Speculative Thinking Makes Them Flee
A: Interesting topic I feel for a post. Now that the market is in the midst of a correction, probably 15 months or so in and past stage 1 where psychology quickly turns as media networks report the changing housing market that affects so many, it seems that speculative investors are no where to be found. What is it about their thinking that makes them run for cover? Thats what I want to know.
Speculative investors, a.k.a. 'flippers', are NOT developers who years in advance plan a lot acquisition and new building with city filings and co-investors. They are also NOT first time homebuyers who have a short term strategy for buying and selling. So who are they?
For the most part, speculative housing investors are those who are VERY familiar with real estate investments, tax code, and the art of marketing a property with the intention of buying and selling a home usually within 6-12 months of closing. Lets go over these characteristics real quick as speculative investors usually never live in their new home.
Buy LOW in a rising market! The mantra of successful speculative investing. When it comes to housing, that means buying a wreck or buying into very heavy demand! Not so easy to find because once a good one pops up chances are a speculative investor, or very savvy buyer, will scoop it up immediately. If a wreck is not moving, obviously its overpricing the potential.
Speculative investors will close, quickly renovate (usually through close contacts in the contracting world saving them thousands of dollars for high end products), and re-list for sale at a fully renovated price.
Understanding the tax code in housing means more dollars in your pocket from any capital gains, come the close of a deal. There are 2 popular ways to benefit from a gain on the sale of your home, that I will not go into detail here but you can click on for a previous post where I discussed them. They include:
1. Primary Residence Tax Benefits
2. 1031 Exchange (Starker Exchange)
The 1031 Exchange is by far the most popular tax benefit used by speculators because it allows an investor to BUY A PROPERTY, do their thing, and SELL THE PROPERTY whenever they want (with no minimum ownership restrictions) in order to DEFER THE TAXES DUE AS LONG AS THEY USE THE GAINS TOWARDS THE PURCHASE OF A LIKE OR GREATER PROPERTY WITHIN A PRE-DETERMINED PERIOD OF TIME AFTER CLOSING.
In other words, if you bought for $400K, renovated, and flipped for $500K, you can DEFER the taxes owed on the gain of $100K as long as you show intent to purchase another property that is $500K or more within 180 days of closing. More info on this at realtor.org.
So, understanding the tax code allows savvy investors a vehicle to maximize the dollars that goes toward their own investments rather than to Uncle Sam! A good way to build wealth, especially when the housing market is booming.
Ahh, the key! Flippers usually have connections when it comes to marketing a property and know that they will be saving money on commissions, in some form or another, or will be making the commission themselves on the sale.
For example, I knew a contractor who teamed up with a friend of his who was a real estate agent and basically formed a partnership whereby they would buy, renovate, and sell as a team and make money on every aspect of the deal. The contractor would take pay for the renovation work, albeit at a reduced cost, and the real estate agent would take the commission, again probably at a reduced cost.
All in all, a plan was put in place beforehand that benefitted all in the transaction. Savvy thinking if you can trust your partner on all sides.
WHATS MAKING THEM FLEE
All of the above is how speculators 'think' about their business model of flipping real estate; and I probably missed a few too. However, in a market like today's it is easy to see why this 'way of thinking' is exactly the same reason that is making these types of buyer's flee the market.
In a recent article in the Examiner.com, Kelly Carson investigates the spillover of speculative real estate investing's withdrawal from the local market:
There numbers aren't pretty - 20.7 percent of housing speculators in the Baltimore region reportedly lost money in the second quarter of 2006. "Speculators are taking a bath," said David Martz, a Realtor with Long & Foster in Baltimore. "Rehabbed [houses] and new construction are hitting the market, and there is a glut of that inventory."John McClain, an economist and senior fellow at the Center for Regional Analysis at George Mason University in Fairfax, Va., said speculative investors who bought property are sending chills through the market because they are being realistic about profits and are pricing their units to sell quickly."
In a market trending downwards with negative psychology, rising inventory, and dampening demand, savvy investors are staying on the sidelines and holding off selling any properties with the intention of using the gains to FLIP AGAIN! In addition, those who have flipped already are paying up on the taxes they owe and holding all gains after that in cash or other investments for now until a brighter short-term housing outlook is seen.
Combined together, speculative investors just aren't buying right now. If anything, speculators are unloading properties at an aggressive pace to secure any gains or minimize any losses in an uncertain industry.
If there is NO CAPITAL GAIN, then there is no tax benefit; unless you consider a loss canceling out other income a benefit. Right now, transaction fees are cancelling out any profits from short term house appreciation making the tax friendly investment useless for speculators.
In other words, there is no tax benefit to speculative investing in a downward moving housing market.
In a market such as today's, marketing a property means pricing it aggressively or else it sits on the open market for months until a price cut is deemed necessary. Not the bext way for speculative investors to profit on their deal, especially if they just bought the property 3 months ago. Even renovations do NOT pay off as well in a downward market making 'flipping' even less lucrative a business model.
In other words, savvy marketing and a reduced commission still may not be enough to convince speculative investors of potential gains. The risk/reward is just not making much sense to them.
FINAL THOUGHTS: Today's housing market is one of price cuts, longer time on market, dampening buyer demand, and negotiations! All of this combined equals a less # of transactions overall. The absence of speculative buyers, a.k.a. 'flippers' is definitely affecting the housing market and the general train of thought that powers this type of investing is directly resulting in making them flee! This will not change until the short-term prospects of the housing market change considerably, convincing flippers that it is time to re-enter the market and get back to work!
