Professional observers of the housing market are bracing for a huge wave of foreclosures slated to swamp the housing market – putting tremendous pressure on prices. The upshot will be great danger for some – and great opportunity for others. Here’s how it’s coming to pass, and what it means to flippers.
In 2010, the courts got word of a variety of sloppy and in some cases outrageous practices on the part of banks and lender-side foreclosure attorneys. Banks had been increasingly careless in keeping track of their paperwork, and stories of banks erroneously foreclosing on properties that were actually current, or properties which they no longer had the right to foreclose on, were making rounds in the media.
Investigation revealed that many banks had essentially set up internal “foreclosure mills,” in which signature forgeries were commonplace. Banks were emphasizing throughput in their rush to foreclose on as many properties as possible. The integrity of the process too often went out the window. And so the “robo-signing” scandal was born.
This was too much for the courts to bear, and so there was a partial moratorium on new foreclosure proceedings. Almost overnight, the monthly nationwide foreclosure volume fell from roughly 330,000 homes to about 227,000 per month, beginning in November 2010.
But that overhang didn’t just vanish into the ether: All the while, a backlog of foreclosures was building up and building up. Now instead of a steady stream of foreclosures holding the market steady, there are nearly 2 million mortgages, lapping at the floodgates, ready to flood the housing market as soon as the floodgates are released.
This month, though, the major lenders involved in the robo-signing scandal set the stage to release the torrent: They arrived at a February settlement with 49 state attorneys general, recognizing their right to foreclose and shielding them from some adverse legal consequences in the event of an improper foreclosure.
Plentiful Opportunities for Deals
First of all, there are going to be a lot of homes entering foreclosure over the next few years for you to choose from. Over the medium term, don’t expect home prices to rise significantly until that backlog is finally clear. Home prices may even continue to fall in some areas. The second wave of foreclosures will likely hurt prices in the same markets that were hurt the first time around – after all, it’s the same market dynamics at work.
Who wins? Buyers. Who loses? Sellers. And flippers? Doesn’t matter much.
Why’s that? Because flipping, properly practiced, is a market-neutral strategy.
Property flippers are always the buyer and the seller, on any given property. So the advantages and disadvantages even each other out, if you move quickly. It’s a wash.
Unlike buy and hold investors, and unlike the homeowner-occupant, the house flipper is a trader. You aren’t betting on the long-term or even medium-term appreciation in the housing market. You’re not planning on holding any property long enough for a broad decline in housing prices to hurt you.
The house flipper can still prosper, even in declining markets. In fact, in some ways, a declining market can help the flipper. Why? Because the source of your returns as a flipper has little to do with the overall market. The source of your returns is in your ability to add value, through improvements, to any property you acquire, and to the efficiency with which you can find a suitable buyer. And you don’t do this with broad real estate indexes. You are working with one property at a time – that you get to pick!
Swimming Against the Tide: Gearing Up for Success in a Bear Market
What will be the effect of a second foreclosure wave? And how can you set yourself up for success?
Deals will be easier to find. If foreclosures reach their pre-robo-signing scandal peak, that’s 100,000 more opportunities for flippers each month – not even counting properties that get short-sold before the foreclosure is complete. In falling markets, lenders and buyers will tend to welcome short-sale facilitators, because a quick resolution helps both parties.
You can therefore spend more time fixing and selling properties and less time searching for them. This is good for your profitability.
What’s more, falling markets tend to repel amateurs. When things are good, people think that any idiot can make a bundle flipping houses. That was never true, even in the heady days of 2002 to 2007. But the idiots were out in force, bidding up prices and making it difficult to find good deals.
Bear markets separate the amateurs from their money, and leave the market to the professionals. Hopefully, that’s you – or will be you, once you’re underway.
Speed is key. In a bull housing market, you have time. Rising home prices mean you can get away with more mistakes, and take longer with any given repair or renovation. Rising equity, combined with leverage, will eventually save you – especially if you have a tenant paying rent in the meantime.
In a falling market, though, you need to be organized. You need to close quickly, and have your contractors on the house making these repairs like ants on dropped candy. The longer you get mired in any single property, the more the weight of a bear market in home prices has a chance to work against you.
I’m a big proponent of being ready to rent if you can’t sell on advantageous terms, and if you can still secure financing for your next flip. But the traditional Plan B, renting a property if you can’t find a quick buyer, is more dicey in falling markets. Concentrate on properties that you can rent on a cash-flow positive basis. This may be difficult or impossible in certain markets – and that’s ok. Stick to your strategy, and work your system.
Jason Van Steenwyk is a veteran financial industry journalist who has been fighting to make the world safe for the retail investor since 1999. He lives at Ground Zero of the real estate bubble in Fort Lauderdale, Florida.