House flipping became noticeably more popular in recent years after a spate of real estate reality shows began popping up on certain networks. It wasn’t long before get rich quick house flipping “experts” began making the rounds on YouTube, at seminars and networking events. With the mortgage crisis of 2008 a distant memory, everyday people around the country began picking up the pieces of their financial losses by taking out new loans in order to buy and flip houses.
The truth is, flipping houses is one way to make a lot of money fairly quickly in real estate. It’s not easy, and it’s certainly not passive, but it can work—under the right conditions.
However, the reality of flipping houses isn’t as shiny and straightforward as some would have you believe. First of all, the market has to be in a certain state for a house flip to work out. There needs to be a demand for housing, which leads to rising home prices, and the house flipper has to be able to sell at a net profit.
Second—and this is especially pertinent in today’s unfriendly trade climate—building materials need to be affordable. If a house flipper is paying premium rates on rehab materials, that just makes it all the harder to realize gains.
The Present Outlook for House Flippers
Currently, the real estate market isn’t particularly welcoming for intrepid house flippers. The challenges include exorbitant interest rates, maxed out housing prices in most states and unknown future market conditions due to a 10-year upswing.
The State of Lending Right Now
As you know, you can’t get conventional lending for a true flip. Fannie Mae only lends for homes in livable condition. Any house flippers hoping to squeeze out a profit from simple cosmetic upgrades on a livable Fannie Mae property are stopped at the gate by sky-high purchase prices.
That’s why house flippers often resort to hard money lenders for funding. Therein lies the danger with fix and flips in today’s economic climate. Depending on where you shop for a hard money loan, you can easily expect to pay in the neighborhood of 12% annual interest on terms as short as six or eight months. You have to pay interest every month no matter what happens. If a project you thought was going to take six months to complete ends up taking 12, that’s a lot of interest every month that you didn’t budget for.
Although you can hypothesize based on previous experience, no one can accurately predict how long a project is really going to take. There are too many variables at play. In today’s market, if your exit strategy was to flip and sell, you could be stuck holding the loan indefinitely.
This could have disastrous consequences for your project, your credit, and your finances. Less seasoned home flippers are finding it harder to earn a profit, albeit some are taking the risks and still making a killing.
Housing Prices Have Hit Ceiling Levels
For the last ten years or so, house prices have steadily gone up. If history has taught us anything, it’s that we can’t count on an everlasting housing price increase. A host of experienced real estate pundits are now suggesting that housing prices have hit ceiling levels. Already, prices have plateaued in a number of key cities, including Boulder, Nashville and even Seattle, where Zillow estimates that prices will begin a slow tumble over the next year.
The Rental Market Is Hot
All signs are pointing to a rental market that’s heating up. Rent prices in 36 states are rising fast, as more and more people are priced out of buying a home and turning to renting instead. This bodes well for the buy and hold investor.
Why Buy and Hold Is a Smart Strategy
Buy and hold is a smart strategy in almost any real estate climate. You can always rent out the property and make positive cash flow. When the real estate market is hot, as it is now, you can cash flow off your buy and hold property to pad your retirement, pay off debt or build your investment fund to buy more rentals.
The Bottom Line
Flipping can work out if you aren’t using hard money, if you can do it full-time, and if the property will positively cash flow in the event of a market crash. But if you’re still getting started in real estate investing and still in a full-time job, flipping isn’t necessarily the safest strategy, at least right now. It’s very risky to borrow at 12% interest rates not knowing whether you’ll be able to get your money out, repay the loan or sell at all.
Instead, consider getting yourself into a more liquid financial situation where you don’t have to rely on a hard money loan, especially if you’re working full-time. Save up for the down payment on a buy and hold or turnkey rental property that’s already cash flowing. This will give you an extra steady income that you can continue to pour back into your investment fund and build out a large rental portfolio over time. In today’s market and the foreseeable future, you’ll have no trouble keeping your turnkey rentals occupied.
If you’re already in the midst of a flip, it might be good to use any profits you make to start investing in buy and hold rental properties, such as turnkey rentals. Whatever you do, consider avoiding any more hard money loans right now. Focus on getting safe financing that won’t make you sweat if your exit strategy fails.
There’s no absolutely perfect answer for every single person’s situation. Fix and flips can work sometimes when every pin is in place. But for now, it’s worth it to seriously consider buying and holding.
This article has been contributed by Antoine Martel from MartelTurnkey.