If you want the opportunity to roll your eyes and shout “what could possibly go wrong!” then check out this Wall Street Journal headline reporting: “Wall Street Is Getting In On the House Flipping Game.” In the wake of the financial crisis, this kind of thing sounds like … not a good idea:
KKR & Co. is raising its bet on high-interest, short-term home loans, the latest sign that Wall Street firms are aiming to cash in on the risky but lucrative house-flipping market.
Take a peek behind the headline, however, and what’s really going on here starts looking much more like good news for the American economy and its built environment. Today’s home flipping is qualitatively different from the condo flipping of 2006, which was driven entirely by bubble-fueled speculation. And the more of it that Wall Street can finance, the better.
The homes we live in are not, as a rule, the homes that were originally built. As Stewart Brand details in his classic How Buildings Learn, humans are constantly tweaking, altering, improving, and customizing, in ways big and small. The question is: Which humans? In the case of residential housing, it’s generally assumed that the people doing the renovations will naturally be the homeowners or the people they hire. But that’s far from the most efficient way of improving the homes we live in.
Have you ever heard a happy house-renovation story? For that matter, have you ever found a contractor who has nice things to say about previous clients? Doing up a house is invariably horrible for all concerned because it’s massively outside most homeowners’ area of expertise.
As a rule of thumb, any renovation where the homeowner remains in the house is going to be a nightmare for the homeowner and the contractor both. Enter the flippers—professionals who renovate homes for a living, who know generally what they’re doing, who work regularly with the same teams of contractors, who only renovate empty homes, and who make money by improving our neighborhoods in ways that homebuyers are more than willing to pay for. Don’t let the home-renovation TV programs fool you: This is not a game for amateurs. Instead, it’s a nationwide $16 billion industry, which grew by 27 percent in 2017 alone, according to Attom Data. It’s a market where professional flippers renovate multiple homes at once, putting down perhaps 25 percent to buy them, financing the rest with short-term loans, and selling as quickly as they can.
These loans are pretty specialized financial products. They’re not traditional mortgages because often the amount borrowed is greater than the house’s original value. On average, flippers buy homes for $136,800 and sell them for $205,000—after putting in somewhere between $40,000 and $70,000 in renovation expenses. That means the lender has to be comfortable lending against the home’s future improved value, rather than its original purchase price. And that, in turn, means the loan is often disbursed only in tranches as various stages of the renovation are completed.
If Wall Street is starting to show interest in buying such loans in bulk, that’s going to make them cheaper, which is going to be good for the construction industry and for flippers, who are not just making money, but also performing a valuable service.
Importantly, none of this activity is contingent on rising house prices. These loans aren’t going to the kind of flip where you buy and sell a Miami condo before it has even been built. Instead, they are a way of making homes more valuable through the smart application of capital and skilled labor. It’s a high-risk, medium-return business that makes urban and suburban America a better place; it’s also a great source of new-company formation in an economy where new companies account for substantially all job growth.
Better yet, the latest trend in home flipping is to renovate a house, rent it out, and then sell it—fully occupied and cash-flowing—to a Wall Street firm. That means home flipping is one of the few ways owner-occupied housing can become high-quality rental housing. There’s a perennial shortage of good rental stock in the U.S., and anything that can help create more of it has to be a good thing.
You might assume that Wall Street landlords are a Bad Thing, but they’re not: They’re the natural alternative to homeownership—and homeownership rates in America, while lower than they used to be, are still far too high. America needs the greater labor mobility that comes with rental housing; it also needs fewer mortgages because fewer mortgages means fewer underwater mortgages, and underwater mortgages are the real Bad Things.
So, let’s celebrate the flippers. They’re providing the smarts and hiring the labor; Wall Street is providing the capital; and the country as a whole is reaping the benefit, in the form of upgraded housing stock and—almost certainly—fewer divorces. In a mature capitalist society, distribution of labor means that people specialize in what they’re best at. Much better that the pros do the renovation than that they leave it to clueless schmucks like me.