established relationships, established contractors and suppliers. I wish you the best. That’s all I can say.”
What is house hacking? A powerful alternative to flipping
Most millennials and Gen Zs believe their housing options are either buying a house or renting. Either way, when they make that payment, their money is gone.
“I would encourage anyone looking to get into real estate that this (house hacking) is your first step. It might not be sexy, and it might not be what you want to tell your friends you’re doing, but it doesn’t make any difference. In the end, you’ll be the one who is laughing.
“House hacking is simple. You need a place to live, but instead of buying a single-family house, look for a duplex (or three- to four-unit building) in an area where you want to live in. It needs a bit of TLC, paints, carpet and the normal stuff.”
“You’re going to purchase this property as an “owner-occupant” — this is a keyword. So, when you purchase, you’re going to move into one of the units and fix it up. Owner-occupants qualify for all sorts of programs that non-owner-occupants can’t access.
“Also, because you have rental income from the other unit(s), your housing expenses will be lower. (You’ll also have more money to fix up the property.)”
For example, as an owner-occupant, you can purchase with a minimal down payment (as little as 3-5 percent) through FHA, VA and USDA loan programs. Investors are often required to put 30 percent down or more.
Moreover, if you’re purchasing a duplex, you may qualify for down payment assistance. According to Rob Chrane, the CEO and founder of DownPaymentResource.com, the average amount of down payment assistance granted in 2022 was $17,000.
Additional ways to increase your value using house hacking
These opportunities may be harder to find, but they represent a tremendous opportunity to increase your value and your cash flow.
“Say that you found a duplex that could be turned into a triplex. Hire an architect to see if it’s possible,” Naugle said. (Do this before you purchase.) “Once you close on the property, obtain the permitting and make the improvements it will take to make it into a three-unit property. By doing this, you have just increased your cash flow tremendously, and you have also made the property much more valuable.”
Provided your local zoning allows you to do so, here are eight additional ways to “house hack” an additional unit on a 1-4 unit property:
- Garage conversion: Convert an existing garage into a living space by adding insulation, drywall, flooring, plumbing and electrical systems.
- Basement conversion: Transform an unfinished basement into a functional living space with proper ventilation, insulation, drywall, and egress windows or doors for safety.
- Attic conversion: Convert your attic into a living space by adding dormer windows or skylights for additional light, insulation, heating and cooling, plus proper ventilation.
- Internal reconfiguration: Create a studio or one-bedroom apartment by redesigning your current space and adding a separate bath and entrance to an existing bedroom.
- Add an attached dwelling unity (ADU): Build a separate free-standing structure on your property, such as a guest house or studio you can rent.
- Add to your existing structure: Build a new unit on top of your existing one-story structure, such as a garage or above one of the wings of your home.
- Prefabricated or modular units: Install a prefabricated or modular unit on your property, which normally requires significantly less time and money than building from scratch.
- Tiny homes: Build or acquire a tiny home that can serve as an additional unit.
“It has gotten a lot easier to make these types of changes because cities need more housing,” Naugle said. “As the price of properties has gone up, the demand for rentals has increased. With rising interest rates, a lot of people are getting priced out of buying a house, but they still need a place to live. This has resulted in a mass rush to rentals, and there’s not enough rental stock out there.”
If you have a flip that goes wrong
Naugle explained what happened when he got into a flip where everything went wrong. His budget doubled, and by the time they finished the work in 2014, the comparable sales didn’t support the price he needed to get.
They decided to rent the house instead of trying to sell it. They made about $500-$600 per month until the tenant moved out at the beginning of this year. After the tenant moved out, they redid the house and made a second profit on it.
Avoid playing the appreciation game in today’s market
Rather than relying on the appreciation approach, putting equity into the house by increasing its value is using the “income approach.” Because of the factors currently in play right now, even if the price of the house goes down, Naugle argues that rental values are going to stay constant.
Naugle’s final piece of advice is:
“If you plan to buy a house today, understand that there is a very strong probability that your house will be worth less next year, and maybe even the year after that. Just be very careful because the game you don’t want to play with fix-and-flips, or any real estate now, is the appreciation game. Instead, renovate, add a unit, and make the property worth more than it is today. Now you’re using the ‘income approach’ and increasing the value. Avoid having tunnel vision and thinking that flipping is the way to go.
“So don’t be in a rush right now. The opportunities are going to keep coming, and they’ll probably get better and better. Be patient, and wait for the right deal.”
Bernice Ross, president and CEO of BrokerageUP and RealEstateCoach.com, is a national speaker, author and trainer with more than 1,000 published articles. Learn about her broker/manager training programs designed for women, by women, at BrokerageUp.com and her new agent sales training at RealEstateCoach.com/newagent.