There's a rule of thumb in the investing world that once an economic trend makes it to the cover of a popular magazine, it has already topped out. So when I discovered not one but two different television programs extolling the virtues of flipping houses, it made me wonder whether that's a big contrary indicator, suggesting that we're in for a longer decline in housing prices than the experts seem to think. Watching these shows, you get the distinct impression that there's plenty of free money to be made just by going out and buying a house, taking a week or two to hire contractors to do some repairs and renovations, and then finding a convenient buyer to pay you a much higher price.
In reality, however, many people who flip houses haven't had to do any significant work on their properties at all. In a rising real estate market, just holding property for a few months is sometimes enough to make a nice profit, especially with historically low interest rates and relatively easy credit. As interest rates rise and real estate prices stagnate, however, it'll be a lot more challenging for people flipping houses to make money.
The basics of house flipping
In a nutshell, the goal of flipping houses is no different from what investors in stocks or mutual funds are trying to accomplish. In order to make a profit, house flippers buy low and sell high, seeking out real estate at depressed prices with the intention of reselling it at higher prices later on. There are all sorts of methods that house flippers use to try to find good prospects. Some focus on properties on which banks have foreclosed, with the hope that a financial institution will be more interested in a quick sale than in getting top dollar for the property. Others look for particular areas that have been out of favor in the past but have good potential for gentrification and urban renewal, which are often accompanied by rising real estate prices. You can even find some people who look through obituary pages to find grieving families needing to sell the home of a loved one.
What house flippers do with their property once they buy it depends on their goals and the particular methods they use. Buyers who successfully find a good property at an artificially low price may be able to list the property immediately at a higher price while doing little or no work to improve its condition. The house flippers shown on television prefer to make major renovations to their properties, expecting to sell at a price high enough to cover not only the cost of the house but also whatever they spend on remodeling expenses.
Does it work?
When you see house flipping on TV, it always seems to work very well. The buyer gets a mortgage with good terms, puts an additional $20,000 to $75,000 into the house, and emerges with a stellar profit. Of course, many of the homes featured on these shows are in southern California, which was one of the biggest beneficiaries of the housing boom. If these shows continue, it'll be interesting to see what effect the slowdown has on flipping.
As with most moneymaking strategies, the stories you're most likely to hear are the dramatic successes and failures. In some cases, people buy property, then find someone willing to pay tens of thousands of dollars more just weeks later without any work or effort. In other cases, people buy property and spend a great deal of time and money trying to fix it up, only to find no interested buyers, thereby creating a financial mess for themselves. On the whole, however, flipping can have a significant effect on the housing economy. Flipping has pluses and minuses for homebuilders like KB Home (NYSE:KBH), Centex (NYSE:CTX), and Ryland (NYSE:RYL); while flippers provide initial demand for their building projects, flippers later turn into competitors when they decide to sell, sometimes even before the entire project has been completed.
Flipping is hard work
What a half-hour TV show can't demonstrate is how hard it can be to flip a house. Depending on where you're looking, it can be extremely hard to find prospective properties for flipping that are reasonably priced. Once you find a good property, you have to go through all the same tasks any buyer faces, such as getting approved for a mortgage and dealing with the formalities of closing. If you're going to fix up the property, you either have to spend time getting the materials you'll need yourself or find reputable contractors who won't eat up too much of your potential profit. Once the work is done, you have to spend time showing the house to possible buyers or else pay a real estate agent to do it for you.
Meanwhile, each extra day you spend owning the house means more money out of your pocket to pay for real estate taxes, mortgage interest, and other incidental costs. It's partly because of this that some people who flip houses choose to live in them while they're on the market in order to save on living expenses. At the end of the day, however, you have to weigh your profits against the amount of your own labor spent getting the property successfully flipped. While a $10,000 profit may sound like a nice payday, it may not be as appealing if you spend three to six months working hard in order to earn it.
With the days of low teaser rates on adjustable-rate mortgages mostly gone, the costs of house flipping are making it more difficult to make a profit. If you choose to flip property, you should be aware of the risks. Even if it looks easy on TV, house flipping is one thing you may not want to try at home.
Related articles:
If you need help with saving money at home or making more money with your investments, give the Fool's personal-finance service, Motley Fool Green Light, a try. Each month, you'll get solid advice that will point you to potential savings. You can look at both current and past issues with the Fool's free 30-day trial.
Fool contributor Dan Caplinger has no plans to flip his house any time soon, though he might reconsider if the price were right. He doesn't own shares of any of the companies mentioned in this article. The Fool's disclosure policy will make you flip.
