Buying a Home or Flipping a House?

8/27/2005, 7:24 am

Those who buy a home as a place to live, a place to raise a family or where they can settle comfortably for a period of time, aren’t usually concerned about the normal, expected fluctuations in home values.

And while it doesn’t make the news as much as the current talk about real estate bubbles and exotic mortgages, I think it’s still true that the American dream includes buying a home. Notice I didn’t write, “buying a house”. In my opinion, there’s a difference.

It feels good when your home appreciates in value. And when real estate prices slide, if your home depreciates in value, it may not feel good, but it doesn’t cause too much stress. You know the primary value of your home is that it is a home.

However, the real estate market has another side that can be stressful and financially dangerous. It’s called “flipping”. And in some places it seems like everyone is doing it and, in those areas, the real estate market is a little crazy.

Large numbers of houses are being bought and sold as investments — not as homes. If you’ve been to the book store, watched the news or read a newspaper, you’ve probably heard the phrase “house flipping”. It’s the act of buying a house and then selling it for more than it cost the buyer. House flipping is not about home ownership. It’s about turning a quick buck and in many markets involves a good bit of speculation.

If a house flipper doesn’t time it right, he or she can face significant financial loss. Someone is always the last to buy a house before the market slides. It’s important for house flippers to remember the old phrase, “what goes up must come down,” because it happens to house prices.

Imagine this scenario: Flipper “A” buys a house (an “investment property”) for $200,000 and sells it to flipper “B” for $220,000. “A” makes a nice profit. It’s probably not as much as he thinks (more about this in a future post), but a profit nonetheless.

Next, imagine that flipper “B” then sells to flipper “C” for $245,000. “B” makes a profit.

What goes up must come down. Let’s assume the market turns downward after flipper “C” buys and prices begin declining. Flipper “C” can’t find a buyer for the $260,000 he expected. Time passes and “C” drops the price to $250,000. “C” is beginning to fret because after closing costs and transaction fees, there’s not much profit between $250,000 and $245,000.

Let’s imagine in this contrived scenario that prices continue sliding until they return to “normal”. If that happens, Flipper “C” is stuck with a heavy loss because his investment property is now valued at $205,000 or $40,000 less than he paid. It happens.

Two Lessons: 1) Be careful flipping in a market that is already over-valued. And 2) if you’re a home buyer in a market that seems too pricey, the path of patience is probably worth considering.

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