Downside of leverage leads to downfall of flippers

NY Times:

The home foreclosure business was very good to Todd Haupt. He started buying and flipping foreclosed houses in 1994, when he was 20, and by 2000 he graduated to building homes.

At 32, with just one semester of community college, he owned a BMW, a Corvette and a 5,000-square-foot house worth $1.2 million. He was a creation of the boom. “I was on top of the world,” Mr. Haupt said recently.

Then, last May, the real estate market stopped booming.

Now Mr. Haupt’s house is in the hands of his creditors, as are the cars, three small office buildings and 89 lots he bought in a subdivision in neighboring Lincoln County.

He owes about $6 million in personal and business debt, and as Mr. Haupt’s fortunes soured, so have those of plumbers, electricians, framers, landscapers, supply stores and others that relied on his business, which he estimated at $300,000 per month.

“And that’s just little bitty me,” he said.

Mr. Haupt is one of thousands of Americans who jumped into the raging housing market of the last decade, which was heralded in stories of neighbors’ windfalls and reality television shows like “Flip That House,” “Flip This House” and “Flipping Out.”

Driving past his empty house recently, Mr. Haupt considered how things had crashed so fast.

“I feel like, yes, I overextended myself,” he said. “But when do you know not to overextend yourself? If I had a crystal ball, I never would have built my house. But when do you know? That’s why we’re speculators.”

He added, “If the banks had a crystal ball, they might not be in this mess either.”

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Note that it was not predatory lending that led to his demise. His wealth was built on leverage. He was making money from borrowing and betting on a continued rise in the market price for homes. Like any commodity, real estate fluctuates in value, just not as quickly as the futures market. One of the reasons for this is that it is what is called an imperfect market. A perfect market occurs on the stock exchange or the commodities market where there are millions of buyers and sellers for what is being sold.

Real Estate relies on local buyers with different taste and varying abilities to pay for a large purchase. Someone may value a piece of property more than another which provides both opportunities and downside risk. When lenders no longer value the property, the flipper is in trouble and sometimes the lender. This happened in the late 80s in the Houston market after the collapse in the price of oil led many companies to layoff workers, and many lending institutions owning property that could not be sold.

It will take a while for the flipper market to come back and it will be with new flippers with short memories.