Wednesday, December 7, 2022

Industrializing Flipping - Why It Failed.

Buying and selling real estate is a "boots on the ground" kind of deal.

Redfin recently got into trouble by trying to industrialize house-flipping.  I noted before that some friends of mine work there and it is a great place to work.  Their basic model was to make the real estate business more rational by using online systems and software instead of using Harriet Hair Helmet and her hoary old Jaguar, to sell real estate.  Buyers are not pressured to buy, as the "agents" are not on commission.  The buyers come to a property to inspect, after seeing detailed information online - they are ready to buy.  Sellers love the 1% sales commissions (on the seller's side, anyway).  It just made a lot of sense.

But then they took it too far.  They thought they would get into this house-flipping deal by offering to buy houses outright from clients - offering them the "convenience" of an assured price and quick closing.  They would then polish up the home, put it back on the market, and profit!  In theory, this is a great idea.  In practice, it sucks.   And as I recall, there were companies doing this back right before 2008 and then something happened - but I can't remember what.

I do recall reading a year ago, about alarm bells being sounded by some analysts over this move.  Redfin was doing OK with their core business, but this new venture required a lot of capital, which was tied up in houses, as well as a lot of local expertise in repairing and re-habbing houses for resale.  In the banking business, it is understood that for every month a bank holds a foreclosure property, the value decreases by 1% or more.  So the name of the game in banking is to unload the property as quickly as possible.  Investors "on the ground" (such as Mark's Dad) could snap these up and fix them up inexpensively (by making his son do the donkey work) and quickly, and either rent them out or sell them.  Mark's Dad sold them - and took back a mortgage as well - offering people with bad credit a chance at home ownership, while creating a steady income stream for himself.  He only had to foreclose on one of those borrowers - but you have to be prepared to do that.

For Redfin, the problem was complicated by a number of factors. Since the people working for Redfin get paid no matter what, they have no interest in turning around the properties quickly or finding the lowest-cost repair people to do the necessary work to flip a house.  So houses sat empty and repair costs (in a labor shortage environment) escalated.  Bad enough, to be sure - enough to sink any "flipping" deal in the world.   But then it got worse.

Mortgage rates went up, and home prices stagnated, or in some markets, went down.  Real estate is a business of thin margins.  You can't expect a house to appreciate 50% in a year (if it did, you are in a bubble market - watch out!) and if rehab costs get out of control and interest rates rise, your thin margins evaporate quickly.

So, Redfin is now selling off their quarter-billion-dollar inventory of homes for whatever they can get for them and shutting down this very bad idea. Sure, you can make money flipping homes.  The guy we bought our house from here does just that - and has done many times in the local area (five homes, at least, that I am aware of).  But he is a contractor and has access to cheap labor (go to the 7-11 and they jump in the back of your pickup truck) and knows the costs of rehabbing like the back of his hand. He turns around properties quickly and knows what things attract buyers. It is entrepreneurship and that is a damn hard thing to teach to people drawing a steady salary.

Sadly, others, such as Zillow, also got their tits caught in the wringer, trying to do the same thing.  Expect a bloodbath.

It is like trying to flip cars for a profit.  Yea, you can do it.  No, there isn't a lot of money in it.  And yes, it helps if you can do a lot of the work yourself.  As Carvana and others are finding out the hard way, while it is easy to make money selling used cars in a pandemic "car shortage" market, it is a business of thin margins in a normal, competitive market.  You can't industrialize Slim's Used Car Lot, if only because Slim was never making much money in the business to begin with.

Again, we saw this happening back in the early 2000's.  You could buy a house or condo or townhouse, do some superficial repair work (paint, carpet, etc.) and within a few months, turn it around for a tidy profit.  As the whole market was going up at an alarming rate, everything you touched turned to gold.  It didn't mean you were a real estate genius or that you had some knack.  It only meant that you got lucky, and eventually lucky streaks run out - as they did in 2008.  We were fortunate in that we sold out before then - for the most part.

The real estate market is predicted to shrink by 20-30% in the next year or so as the economy - worldwide - contracts.  People are complaining that housing prices are too high - if they can hold off a year, I suspect they will find better bargains.  There is no such thing as unaffordable housing - at least in the long run.  Bubbles are speculative and awfully brief.

The people who get stung by bubbles are the ones who fall for the "buy now or be priced out of the market forever!" line - a line that has been shown to be false in 1989 and again in 2008. Those poor sods wait until just before the bubble is set to burst, and then give in and buy an overpriced house using sketchy loans - and they end up in foreclosure, convinced the system is rigged against them.

We will see such tearing of hair and rending of garments in the next year or so. Redfin can afford to absorb the cost of this mistake - let's hope, anyway.   For the Joe Homeowner, it is far more devastating.