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14: Flipping is not investing

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When you talk to people about real estate investing who have never done it before, they automatically think you are talking about flipping houses. What is flipping houses? Well, it’s not “investing”.

Flipping houses is a business. You buy something undervalued, you put work and money into it and then you try to sell it for more–preferably within a year’s time. You don’t make money on the project until you’ve sold it so shorter hold times are better.

Good flippers can make a lot of money in the right market with the right team. But again, it’s a business. If you run out of inventory, you don’t make any more money. If customers dry up, you don’t make any more money. Flippers are the real estate equivalent of day traders. Some of them are very good at it, but it’s not investing.

Now you can invest in a flipper’s business. Many of you hold short term notes that do not require any work from you. However, what you are investing in is a business, not an asset. Businesses are inherently riskier than assets such as rental homes and apartment buildings.

Investing in real estate implies at least the intention of holding a property for several years with cash flow along the way. We buy real estate based on net operating income (NOI) and we do not buy unless we show positive cash flow.

If we have positive cash flow and a nice cushion, we don’t really have to worry about losing much money in down economy? Why? People still have to live somewhere. They might need to move into a less fancy apartment, but they still have to live somewhere.
By the way, that’s why I prefer investing in working class apartment buildings.

So, why do you often hear that real estate investing is risky? I believe that most people are thinking about flippers when they think real estate– look at what happened to flippers in 2008! No wonder it freaks people out. And for those of you excited about your returns on those short term flipper notes–beware! Don’t get caught with a note when the music stops again!
On the other hand, many real estate INVESTORS got very rich in 2008 because people who were not investing properly or flipping had to sell in distress. My father increased his rental cash by several hundred thousand dollars during that period and called it one of the best times to buy in his whole life.

So next time your friends tell you that investing in real estate is “risky”, please help them understand why they are wrong.

Buck