Now that the housing market is off its tear in most regions flipping has lost some of its shine. Maybe one of the most telling indicators that the pendulum has started to swing is that accusations of fraud are popping up even in the sanitized world of reality TV. One Flip This House participant evidently didn’t even own the properties that he allegedly was flipping for big bucks. If you can’t trust what you see on reality TV then whom can you believe these days?
All of this submitted as evidence of a fact that we already knew: flipping isn’t investing, it’s speculating. Not that there’s anything wrong with that (s they say on Seinfeld) but it’s important to acknowledge that flipping is a speculative technique that works if the market is zooming and the buyer has a healthy risk appetite.
But that’s all so 2006, so what trend are they going to selling us next?
Well one person's pain is another one's profit, so expect the focus to shift to short sellers and pre-foreclosure investors. Not as groovy as the high rolling world of the flippers since it requires the investor to deal with the unpleasant task of negotiating with folks who are having their home foreclosed, but in an environment of flattening prices and embattled mortgage holders short selling can work.
Quick primer: The bank doesn’t want to get stuck with a foreclosure. I’m always irritated when I read these exposés about banks licking their chops to kick old ladies out of their houses and sell it on the auction block the minute she gets behind on her payments. The truth is that a foreclosure is a black eye to a bank. Banks don’t want to own houses, especially one that has been trashed by a foreclosed owner.
If the owner is getting foreclosed on a house with no equity then there isn't a lot he can do. Say the house has a current value of $150 thousand and he owes $160 thousand on the mortgage; he can't bail himself out by putting it on the market.
Enter the short seller. He makes a deal w/ the owner to give him the house (and the debt) and at the same time cuts a deal with the bank that he’ll pay, say, $125 thousand for them to release the lien. Voila, everyone is happy: the investor bags a quick $25 thousand in equity, the owner avoids the indignity of being foreclosed, and the bank avoids the cost, time and bother of trying to sell the property –which probably would have cost them more than the $35 thousand it just wrote off.
Note that this is nothing new. Investors have been doing it for years. But it about to be the new thing which will be promoted online and in the media.
If the flipping phenomenon was vulnerable to fraud, this one will be as well. Two reasons:
- It’s difficult: Making profits flipping houses in a rising market is as easy as falling off a log. All you need is the right level of risk appetite and lots of guts and initiative. Making profits off of short sales and pre-foreclosures is hard. There are a lot of details to these deals and pulling them off requires knowledge, negotiating skill and patience.
- I'm just here to help: Short selling means dealing with vulnerable, distressed sellers. Short sellers promote themselves as investors who help people - and indeed many of them are good, decent people. But investing isn’t an altruistic pastime, and when a dishonest investor comes into contact with a troubled owner who is looking for a lifeline there is a potential for bad things to happen.
I’m trying to look into the crystal ball on this one. I’ll revisit in a couple of months…