House flipping is all the rage. Any time real estate prices start going haywire, an army of flippers takes advantage by buying old houses, fixing them up a little, and then reaping a nice short-term profit when they sell them.
The economics are good when prices keep going up. If you put 10% down on a $350,000 house, invest another $50,000 fixing it up, and then sell it for $450,000, you have $50,000 of profit on an $85,000 investment. That's good for a 59% return. Funnel that profit into even more houses, and it starts pyramiding into a little fortune.
The problem is when prices stop going up. Let's go over a few reasons why house flipping in the real world isn't as a great an investment as HGTV may make you think.
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Prices won't go up forever
House flipping and stock trading have a lot in common: Easy money increases demand, pushing up prices, which attracts more investors, increasing demand more, which increases prices, and attracts even more investors. Of course, house flipping is more involved -- you have to have some level of expertise to fix up the houses that you're flipping -- but it can be the same house of cards that all comes falling down once the momentum stops.
We may be there now. Interest rates are heading up, and demand is starting to slow. The average 30-year mortgage rate is up from 3.42% at the beginning of the year to 5.56% now, and mortgage originations have fallen in eight of the past nine weeks.
Let's go back to the example above. You buy a house for $350,000 with the intention of flipping it and invest an extra $50,000. What happens if you list it for $425,000 and no one buys it? Even worse, what happens if you used an adjustable-rate mortgage to put less money down and now your payments are set to almost double?
House flipping can turn into a game of musical chairs once interest rates start to increase -- and you don't want to be the one left standing when the music stops.
Materials prices could keep going up
For house flippers, the worst of both worlds is if housing prices stall or even fall and materials prices keep going up. The prices of materials such as lumber, steel, and copper have already skyrocketed over the past two years, and even if demand for single-family residences falls, there could be plenty of demand for commercial buildings and large multifamily complexes (people who can't afford to buy a house anymore need to rent).
Rising materials prices can wreak havoc with your investment analysis. If you bid out a job and can't get the purchase closed and the job going for six months, your costs could be up 40% in that time. And you can't just depend on the contractor to stay with their bid. Many contractors don't have close to that level of margin and would go out of business.
Speaking of contractors, in many areas the good ones are already booked out for months. It may tempt you to try to do the work by yourself. But that brings you to the worst-case scenario.
It's a ton of work
If you have a TV network funding your flip, you can probably find good contractors to plan and do the work fixing up old houses. For the rest of us, though, house flipping will consume your life.
I work in construction, and on most jobs there is a project manager, superintendent, and some type of administrator for the general contractor, and then the same tiers of middle management for each subcontractor (subcontractors take care of things like electric or HVAC work that the GC doesn't have the expertise to do).
There's a reason for each of those managers. Someone needs to be on-site fighting daily fires. Someone must be managing the project and making sure everything is going as planned (it never does, so they need to make new plans, too). And someone's got to be in the main office doing the accounting, HR, IT, and corporate planning work. You can get away with skipping some of this (like HR), but the more corners you cut, the more liability you could be taking on if things go wrong.
And if you don't cut corners, you're taking on multiple full-time jobs. If you already have a full-time job, say goodbye to night and weekends. If you don't and real estate prices drop while material prices increase, say goodbye to your money.
Flippin' ain't easy
Most people wouldn't watch Diners, Drive-Ins, and Dives and plow their savings into a new restaurant the next day, but plenty of people watch HGTV and become convinced that flipping houses is the way to get rich. In reality, flipping houses usually costs a ton of money and means a ton of work -- but doesn't pay off with much profit.
