A House of Cards? Why Flipping Might Be Hazardous to Your Wealth…

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The US housing market rebound is a house of cards ready to topple. Flippers should take the changing environment into account when modeling their next flip investments.

Before all the real estate flippers jump down to the comments and state why I am wrong and how flipping is locally drive, I just want to lay out my reasons for why I think that the housing prices are headed for a second crash speaking at a marco/national level.

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Reasons for the House of Cards

I have a couple of statistics that I would like to point out:

New home mortgages are guaranteed by government, and he or she is unlikely to estimate anywhere near 91.6%. And yet that is the actual figure as of the first quarter, based on data from Inside Mortgage Finance.

As FHA and VA are concerned, the down payments required are minuscule by conventional standards, ranging from 0% to 5%. According to a recent FHA report, the average down payment required on it’s insured mortgages in the first quarter has been a little over 4%. The VA’s rather chilling statistical category called No Down Payment indicates that close to 90% of its home loans normally enjoy this status.

Housing has also been “supported by low mortgage rates and improved sentiment on the part of potential buyers,” to quote from the May 22 congressional testimony by Federal Reserve Chairman Ben Bernanke, who has been playing a proactive role in such matters. Through it’s aggressive program of buying new mortgage debt, the Bernanke Fed has been helping to push mortgage interest rates to lows previously unseen for 100 years.

Furthermore, mortgage interest rates are rising. In the week ending June 6, the 30-year fixed rate mortgage clocked 3.91% in its fifth consecutive weekly gain, according to Freddie Mac, after hitting its highest level in a year last week. That’s 18% higher than the 3.31% record low set in November of 2012 and almost 17% higher than the 3.35% rate logged in the beginning of May. The 15-year fixed rate broke above 3% as well, to 3.03%.

How the Market Trends Might Affect the Future Housing Industry

Compared to a month ago, the increase translates roughly into an extra $30 per month for every $100,000 of debt accrued. If rates continue their upward march, mortgages will become more expensive.

Current affordability is almost entirely dependent on low interest rates, and there’s no doubt that rates will begin to rise in the next few years,” asserted Stan Humphries, chief economist of Zillow.  ”This will have an undeniable effect on demand for housing, as home buyers will have to spend more of their incomes to buy a home. Home values will have to either remain stagnant while incomes catch up or, quite possibly, home values will have to fall in some markets. This will especially be the case in some markets that have seen strong home value appreciation.”

The first thing rising rates affect is refinance applications. Refi apps have fallen for the past several weeks, logging a 15% drop (after accounting for Memorial Day) last week from the week before, according to the Mortgage Bankers Association. Mortgage applications have begun to tick down too, falling 11.5% from the week earlier.

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About Author

Ankit Duggal

Ankit Duggal(G+) is the Investment Director of a New Jersey Income Operating & Consulting Company . Ankit is a seasoned value investor who enjoys achieving a zen through surfing, hot yoga, and snowboarding.

14 Comments

  1. I wouldn’t disagree with that stats or the trend.

    If flipping is about getting in and getting out quickly, and buying far enough below to make a safe profit I don’t see how flippers are any more vulnerable to the market then anyone else?

    If demand slows, and supply rises I would also think it would be easier to aquire houses at the right price if owners cant easily sell.

    • Ankit Duggal

      I agree completely it is about getting in and getting out. However, when you get into a deal you are projecting some type of exit/resale value. Let’s assume you get into a deal projecting a certain sale price that is no longer affordable to buyers given a 100 basis point rise in the interest rate or the 10-T rate as we have seen from May into June of this year. That would have a material impact to the profit line of the flipper given that a price reduction maybe in order as demand stalls or slows down and if you are midway through your rehab project then you may have to reconsider the profit estimation from the deal.

      • I am right there with you Ankit – but we usually whisper this kind of thing in lieu of saying it out loud. Nobody wants to hear it.

        Home ownership rate has been continually falling – people don’t trust RE. People intuitively know that it is a house of cards!

