Real estate investors have come under fire recently, particularly for the common practice of “flipping” a property. An investor finds a seller who is willing to sell for a low price (perhaps because of imminent foreclosure or to gain immediate cash to pay other debts), then immediately attempts to resell the property to a third party. It’s the day trading of the real estate world, with advantages to those familiar with real estate law, finance, and the nuances of local real estate conditions. FULL ARTICLE
Source link: http://archive.mises.org/5792/is-house-flipping-sleazy/
Is House Flipping Sleazy?
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Why weaken your argument by trying to defend “predatory” lending along with “house flipping”?
It strikes me that this piece is certainly Digg Worthy.
Old saying, “Nothing happens until someone sells something.” This is the truth in the last 20 years. Most all purchases are elective – not generally life sustaining.
M E Hoffer,
I’m not sure how (a) Terrell defended predatory lending or (b) how it (would have) weakened his argument.
He cites a bill with the name ‘predatory’ in it, but only insofar as it included actions against house flipping.
Where is the added weakness in his argument?
My passing comparison to subprime lenders, network marketers, and faith healers has generated some misunderstanding, judging from blog-posted and privately e-mailed responses to the article. I could have been more clear. I was trying to give people who are unfamiliar with property investors an idea of how they are regarded socially, by comparison with others who (rightly or wrongly, but probably wrongly) are regarded as unsavory bottom-feeders or preying on the ignorant and unsophisticated.
Mr Terrell,
I suppose your article was set to defend the market-working and justify flipping as simply part of that (in a sense: no one can tell me what price I want to sell my home, nor whether I am allowed to by at what price); by this point of view, I surely agree with your work.
In my opinion something should be stressed in economically criticizing H.R.200: law does not consider the value individually attributed to time by the home-seller.
The getting money sooner than later is a service (or a “goods”) which the seller considers worth-paying, and he simply translates it into a lower price (the original price less the value of time spared); it could more formally be said that in certain circumstances personal “intertemporal preferences” can change, a person’s “intertemporal preference ratio” can rise, so to even relevantly discounting the price of the house he is selling (if there is no rationale to save us from higher bank-lending interest rates, there must be no rationale also to save the seller from his higher preference for liquidity).
Moreover, what a flipper makes is simply increasing market’s liquidity, letting houses more easily depart from who wants to sell them, while these remaining available for those who want to buy them; it is, as a principle, what financial market-makers and specialists do in financial markets like NYSE. This does not help forming a bubble, it helps prices in reflecting market’s preferences and values instead; in a sense it solves part of market’s frictions: with increasing demand it avoids excessive rises in prices (when supply-scarcity could be otherwise perceived), conversely, with decreasing demand it avoids falling prices (when fears of weakening demand could otherwise fell sellers into panic-selling).
I’d say that at least one piece of evidence used for the maltreatment of flippers is faulty. Why should flippers, or anyone, be allowed to borrow from the government at favored rates?
Other than that, a fine article.
“in a sense it solves part of market’s frictions: with increasing demand it avoids excessive rises in prices (when supply-scarcity could be otherwise perceived), conversely, with decreasing demand it avoids falling prices (when fears of weakening demand could otherwise fell sellers into panic-selling).”
Are we supposed to understand, that because of the existence of “liquidity-providing” “flippers”, the numerous anecdotes of recent “bidding frenzies” and transactions closing at significant premiums to asking prices were ephemeral, merely fables? Conversely, now, seemingly after the fever has broken, the anecdotes of “broken” speculators(former “flippers”) disgorging their positions, in flailing attempts to get “whole”, fueling the downside correction of RE prices, are similiar tales?
Funny, too, the many price charts, throughout the Economy, including the vaunted NYSE, that show similiar upside/downside gaps.
Maybe our Fair Liege, the exalted liquidity-providing speculator, has more than few chinks in his armor of lore?
While I’ll grant that I may be taking the post too literally– the Myth of the grand Good of the speculator only greases skids of an Economy that produces little else than Transactions.
Looking for specific instances of government intervention resulting in redistribution of wealth? This is it.
