You can’t get away from it. The media fawn over it. Rational neighbors drool unexpectedly. Ads flood the airwaves. “Learn our simple three-step system on how to flip homes,” the announcer says. Everyone knows: untold riches are waiting for you. “Right here in the Bay Area,” he said. It’s hot, so hot that people are going to get burned. “You have to think it through and do some careful math if you want to make a profit,” warned Justin Singletary, a house rehabber and flipper in Savannah, Georgia.
I even ended up on spam lists for flipping, perhaps because of my series of articles on the current housing bubble [first one in March, Housing Bubble II: But This Time It’s Different]. One company offered to fund rehabbers. Among other goodies, it had an “All in one Rehab Special ‘Non-recourse Loan.'” While it was at it, the email admonished me: “Leverage your money!” and “Increase your profits.”
It’s driven by the numbers. Home prices have jumped! Yet volume hasn’t. A bubble without volume – reminiscent of the stock market. Pending home sales, considered a harbinger for future homes sales, have dropped 1.6% in August, more than expected, and are down for four months in a row, seasonally adjusted. Pending contract activity in August was the fourth highest since, well, 2010, during the depth of the housing crisis, when sales were boosted by government subsidies. But they were a far cry from, say, 2005, when contract activity was much, much higher.
The National Association of Realtors pointed out that “sharply rising mortgage interest rates in the spring motivated buyers to make purchase decision.” So contract activity perked up. But as rising home prices and rising mortgage rates have jacked up monthly carrying costs, affordability became an issue, and volume is now getting hit. The NAR expects volume to decline faster in the fall than it usually does, and it expects stagnation next year.
But for the first half of 2013, RealtyTrac’s Midyear Home Flipping Report found that the number of flips – homes sold within six months of acquisition – jumped by 19% from the same period in 2012 and by 74% from that period in 2011. The average gross profit on the initial purchase price rose 9% to $18,391 per single-family home, more than triple the $5,321 during the same period last year.
Why is flipping suddenly hot again? The perception that it will lead to immense, quick, and risk-free profits. If you know what you’re doing, you can’t lose money in real estate, they say these days. It helps that “inventories are lower than they have been in years,” explains Singletary. It gives flippers the hope that they can sell their properties for a profit.
But ominous clouds are appearing. The same ones that appeared during the prior housing bubble. While home flipping is still hot in a lot of markets, such as New York, Washington, D.C., Chicago, and some Florida metros, it’s “tapering off” in other markets. Of the 100 markets in the report, “32 had declining flipping numbers, including perennial flipping hot spots like Las Vegas, Phoenix, Southern California, and Atlanta,” said RealtyTrac VP Daren Blomquist.
“The opportunity to buy and flip homes in Southern California is diminishing each month, as the price to purchase fixer-uppers continues to increase rapidly,” said Rich Cosner, CEO of Prudential California Realty. “The allure of a quick profit from flipping can entice many first-time home buyers, but the gross profit does not take into account the costs of repairs, upgrades, cleanup and the money spent while owning the property. In some areas home prices have increased so much that there is little or no profit available to flip it.”
A scenario that flippers should anticipate, Singletary warns. “Which market should you invest in, how much can you expect to sell the home for, and how much can you really afford to invest in updates, without blowing your profit margins? Those are the questions that potential flippers should be asking,” he said.
The most profitable flipping metros were Daytona, Daytona Beach, and Ormond Beach in Florida, where flipping more than doubled from prior year and average gross profit surged to an intoxicating 82%. In Omaha and Council Bluffs, Nebraska and Iowa, flipping quadrupled from prior year, and average gross profit jumped to 56%.
“It’s a perfect storm for flipping right now in many parts of the country,” Daren Blomquist told CNBC. These rampant home price increases are “something that flippers can catch on the coattails of and ride that wave as long as it lasts.”
And it’s not going to last forever. Flippers must eventually sell the homes, but their buyers, the end-users, often have to get mortgages, and rates have risen sharply, putting a squeeze on these deals. That’s the tail end. At the front end, flippers have become numerous, and the trade is getting crowded. “Every time a listing comes up, it’s like piranha in the water,” Steve Jones, founder of Los Angeles-based Better Shelter, told CNBC.
“A feeding frenzy, a mad dash to snap it up,” is how Singletary put it, from his perspective at the other end of the country. That feeding frenzy drives up prices – input costs for flippers. Then there is the cost of rehabbing the house that will, as he pointed out, “eat into the profit margins” to the point where flipping becomes unprofitable. He has some advice: think it through, make a budget, and stick to it. “This is not a job for those who are not fairly well-versed in accounting,” he said.
If not, flippers might get stuck with homes that they can only sell at a loss. When prices decline, losses grow. Then they’ll try to dump their properties to get rid of them. If they financed their purchases, they’ll walk away from these homes and leave it up to the banks to dump them. Yup, been there, done that.