        BTW – flipping is not an investing strategy; it is a trading activity – glorified speculation…I think that the professionals like J Scott and other know this and will be ready, but the newbies on BiggerPockets who know nothing of history will definitely get their clocks cleaned….

        • Ankit Duggal

          Ben

          Oh geez. I did not get the memo on not saying it out loud. I guess the secrets out now.

          I agree that flipping is a trading strategy hence a flipper needs to be a professional like J Scott and others as they really understand supply, demand, affordability and general market analysis of their investments prior to making those trading bets.

        • Wholesaling is a trading activity. Flipping is real estate development. Your investing time, money and labor to improve the value of an property. Flippers build real value. Long term investors have more to do with speculators than flippers.

  2. Mark Ferguson

    We’ve made money on flipping for over ten years through up and down markets. Like it was mentioned, it is all about selling quickly and leaving yourself enough room for unknowns like market corrections, unknown repairs, legal issues etc.

    The Fed basically came out and said they fear rising rates will hurt the economies recovery and will not let them rise too high. In our market, it is not a lack of buying power that is slowing down buyers, it is a lack of houses. Even if rates rose a couple points we would still have enough buyers to pick up our inventory in the lower end. It might hurt the higher end a little bit.

    • Ankit Duggal

      Thanks Mark. What is the amount of room that you have found to be a good margin of safety on your flips through both markets?

      You bring up a great point as to which buyer type would the change in interest rates most affect. I thought that as rates went up the higher priced buyers would be better able to absorb the change given that they have more personal and investment income would be better able to sustain the change in payment without having to drop the price down. That is my thought on it atleast.

        • My main point was there is so little inventory in the low end, that there is a surplus of buyers and by shear volume there should be enough buyers that still qualify for low end house if rates go up. The higher up the price range you go in my area, the more houses there are available. I think the higher end would be hurt more, because buyers have more to choose from and there are fewer buyers in that price range.

          Our flips are pretty close to the 70% rule. We may go slightly higher up to 75% of ARV minus repairs.

  3. I have a investment house I own with a partner who is now living on long term disability and makes about $15K a year. The mortgage has always been in her name, though I have been a 50% owner on the deed of trust. I have never signed a promissory note for this property. We decided to go ahead and refi this property and she contacted BOA, the holder of the current note. I told her they would never refi her with her current income and basically no assets to speak of, though she has a 750 FICO score. They refi’ed her $99K, the balance of the note, the home being worth maybe $120K, with me remaining on the DOT, but not signing the promissory note. They didn’t even bat an eye, nor asked me for any financials. Sorry, but I think BOA are out of their minds. I wouldn’t have written the note. It’s actions like this that make me wonder about how stable things really are. This is the kind of lending scares the crap out of me, even though it was beneficial to me. Would any of you extend this loan?

    • A NEW loan in this situation would be nuts, but if they already held the $99k note they were already at risk, right?

      If she is in a tight money flow situation the refi might reduce the risk of a foreclosure, since it presumably resulted in lower monthly payments. So not necessarily as crazy as it sounds.

  4. I think the newbies who got killed in the last market were heavily influenced by the media and more accurately the reality series on flipping. The latest batch of house flipping shows is even more reckless.

    My favorite is the Las Vegas based group, buying houses at auction completely blind of what the interior of these homes might look like. After shelling out $200k-$400k for a property then celebrate the idea of making $20k on the flip.

    My advice to flippers, don’t buy and renovate anything that you cannot hold as a rental if the need arises.

  5. Thanks for the article, I do agree with you that the increase in interests rates would likely have an effect on the real estate market. However, given the size of the country, the diversity of the real estate and real estate values, I’m curious as whether you might have any specific areas, property types etc, in mind when you wrote this?
    The reason I ask is because I was just discussing with my realtor about how some real estate here in Orange County, California hasn’t enjoyed a run up in prices despite the red hot market, and obviously in those cases, a rise in interests rates would have no effect either. By knowing at least the price range or property type you are referring to would really help to give context to your opinion. Thanks.

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