Is the flip dead in Denver?

Sure looks that way

“Learn how to flip houses in three easy steps using someone else’s money!” Sounds like a great deal; everyone can make millions in real estate by “flipping a house” just by following three “secret steps”!   Is this radio ad a reality?  Can you easily strike it rich by flipping houses?

Being a hard money real estate lender in Colorado and looking at hundreds of residential properties a year, I’d like to be the first to declare the “flip” is over in Denver for the vast majority of investors.  First let’s define what a fix and flip is. 

The objective of “flipping” a house is to make money on the margin between what the house is purchased for + repairs and the net selling price (after holding costs, commissions, etc…).  This is best understood through a quick example.  Let’s say a house was acquired for $90,000 and $15,000 was put in for repairs; the house is subsequently sold for $145,000 (less 5 percent commissions and hold costs) the net profit is $32,750.  Let’s say this flip took 6 months start to finish due to some unforeseen issues.  The net profit is approximately 62 percent annualized over a year.  Quite a nice return!  There is no wonder why it seems like everyone is now a “real estate investor”.

The above example is a best case scenario where the property was bought at the right price, repairs were minimal, and the property was sold at the right price.  As you can likely suspect, best case scenarios where all the stars align rarely happen.  Unfortunately real estate like any other industry is dictated by basic economics and the laws of supply and demand. 

Now let’s focus on Denver in particular.  Denver’s market is healthier than others in the country due to limited supply and increased demand. In many cities (think Atlanta) growth is not controlled as much as Denver.  In Denver, growth for the most part is planned and controlled which limits supply in the metro area (and the Western part of town has a physical barrier—aka mountains, national forest, etc.. which further limits growth).

Along with the tight supply, there is considerable demand for housing in Denver.  Denver is known for its quality of life, educated workforce, etc… which is attracting companies and therefore workers to the metro area. The reduced supply and increased demand has pushed prices up.  One would suspect this would be great for someone trying to flip a property.

The reality of the situation is that the reduced supply has increased prices too much so the margins have been compressed/eliminated.  The sell side prices can only go up so much with Denver’s market fundamentals. 

On the same transaction above, instead of buying the property for $90,000, now the property purchase price is $115,000 due to competition from not only other investors (seems like everyone is now trying to be a real estate investor on the side), but also homeowners that are looking for their first house.  Under this scenario assuming everything else is constant, the total invested ( also known as basis) is now approximately $130,000 assuming the sales price is the same $145,000, the net profit is now only $7,750 after real estate commissions of 5 percent. 

This is a very small margin on a flip since inevitably something goes wrong (for example let’s assume you found out that the roof needs replacing or the furnace blows out setting you back another $6,000 to $8,000). 

Although the radio ad says: you can flip a house in three easy steps using someone else’s money; the reality of the situation is that the vast majority of investors will barely break even and many times lose money on a flip.  As a result of the increasing prices in Denver metro and subsequent margin compression, the flip is officially dead for the Denver metro area.

Categories: Real Estate