Get Rich Not So Quick in Real Estate

Construction GuyAs you may have noticed, we are getting ready to sell our house.  After living in our first house for about 7 years, we’ve been in our last two for 2 and 3 years respectively.

The interesting thing is that each time we have made a lot of money.  The past two times we’ve used this new wealth to buy more expensive houses.  This time, we’ll be trading down, but we will also be paying off every dollar of debt we have other than the new mortgage.  This isn’t insignificant when you consider that we are in our early thirties and both had to go to college on the back of student loans (including the wife’s three years in law school.)

Looking back, I’ve noticed a parallel to the stock market.  In the stock market, there are day traders.  You probably remember more than one or two friends who tried this way to easy wealth in the late 90s.  Only, it turns out it isn’t so easy, and ironically, that most of the people who thought they were day traders really weren’t.

A day trader buy and sells positions within the same day.  The entire concept is based upon taking advantage of quick moves in stock prices, so the very thought of holding a position overnight, let alone for several days or even weeks is not what day trading is about.  However, one can make good profits by trading in this longer range particularly when the market overreacts to events.

Likewise, there is a method for making money in real estate call Fix and Flip.  With a Fix and Flip someone buys a house and then fixes it up and then sells it immediately for a profit.  There is a lot more to it than that, and as they say, the devil is in the details, but the concept is similar to day trading stocks.  What we have done can be considered more along the lines of trading over days or weeks in the stock market.

If you still think that every time you sell your home you have to roll all of your money into a new home, or another kind of real estate, you’ve fallen behind the tax times.  These days, the first $250,000 (if single) or $500,000 (married) of capital gains in your home is tax free, no matter what you do with the money.  The catch is that it must be your primary residence, and you can only do it every 2 years.  Although it was never our intention, this is what we have done the last two times.  Each time we bought a house that wasn’t at it’s full potential.  When we bought our current house we paid the lowest price per square foot in the area.  This was a bit of an ego blow to our real estate agent who bought a home in the same area a couple of months before and said her goal was to pay the lowest price per square foot in the area, which she did, but we paid even less when we bought our house.

The reason we were able to do so is that the house is an older bungalow house.  Although it had been updated some, the last time was probably back in the 1980s.  Wallpaper everywhere, and not the subtle kind either.  One room had wallpaper that literally had white fibers “peeling” from the wall.  I assume this was someone’s idea of adding texture, but it was clearly out of fashion when we looked at the house.  The not so popular wallpaper, plus a pink kitchen, and tons of clutter kept people from seeing the house’s potential.  When we bought it another realtor remarked to our realtor “You finally found someone who could see the upside.”

We spent the first two weeks we owned the house stripping wallpaper and painting.  The next year we remodeled the kitchen.  It’s now a nice blue color and we took out a half wall that made a breakfast nook, but also made a tiny kitchen.  People interested in the house now are looking at a nice big kitchen with plenty of counter space and granite counter tops.  More importantly we remodeled the bathroom which was the only room in the house to have never been redone.  When we met the previous owners at the closing the woman remarked that they always meant to do it, but they didn’t want the inconvenience (the other bathroom is in the basement.)  Our reward for two months of construction is a shining gem of a house, and a pretty tidy profit when we sell.

Our previous house went down in a similar way.

How to Slow Fix and Flip

Real estate can be a great wealth building tool.  Usually this comes from the leverage provided by mortgages.   Of course, this is also it’s biggest risk.  Going the Slow Fix and Flip route though mitigates this risk and still offers big rewards.  Here is how.

First, you have to live somewhere and you are going to pay for it anyway.  By living in your investment you are splitting the expense of the house payment between investment and cost of living.  Basically, killing two birds with one stone.

Second, by living in the house, you get get to see all of the potential.  While a quick stroll might reveal that new kitchen cabinets would be nice, a few months in a home might open other possibilities.  As you try and figure out where to put your cappuccino maker, you might notice a way to extend the counter by removing a not very useful closet, or notice that the sun is really great in the summer and would be even better if you could get a skylight, and so on.

Third, eliminating the ticking clock.  When you buy a property to fix and flip, the clock on your profit starts ticking.  Everyday that passes before you sell the house eats into to your profit.  When you live in the house that clock goes away.  Who cares if it takes you an extra month to get the new landscaping in.  You aren’t going anywhere for a while.

Fourth, tax free profits.  If you live in the house as your primary home for two years, then you can take all the profits (up to $500,000) tax free.  With a regular fix and flip you’ll have to pay taxes or jump through some pretty tight hoops to get the money into your next investment.

Finally, you might accidentally end up owning your dream home.  Frankly, we love our home and the only reason we are looking to move is that we both want to make the jump out of the corporate ship.  A smaller mortgage and no debt will make that easier.  So, when you look for your next home, or if you think there is the possibility of selling in the future, start looking for things that you could fix or update while you live there.  You just might reap some nice profits down the road.

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