2 Reasons House Flipping Is Plummeting

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It's getting harder and harder for house flippers to make a dime as home prices rise, inventory gets tight, and investors with plans to hold single-family houses long term compete with flippers at foreclosure auctions.

House flipping was made exceedingly popular by reality TV shows like Flip this House that feature savvy do-it-yourself investors buying fixer-uppers, remodeling them, and selling them a month or so later for a pretty profit. It looks easy on TV and seems like a simple idea that should be particularly profitable as the Case-Shiller home price index shows national home values have appreciated more than 12% over the last year.

But, it's not so simple and market conditions have made it almost impossible for flippers to buy properties at the right price.

RealtyTrac, a real estate information and research firm, tracks quarterly house flipping data and found that investors flipped 32,993 single-family houses in the third quarter of this year, down 35% from the second quarter and 13% year-over-year.

Tough market

Home inventory fell to all-time lows in cities throughout the country in early 2012. At the same time, buyers reemerged on the market. Cities such as Washington, D.C., and Denver reported rapid home sales with buyers getting into bidding wars that drove sales prices tens of thousands of dollars over asking prices.

It's not easy for flippers looking to buy on the open market to compete against someone trying to buy their permanent residence. Homebuyers who plan to live in a house will attribute more value to it than someone who wants to make some cheap fixes and resell it within a month or two. And the resident will have a much easier time financing than a flipper if the investor doesn't have cash.

Foreclosure competition

For many years, house flippers have enjoyed easy access to affordable inventory at foreclosure auctions.

But auctions all over the country have grown crowded. Big institutional investors and new publicly traded single-family real estate investment trusts are squeezing out the flippers, who used to be the staples at foreclosure sales.

Companies like Silver Bay Realty Trust (NYSE: SBY  ) , American Residential Properties (UNKNOWN: ARPI.DL  ) and American Homes 4 Rent (NYSE: AMH  ) are bidding against flippers in foreclosure auctions where everyone has to buy with cash. The difference is that those REITs plan to hold the houses long-term. According to a Fool article, American Homes' portfolio consists of roughly 20,000 homes, while Silver Bay and American Residential owned around 5,500 and 4,000 homes, respectively, at mid-year.

Since these companies have more time, they can invest more money and still get a good return on investment. Also because they have more time, the cost of their capital is probably lower, meaning they can spend more on individual properties without it costing any more than flippers would ultimately pay after covering interest payments.

On top of hot competition at foreclosure sales, flippers are faced with falling foreclosure rates. CoreLogic, a real estate information firm, reported that completed foreclosures fell 39% year-over-year in September. That means there are few properties to bid on in foreclosure auctions.

Silver lining

Most investors, whether they want to flip a property or hold it, are looking for lower-end houses. The most affordable properties have long been the bread and butter of real estate investing because investors don't have to tie up big sums of cash in properties.

While the low-end market is pretty well dried up for flippers in most U.S. cities, RealtyTrac found that high-end and luxury home flips were still profitable. There is little competition with institutional investors or even homebuyers at the $750,000 and above price point. And luxury real estate is a market that's just starting to come back in most cities, creating a lot of opportunity for flippers with the deepest pockets.

High-end home flipping was up 34% during the third quarter, according to RealtyTrac.

"The sharp rise in high-end flipping indicates there is still good money to be made for flippers willing and able to take on the additional risk of buying and rehabbing more expensive homes," Daren Blomquist, RealtyTrac vice president, said in a statement. "With that higher risk also comes the potential for higher reward. The average gross profit on each high-end flip equals more than four times the average gross profit on each flipped home in the lower price ranges."

Longer-term investments

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