Low interest rates mean home ownership is cheaper. The flipper is really just participating in arbitrage. In order to sell the house to a buyer he has to fix it up and make it attractive, just like you would wash and clean a used car before selling it.
In this system the flipper is really working for the banks, giving them the new mortgages they demand. Of course, as this artificially low interest rate boom turns around, the banks end up turning in to the losers because of mortgage defaults.
The real winner here is the flipper. He has has that cheap credit converted in to cold hard cash. The home owner may be left with a mortgage for more than the house is worth; if the home owner can keep paying it off, the bank is ok. In some scenarios a bank could lose well over $100,000 from a mortgage default.
I am suprised that the writer did not emphasize this further. Real estate flipping should be a classic example of the real world effect of interest rate manipulation which is a cornerstone to Austrian theory.
Is it morally wrong? Absolutely not. The market is simply a manifestation of human wants. The home owner wants a nice new home. The bank was a mortgage. The flipper wants to make a living.
The problem element here is the government (actually the Federal Reserve) which has created a artificial boom. This boom has simply moved wealth from average people to wealthy individuals.
Is that morally wrong? Perhaps.
I do not believe that the “flippers” themselves fully understand what and why is happening from an economic standpoint. All of them take on substantial credit risk while waiting for a home to sell. Unlike the glamorized television shows, many properties will sit on the market for a few months. Undoubtedly many are in trouble right now as the market has turned.
We can already observe condo “flippers” being hit hard in the hot markets, primarily in Florida. Numberous condo developers have simply left projects, defaulting on their bank credit they required to build the property. The intial flippers lost their down payments while bank loses are in the six to seven figure range (and possible eight and beyond.)
In my observations banks are not particularly keen on the entrepreneurial side. I have a friend who sold a mortgage related business to a large bank for probably 50-100 times what it really was worth. It appeared the bank was oblivious that the mortgage boom had already peaked.
I am seeing evidence that banks were very lax on lending standards during the mortgage boom of the past few years. I have to study the process more but is this because they repackage the debt and pass the risk off to someone else?
In summary, I believe house flipping makes for a great case study in the fundamentals of Austrian theory. It would suprise many that had they had only followed late night informercials 6 years they could be retired right now… all thanks to cheap government credit.
There is something magical in exchange; merchant purchases wares cheaply and sells those dearly without even changing their physical substance. This kind of activity is plain sorcery and state is needed to put an end to these devilish practises.
Since we all know that value of thing depends on it’s costs of production there is no space for excessive profit.
Just kidding
AJ,
I was going to post a similar comment, but you hit the nail on the head. The only point you left out was the inevitable loser in the cycle will be the taxpayer, as the government has a history of bailing out banks (“for the good of the economy”) on the back side of the boom. They did in the Depression, and they did after the S&L bust. I’m sure there have been other, smaller bailouts along the way too.
So don’t feel too bad for those banks – they take those stupid risks because they know they won’t be left holding the bag.
Mr Hoffer,
yes, you’re taking the post too literally and I surely have put it too straight: I am surely not saying that speculators (and flippers are speculators) stabilize the market at all (e.g. like Friedman said). My opinion is that in “normal” periods they make the market more liquid than otherwise, and this allows smoother working.
“Frenzy”, with huge price bubbles and sudden deep falling in prices, is another matter; it occurs both with or without “market makers”, and this is a subject still to be completely explained. But unless you think that everyone in the market is crazy all the time, we can surely distinguish a normally working market from a frenzied one.
Please note I mentioned the NYSE: do you really think I am not aware of its chilling up’s and down’s who occur from time to time? I just wanted to say, that we can find in flippers a housing-”alter ego” for market-makers, surely unaware of their role but never the less doing this (by the way, is not the Austrian school who says that anyone plays a role in developing the economy through simply pursuing his own interest, companies included?).
That you may say that market makers are useless or harmful, is another question.
LB
Flippers and Rehabbers are two different animals. Flippers perform a function similar to day-traders: fine-tuning the price and helping to ensure a more efficient allocation of capital.
