What Goes Around ...
More and more people are buying houses with the intention of sprucing them up and reselling them at sizable markups a few months later. Why not? Residential real estate prices have been consistently moving higher, especially in the markets that tumbled the most during the financial collapse. Mortgage rates remain reasonable. The economy's improving. What could go wrong?
Housing data analytics specialist RealtyTrac reported on Thursday that home flippers made a 30 percent gross return on their short-term purchases through the first three months of this year. That's impressive, and it's going to tempt more casual market observers into the fold.
However, the easy money has already been made, and it's going to be a lot more difficult to turn a quick profit on properties in the future. Let's go over five things to watch out for in this now-flawed pursuit for easy cash.
5 Reasons You Might Want to Skip the Flip
1. A 30 percent gross return is not a net return. RealtyTrac's data shows that flippers paid an average of $183,276 on a property investment, selling the house for an average of $238,850 a few months later. That sounds neat, but keep in mind that this doesn't mean pocketing a profit of $55,574. Flippers spend an average of nearly $5,000 to improve the properties they buy to make them more marketable -- about 3.34 percent of the purchase. But the bigger bargains are usually in sorry shape, making them more costly to spruce up. And in depending on where you live, the average price tag gets much higher: As RealtyTrac reports, in Atlanta the median amount spent on improving a flip was $18,250; in San Francisco, it was $13,900. Let's also not forget real estate brokerage commissions that can eat as much as 6 percent of a sale.
2. Carrying costs can be a killer. Anyone who has owned a home can tell you that it's not always a bargain. Utilities may not be as expensive for a vacant home, but taxes and insurance costs accrue between the purchase and the eventual sale.
3. Homebuilders are developing again. One factor helping the housing market's recovery is that real estate developers were forced to the sidelines during the early stages. Folks weren't buying houses, so they had no reason to build more. That has changed lately. Higher prices and rising demand have breathed new life into the construction business. That spike in new supply means flippers aren't just competing against existing properties. Deals may still be there for buyers of distressed properties, but the increased supply will make it harder to sell later.
4. Mortgage rates won't stay low forever. The Federal Reserve kept interest rates low during the long recessionary stretch and its aftermath, but now that the economy's showing genuine signs of life, we're seeing rates inch higher. Mortgage rates have actually been sliding a bit in recent weeks, but they're still almost a full percentage point above where they were during last year's record lows. Higher mortgage rates means fewer people who qualify to borrow the money to buy the homes that flippers are selling. As for investors, higher interest rates give more of an advantage to folks paying all cash for properties to flip. It's not easy to have all that money tied up in a property that may or may not sell a couple of months later.
5. Prices won't keep rising. The combination of the last two points -- more new homes going up and higher mortgage rates -- make it highly unlikely that prices will continue to increase at a rate that makes flipping as profitable as it has been recently.
It was fun while it lasted, but it's time for home flippers to find a new way to get rich.
Rick Munarriz is a Motley Fool contributing writer.