National Housing Market Outlook

Don’t Flip Out: Beware the Risk of Artificial Appreciation

September 18, 2013

Flipping is back!

Home price appreciation has been so rampant, particularly in California and Florida, that flippers and get-rich-quick scam artists are flourishing again. 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. We are advising our clients in areas with a high percentage of flippers to take into account the risk of artificial price appreciation.

Using a wide range of articles on flipping from across the nation, I looked at the initial prices paid, amounts invested in repairs and improvements, and selling prices for this anecdotal set of flipped houses. The average net profit after allowing for expenses – sometimes the property was a major fixer, sometimes the repairs were cosmetic – was 32%. While successful flips are more likely to be reported than unsuccessful ones, the profits described to the public wildly surpass the reality of the recovering market. Flipping has moved beyond a segment of professionals working with undervalued and distressed properties; 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 perceived gains from flipping are exaggerated in a market where prices are rising at 10% per year. A profit of 30% means that the flipper has quickly identified, produced, and extracted a previously unnoticed 30% value opportunity. If overall prices have risen 5%, the flipper has been 25% 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.

Today, the fundamentals for continued price appreciation are very good in the majority of markets. However, 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 – can distort your market.

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