REUTERS/Rebecca Cook
- J Scott, author and cohost of "BiggerPockets Business Podcast," thinks the real estate market is nearing a top.
- He outlines an investing strategy that accounts for drastic downside risk, so he can thrive regardless of how much market conditions deterioriate.
- Scott - who reveals his tried and true three-part strategy for housing-market success - says flipping homes is "a great way to generate piles of cash."
- Click here for more BI Prime stories.
When J Scott - author, former Microsoft engineer, and cohost of "BiggerPockets Business Podcast" - decided to quite his job alongside his wife so they could pursue an entrepreneurial lifestyle, they really didn't have a plan.
"We should flip a house," said Scott's fiance in the middle of watching a real-estate investing show on HGTV.
"I honestly - I thought she was joking," said Scott on the "Real Estate Investing" podcast. "I am not the handy-man type."
It turns out Scott's wife wasn't joking.
After a few months of learning the ins and outs of the industry - how to analyze deals, run numbers, shop for properties, etc. - the couple set out to buy their first property.
They wound up putting three houses under contract, thinking they'd ultimately follow through with just one. But that plan - or lack thereof - soon changed.
"At the end of the day, we said: 'Let's just buy all three of them," he recalled. "We were basically doing our first three flips simultaneously, with no experience, no real-estate background - no plan to do this, like literally, this was serendipitous. We just sort of fell into it."
Fast-forward to today and Scott and his wife have successfully flipped 400 to 450 homes.
Scott's 3-part strategy
"I can't tell you when the next recession is going to occur," Scott said. "I can't tell you how bad it's going to be. But if history is an indicator - and history is an indicator - we know that the next one is going to come at some point."
He added: "The cycle is always going to continue."
Currently, Scott thinks the real estate market is nearing a top, so the tactics that he's implementing have been modified to account for a potential downturn.
It's a sentiment that's been echoed by a range of experts, from Carl Icahn - who's currently betting on the decline of the American mall - to Mark Yusko, the CEO and chief investment officer at Morgan Creek Capital Management, who thinks the real-estate market is "about to get crippled."
Scott's goal is simple: nail down a strategy that mitigates his risk while ensuring his investments and profits remain unharmed.
Here's the three-part criteria he formulated:
1. Flip what's in demand
"In a downturn - typically at the beginning of a downturn - the first parts of the market that start to soften and lose value are those parts of the real estate market that are well-above, or well-below the median house price," Scott said.
He continued: "Let's say you live in an area where the median house price is $400,000. Houses that are well-above that $400,000 price point, or well-below that $400,000 price point, when the market starts to turn, those are the parts of the market that are going to soften first."
Scott says that if you're going to flip during this time, make sure the resale value of your property is near the median home price in your specific market.
2. Speed
"I'm focused on deals that are going to go quick. I'm focused on those deals that I can be in and out of in 2, 3, 4 months," Scott said. "That way, even if the market starts to turn, we're probably not going to hit the worst part of the downturn before I'm ready to get out of those properties."
He added: "I'm no longer doing those projects that are going to take me 12 months from the day I purchase to the day I sell."
"I'm not overly concerned that we're going to see a major 10, 20, 30% crash overnight. Again, I don't know for certain, but I'm willing bet some money on that," Scott said. "I'm not as confident that we're not going to see a downturn - and maybe a major downturn - in six or 12 or 18 months. Given that, I'm trying to keep my projects short."
3. Utilize 2008 as a measuring stick
"The one thing we're really fortunate about with 2008 is it was a great barometer for how bad things will realistically ever get," Scott said. "I'm not going to say it will never be worse."
He continued: "So what I like to tell people is: 'Take a look in your area; take a look at the data in your area and see exactly what happened in 2008.' Assume that that's now going to be your worst-case scenario, and don't do any deals that you're not comfortable with that being your worst-cast scenario."
Scott notes that home prices in Baltimore - a market he frequently flips in - fell about 13% to 14% in 2008. When he flips in Baltimore today, he accounts for at least 13% to 14% of margin before moving forward with a deal. This way, he'll still break even if another worst-case scenario happens to occur.
"Flipping is a great strategy for somebody that has the time, has the energy, has the money, and has the fortitude to deal with active real-estate investing," Scott said.
He concluded: "Flipping houses is not a great tax shelter, but it is a great way to generate piles of cash."