Realty Views By Terry Ross

House Flipping And Artificial AppreciationTerry Ross, Realty Views

September 24th, 2013 – House flipping is far from a new phenomenon in real estate, but during the depths of the recent Great Recession there wasn’t much of an appetite for this area of real estate “investing” – especially with prices going in the wrong direction.

But as lending institutions cleared out their foreclosed/short sale inventory and sellers not forced to sell because of circumstance chose not to sell and leave 30 percent of their equity on the table in a depressed market, the availability of inventory for the limited number of buyers in the market dried up. This shortage has stabilized prices and even inflated them to an extent in some areas.

Flippers, by definition, take homes in a rapidly rising market that are undervalued and need some minor upgrades, buy them, do some fixing, then sell for a profit. The problem is that this is not always a guaranteed formula and can have a number of pitfalls – especially for novice investors in a market like we have now where trends may be short-lived and an unstable economy might turn today’s hot trend into tomorrow’s nightmare.

According to Chris Cagan, vice president of John Burns Real Estate Consulting Inc. in Irvine, today’s market – one that most experts agree has been artificially inflated to a degree by investors pumping money into a shortage of inventory – is not the best environment for get-rich profits in flipping homes.

“Home price appreciation has been so rampant, particularly in California and Florida, that flippers and get-rich-quick scam artists are flourishing again,” Cagan said. “Just as in the mania of 2004-06, flippers make money when the party is raging, but inevitably, someone loses when the party is busted.”

Cagan and his colleagues at John Burns have taken a very analytical look at the current state of flipping homes and have come to some interesting conclusions. The average reported net profit for flippers across the nation was 32 percent – that is allowing for the cost of repairs and sales. He allows that successful flips are more likely to be reported than the failures and challenges the premise that you can make a 30 percent profit in a market that he says is probably rising at the rate of 10 percent a year.

“The perceived gains from flipping are exaggerated . . .” Cagan added. “A profit of 30 percent means that the flipper has quickly identified, produced, and extracted a previously unnoticed 30 percent value opportunity. If overall prices have risen 5 percent, the flipper has been 25 percent smarter than the market. Such extreme, beat-the-market gains can sometimes be made by expert investors willing to take risks, such as those who recognized the over-depressed level of distressed home prices in 2012. But not everyone is that sharp or fortunate. Smart investors will realize there is more risk in investing now, given the degree prices have risen due to flippers.”

Cagan also cautioned about the “get rich quick” mentality that pervades the flipping market and the media hype that goes with it.

“Flipping has moved beyond a segment of professionals working with undervalued and distressed properties,” Cagan explained. “Seminars, tours and television shows encourage people to invest with flippers or to flip homes themselves. As in the boom of the previous decade, many people see easy money to be made.”

The fundamentals of the market appear to be on the upswing, but he cautions that there are elements at play that are creating artificial demand and that could leave unlucky flippers holding a property and some repair bills – with no buyer.

“. . . [Do] not assume that recent successes will continue forever, and be cognizant of the fact that artificial demand – flippers flipping to other flippers – is the ultimate artificial demand and can distort (the) market,” Cagan said.

(Terry Ross, the broker-owner of TR Properties, will answer any questions about today’s real estate market. E-mail questions to Realty Views at terryross1@cs.com or call  562/498-1049.)