It’s crucial understanding the different markets within a certain area. It's a good idea to breakdown your market into at least six different price levels. The “levels” shown below are the retail prices within a “composite” suburban area.
These vary by geographical location but this gives you an idea about how to segregate local markets by price ranges:
Price levels will vary in your specific market. Obviously, in Southern California and Manhattan, the price levels are much higher than most markets. It's up to you to adjust the prices according to the market you invest in.
A level one area is considered “low-income”. Theses areas tend to be high rental areas due to the low prices (under $100,000). These are the least desirable areas for homeowners to live. A level one area tends to be very risky for a few reasons:
Example: Don't learn this the hard way! What is likely to happen in a level one area is you buy for $20,000, put $10,000 into the rehab, and contract to sell it for $55,000 to a retail buyer (FHA). Unfortunately, your appraisal comes in at $32,000! When examining the comps, there are several REO sales at $30,000 and under. There are no retail comps above $32,000 that meet FHA requirements. (If you’re fortunate, you put a tenant in the property and wholesale it as a turnkey to a landlord-investor for $35,000).
An exception here is when you seller finance the sale. People will buy a seller financed home when the mortgage, insurance, and taxes cost the same or less than to rent. You don't need an appraisal when you seller finance.
Investor Mistake: Why do a lot of new investors try flipping houses in the price level one areas? They do it for one primary reason - low capital investment. They start out saying, “I have $50,000 from my IRA (or whatever) and I can buy a house for $30,000, put $20,000 into repairs, and then sell it for $80,000.” Although that sounds good on paper, when you understand the ramifications of a level one area, it becomes a very risky investment. It’s better to raise the capital and go into a higher-level area to flip houses.
Successful flips are more likely in levels 2 through 4 with prices from $100,000 to $300,000 (or appropriate to your geographical location). This is where the largest segment of buyers is found. And an inventory shortage has existed for a couple of years. Levels 2-4 include first time buyers as well as downsizing buyers. Typically, levels 2-4 are the ideal levels to flip houses. However, do to the price range, these levels are mostly FHA buyers so you must be prepared to deal with FHA flipping guidelines, appraisals, and all of the ins and outs of FHA requirements. This is where you should do 90% of your flipping.
Levels five and six are the $300,000 and up priced homes. The challenges with flipping these homes is that these are typically bigger homes, longer rehabs, more capital intensive, longer time on the market, and fewer buyers. Be wary that high priced sales are in decline. However, the tradeoff is you have a more qualified buyer (conventional instead of FHA) and you have a higher profit potential. You can make a lot more money per deal at price levels 5-6.
Please leave a comment if this article was helpful or if you have a question.
Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for seven years. He also draws upon 30 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest. In the Olympic Mountains with the Pacific Ocean a couple of miles in the opposite direction.