Photo: The Motley Fool
The rebound in the housing market has been dramatic with residential real estate prices climbing at a frenetic clip. The long lost art of house flipping -- the practice of buying distressed properties, sprucing them up, and selling them at healthy markups -- is back.
It might not last, however. Let's take a look at the few of the reasons why the house flipping craze may have run its course.
1. House flipping rate is cooling off
Industry tracker RealtyTrac reports that just 31,000 single-family homes were sold within 12 months of purchase during the second quarter. That accounted for just 4.6% of the number of homes sold in this country.
The number of houses flipped has suffered sequential declines for six consecutive quarters. Given how badly flippers were burned last time that greed got out of hand, do you really want to bet on the wrong side of momentum? House flipping activity has gone from accounting for 6.2% of all U.S. home sales a year ago to 5.9% during the first quarter of this year to 4.6% in the latest quarter.
2. House flipping isn't as profitable as it used to be
Speculators are still turning a profit if they buy the right properties, but the practice isn't as lucrative as it was late last year. RealtyTrac reports that the average gross profit on a flip was just over $46,000 last quarter, a 21% gross return on investment. That may sound decent, but keep in mind that average gross return on investment clocked in at 24% during the first quarter after peaking at 31% during last year's fourth quarter.
Oh, and before you start thinking that you can live with $46,000, keep in mind that this is the gross profit. It doesn't include the cost of renovations or of actually selling a home. Bargains are often fixer uppers so these expenditures can be substantial.
3. Homes are sitting on the market for a longer time
Time is the enemy of the house flipper. The longer the house sits on a market waiting for a second buyer the more it costs the flipper. Cash purchases by flippers tie up their capital, and house flippers financing the purchases -- a dicey proposition in this climate -- face mounting interest payments. All flippers also face the carrying costs that include taxes, insurance, and other maintenance overhead.
A year ago the average flipped home sale was completed in 135 days according to RealtyTrac. That has increased to 164 days during the first quarter and 187 days during the second quarter. Patience has become a costly virtue.
4. Luxury homes may no longer be a safe haven for house flippers
The most resilient niche for house flippers has been premium properties. The biggest year-over-year percentage increase -- and one of the few pricing categories to move higher -- came from homes priced at $750,000 or more.
One can argue that affluent home buyers are better able to absorb the spike in property prices, but the biggest bellwether we have on that front tells a different story. Toll Brothers (TOL 0.64%) is the leading publicly traded builder of luxury homes. The average price of a contracted home by Toll Brothers was a whopping $717,000. It reported quarterly results earlier this month, and it wasn't pretty. Revenue may have soared 53% on increasing prices and a 36% spurt in delivered properties, but the near-term outlook isn't as rosy.
Toll Brothers actually spooked investors with a year-over-year decline in the number of new contracts signed by the homebuilder. The cancellation rate also moved higher.
5. Don't miss the A&E froth signal
"Flip This House" began airing on A&E in 2005, just as the real estate market was heating up. The show followed professional house flippers as they went about scouring bargain properties and reselling them. By the time the market crashed three years later the shine was gone. "Flip This House" was nixed in 2009.
A&E came back to the house flipping well with "Flipping Vegas" a few years ago. The pilot aired in 2010, receiving the green light as a series in 2011. "Flipping Boston" followed in 2012 and "Flipping San Diego" in 2013. We saw how badly things ended a couple of years after "Flip This House". If this isn't a signal of things getting a bit frosty you may want to turn in your remote control.
There may still be some money out there to be made flipping properties, but you don't want to be the one left holding a title when the tide turns.
