It had been removed from everyone’s vocabulary for the past decade. But now I’m starting the hear the “F” word again in real estate. The “F” word I’m talking about is “Flipping”… The very thing that cost so many people their life savings, credit score and sanity is now making a comeback. Flipping, along with adjustable rate mortgages (which are also making a comeback) are mostly responsible for the housing crash we saw in 2007.
I only bring this up because I see amateur real estate flippers, and some under-funded builders, once again trying to strike gold by flipping properties. I saw what this did to our economy 8 years ago and would hate to see history repeat itself.
What’s the difference between a flipper and a real estate investor or developer? Real Estate investors and developers develop or invest in real estate as a profession. They are well funded in their projects and have their risk spread out over several projects. And they typically have a lender who is holding their funds and will release new funds based on the success of their previous investments. For example – a developer wants to build 60 townhomes on land he/she just purchased. The lender will release construction funds based on the # of pre-sold units they have written contracts for. So instead of building all 60 at once then possibly getting into financial trouble if they don’t sell fast, the lender will release funds to build 10 at a time each time the developer pre-sells 10 units.
On the other hand, a flipper is typically someone who perceives that everyone around them is getting rich off real estate and they decide to jump in to make a quick return. They often lack the funds to do this so they look to financing, usually in the form of an adjustable rate mortgage and lowest possible down payment (because after all they’re flipping it and don’t plan to own it for more than a few months…). Here’s where the trouble begins – the property usually needs upgrades before it can be flipped. So the flipper spends what cash they have on the repairs (which usually cost more than originally estimated). Then instead of selling in 30 days, 90, 120, 180 days pass with no buyer. The flipper is out of cash and can no longer pay the note. The bank forecloses and now the neighbors have a foreclosure property in their neighborhood which will negatively affect their values. Oh, and the flipper is now broke with no credit..
Additionally, some of these amateur investors bought multiple properties with the intention to own them long term and put renters in them. And they made money for a few years on the difference between rent amount and their mortgage payment. Then the adjustable rate mortgage adjusted and their monthly mortgage payment doubled or tripled and suddenly they were having to cover the difference in the monthly payments. It didn’t take long for the dominos to start falling after that.
I write this as a cautionary tale for those who are once again tempted to dabble in real estate flipping. My advice – buy and plan to hold that property for at least 5 years. And get a fixed rate mortgage if you need financing. It’s 2016 now, prices have been steadily climbing since 2010. The real “deals” were bought up in 2009-2012 by cash investors. If you’re a flipper looking to make a quick return, resist that urge to “buy now before prices get any higher”. Speculative buying got too many people in trouble 10 years ago. Let’s not let that happen again.
If you want to see how this all played out in the mid 2000’s watch The Big Short, it’s eye opening to say the least! The Big Short trailer