A combination of low interest rates, low inventory and a booming economy has created a near-ideal situation for home flippers who buy properties, fix them up and sell them quickly at a profit. But the prospect of a recession could quickly change that equation, experts warn.
“We're definitely reaching the top of the bubble,” Taylor Denchfield, a Washington, D.C.-area real estate broker, said in an interview on CNBC's “American Greed.”
Denchfield says he has been flipping houses since he was 17 (he is now 25).
Data from the first three months of the year suggests the property resale market is already starting to cool.
Flippers flipped more than 49,000 homes in the first quarter, accounting for 7.2% of total home sales in the quarter and the highest rate since 2010, according to real-estate-research firm Atom Data Solutions. But profits on those sales were down nearly 10% from a year ago. The average return on investment (38.7%) was the lowest since mid-2011. And the number of flippers fell 11%.
“Investors may want to exit while they're strong, before the market weakens further,” said Todd Teta, chief product officer at Atom.
But Denchfield said that's no reason to panic.
“There's still some room to make money, but we need to be a lot more diligent in the deals we're making,” he said.
Calculated Risk
The consequences of misusing the market can be severe.
In one of the most extreme examples, Phoenix businessman Scott Menage tried to become a home-flipping king, haphazardly buying up foreclosures after the 2008 financial crisis. He was so successful that he appeared on the Discovery Channel reality show “Property Wars” in 2012.
But as his debts mounted in 2014, Menagerie turned to fraud, lying to banks and other lenders to keep his empire afloat and support his lavish lifestyle. Even more brutally, he even used Social Security death records to steal their identities and set up lines of credit in the names of deceased borrowers.
“Everything that was connected to Scott was tainted with some kind of fraud, some kind of lie,” IRS Criminal Investigator Dennis Lucero told American Greed. “The question was always, is this guy going to stop?”
Not even a market downturn could stop him, and finally the authorities caught up with him. Now, Menajid is serving a 17-year prison sentence after pleading guilty in 2017 to bank fraud conspiracy, money laundering conspiracy, and aggravated identity theft. He was ordered to pay more than $33 million in restitution. But tragically, it was too late for his main lender, Densco founder Denny Chittick, who committed suicide in 2016 after suffering huge losses.
Flipping 101
Although Menaggi's case is extreme, Denchfield said it offers lessons for anyone trying to operate in the home resale market.
“You shouldn't try to do more than you can handle. You shouldn't try to do more than you can handle,” he said.
This is especially true for beginners, who he urges to take it slow.
“If this is your first time reselling, see it through to the end. Make a profit and move on to the next venture before scaling up.”
Denchfield said the most common mistake flippers make is not having enough assets to go through the process. In addition to the money to buy the property, they have to cover upkeep costs like property taxes, insurance, homeowners association dues and mortgage payments. Plus, there are renovation costs and the costs of marketing and selling the property.
“The biggest mistake home flippers make is running out of money,” Denchfield says. “Many flippers underestimate how much money they'll need to complete the project.”
With most home improvement projects, there are always unexpected things that happen. It can be very difficult to predict how long a property will take to sell. Successful real estate agents factor these variables into their budgets.
“In any deal, there are always going to be budget overruns and delays,” Denchfield said.
He recommends gaining knowledge about home renovation and construction.
“Controlling the construction and managing the schedule is the most valuable resource,” he said.
If you are serious about making a living from flipping homes, you should consider getting a real estate license. Working as your own real estate agent means you won't have to pay commissions to someone else.
“Typically, you can save 3% when you buy and 3% when you sell, adding 6% to your bottom line on the deal.”
Denchfield sees the growing talk of a recession as a warning to be disciplined, not a signal to switch jobs.
“A recession is definitely on the way, but we're not there yet,” he said. “Use your time to your advantage and get out of your holdings before the economy changes.”
But it's becoming increasingly important to have contingency plans in place in case the market worsens, he said.
“You should always have a backup plan so you can rent out your home in case it doesn't sell for the price you expected,” he said.
Watch as real estate reality TV star Scott Menage turns his successful home flipping career into a web of lies, deception and huge losses in an all-new episode of “American Greed,” Monday, September 16th at 10PM ET/PT only on CNBC.