However, rehabbers do a lot more. Although some rehabbers do merely “throw on a coat of paint”, most do much more. Many (1) strip the house down to the studs, (2) ensure plumbing and electrical is up to snuff while the “hood is popped”, (3) put in new walls, (4) fix the roof, (5) put in new hardwood floors, (6) repair broken windows, (7) install new kitchens and bathrooms, (8) paint the outside, and (9) maybe do a little landscaping.
It’s a lot of work, but they are NO DIFFERENT than the home builders. They are increasing the supply of livable homes, making prices lower.
Some of the most desirable neighborhoods to live in Metro areas are 100% re-habbed urban neighborhoods. what was once blocks of beat-up 100-year-old brick buildings that actually stand the test of time (I feel the homes being constructed now will not be around in 100 years, unlike homes built in 1905) are now beautiful brick buildings, often restored to their original decor. You get immaculate hardwood floors, massive kitchens (the trend nowadays), and nicely-tiled bathrooms.
The buyer gets a really nice home within (often) walking distance to stores and restaurants, a short commute, and a reprive from overcrowded government roads.
Upper-middle class urban neighborhoods are in strong demand nowadays, and rehabbers are meeting it.
Quasibill,
The FDIC has its own discretion whether to bail out a bank or not — and not everyone gets bailed out.
There is no empathy from me toward “flippers” or banks. My disappointment is toward hard working employees who just want to earn a modest living and support their families. Agile entrepreneurs (myself included) work our tails off to stay ahead of the markets. That means more dollars in our pockets thanks to an inflationary monetary system. Not a good deal for the rest.
I agree with Nick that honest-to-goodness flippers (those who buy, fix up fast, and resell) are really no different than home builders. They add value to the market place. They make a less desirable good more desirable (at least, that’s the idea anyway).
This business about signing a piece of paper, then signing a new one 3 weeks later and finding yourself $50K richer, on the other hand… not sleazy, but certainly a europhic-inducing fantasy of huge risk in which most who indulged are either sorry or will be. http://www.strike-the-root.com/62/losapio/losapio1.html
LB,
“That you may say that market makers are useless or harmful, is another question.”
As NB, above, correctly points out, “flippers” and “rehabbers” are distinct fauna of the Marketplace. As well, “flippers” should not be confused with “market makers”, either.
Traditional “market makers”, typically, have their own, Considerable, capital at risk, and are charged with the responsibilty of providing a semblence of continuity in the face of market “imbalances”.
“flippers”, on the other hand, much like their recently departed stock market analog, the “day trader”, are, typically, flimsily Capitalized momentum-based Transaction-junkies. Addicts with no responsibilty, serving little else than to exacerbate current market trends, at first, to the Upside, then, predictably, logically, if not chronologically, to the Downside.
Should “flippers” be “banned”, hardly. Should they share the same place, in our analysis/understanding, as “market makers”, No.
Enrepreneurialism, dynamism, and property-appreciation acuity do exist and are good things.
But chicanery is even more prevalent.
I have no connection with real estate but have been acquainted with a number of people involved with “flipping” properties and was not in the least surprised that, in every case in which I was able get below the surface, the entire enterprise hinged, not on a better recognition of underlying or potential value but, rather, on an ability to construct such new value through influence on the appraisals and loans placed on those properties. This was normally accomplished through gross, inflated revaluation of either the underlying property or the improvements and involved (in every case) either misrepresentation or improper relationships between “flippers” and loan and appraisal personnel.
Mr. Berman seems to have seen only the seedy – and illegal – side of flipping: the method that is fraudulent. The people who involve themselves in the type of transaction he describes can – and often do – go to prison. They are the ones responsible for HUD’s policy of seasoning mortgages, which makes even legitimate flipping more difficult. My experience (real estate investor for 37 years) indicates that most “flippers” are honest, and do not perpetrate such fraud, so I am unsure where Mr. Berman has been seeing so many of these fraudulent flips. Yes, “flipping fraud” certainly exists – there are criminals in every field, i.e. Ken Lay of Enron. But my experience shows it to be the exception rather than the rule.
Ludwig von Mises: “The influence of speculation cannot alter the average level of prices over a given period; what it can do is to diminish the gap between the highest and the lowest prices. Price fluctuations are reduced by speculation, not aggravated, as the popular legend has it.” – The Theory of Money and Credit
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