Why Real Estate Flippers Have It Wrong

Maybe I got it wrong. Or at least wrong for today's growing group of folks interested in learning more about real estate investing.

Over ten years ago, when we started the monthly real estate Round Tables that grew into the Urban Rehabber Program, the buzz word that attracted so many was "rehab". Everyone wanted to learn about rehabbing, to be a Rehabber. Today I guess the idea is to learn how to "flip" real estate.

Well, I get that. Only the proper word (according to tradition and the IRS) is "dealing"–buying, maybe fixing or "rehabbing", and selling. As quickly as possible. As we like to say, "for fun and profit". Over the years I have done a lot of buying, fixing and selling, and taught many others how to do it as well.

But at the same  time we have understood the 'serious money' in this business is not made by the dealers, or the rehabbers who fix in order to immediately sell, or today's Flippers. The real opportunity resides with those who buy and hold. That is, with Investors.

Real investors, those who acquire or build portfolios of rental properties. Houses or multi-unit apartments held and operated as rentals for income and appreciation over time.

I learned very early on that when I bought and improved apartment buildings in Chicago for conversion to condominium, in the end it was my customers who benefited most from my work. Within just a few short years (sometimes months) they enjoyed far greater appreciation–increase in value–than I did taking my short term profits. For all my effort and risk, it was they who made the money.

It doesn't take a case study to illustrate the point. In today's market (winter/spring 2014) in the  urban neighbrohoods where I work, a typical distressed single family home can be purchased for under $50 thousand and improved for–say $25 thousand–and the improved value realized upon completion will be $125 thousand or more. If sold the pre-tax profit will be about $25 thousand (after closing costs, commissions, etc.).

Not a bad month or two's work some would say, the "rewards of flipping". But of course that's before the government collects it's $8-9 thousand in taxes. Kinda takes the fun out of it all.

The investor, on the other hand, finds him- or herself owning a $125 thousand income-generating rental property for which he "paid" $75 thousand, including the improvements. And the property, all the while increasing in value as our market recovers value, is netting $5-6 thousand per year after expenses. There is more to be said; there are further tax advantages to holding. But I presume the point is made.

The rehab side of the coin is not to be ignored. Investors are best served when they seek out "distressed" properties, properties that require some work–call it "rehab"–to restore value. This is what I call combining entrepreneurship with investing.

The entrepreneurial investor is best positioned to create wealth "on the Fast Track". Traditional investors have always relied on long term equity growth and ongoing income to build wealth. And that will always be the prudent approach to investing in real estate.

Our Entrepreneurial Investor simply jump starts each addition to his portfolio by intentionally seeking out under-valued, often distressed, properties and immediately restoring value by employing the rehabber's unique acumen, skills and energy. This is not accidental, a matter of good luck or merely good timing. This is an "activist" investment strategy designed to speed wealth accumulation.

In our example case study above, our investor realized a profit of 50-70% in new equity growth by keeping the property. The property went from what accountants call a "cost basis" of $75 thousand to an after-repaired-value (ARV) of $125 thousand or more, within months rather than years. Taxes on that gain in value are deferred until the property is sold sometime in future; at which time taxes are paid, at a reduced "capital gains" rate. Meanwhile, as with any income-earning investment, the investor enjoys ongoing "cash flow" (rental income).

This is what the Urban Rehabber Program is truly all about. We understand real estate investing and we value entrepreneurship. We teach and undertake rehab as a means to an end rather than as an end in itself (the Flipper's way). As savvy investors, we need to understand rehab in order to speed our investing agenda. Our approach combines investing with entrepreneurship.

Our role model? The Enrepreneurial Investor.

- Philip Elmes