flipping houses

If you yahoo “house flipping” (yes, that’s an anti-Google protest – shout out to my friend Robs for inspiring me with her facebook status), you’ll get a long list of sites telling you how to do it. There are youtube clips of success stories, and blogs, and a froth of websites trying to sell you books and inspirational audio guides. In fact, it all sounds a bit like a Ponzi scheme – which is exactly what a nationwide house-flipping craze should be called.

You might be wondering what brought about this post. Well, it came up in conversation last week, where I got told that house-flipping is “worth a shot and better than doing nothing”. A phrase which gets me almost as riled as “I’m not paying someone else’s mortgage!”

Oh no. There are a great number of things that are, in fact, not worth a shot. And where it would almost certainly be better to do nothing. For example, I really don’t think that your average Joe should be playing around with derivative contracts – mainly because not knowing what you’re doing makes you a sitting duck for someone who does.

So let’s talk about house-flipping.

What It Is

House-flipping is a style of investment that is famously American. You buy a house on the cheap, and sell it high, and pocket the difference. The aforementioned manuals and internet spirit guides will tell you how to do quick and cheap renovations that can help that profit be amazing. A basic summary:

  1. Apply for a mortgage.
  2. Buy an old-lady house in an up-and-coming suburb that could do with care and attention.
  3. Break down connecting wall between lounge and dining room to “open the space”. Add extra guest toilet. Redo finishings in kitchen. Replace old windows with sliding doors. Varnish and paint as necessary. Furnish with signature pieces and abstract art. Bake cookies to denote homeliness.
  4. Sell at a higher price.
  5. Repay mortgage.
  6. Throw a party on the profits.

Does It Work In General?

Well, it certainly has worked historically in the United States and in Europe. After all, in the 2000s, there was a housing bubble. You didn’t even need to renovate – you could just buy now and sell in 3 months and celebrate. Which is why I’ll use the term ‘Ponzi scheme‘ and mean it.

But here’s the thing about the American experience: America has a government that is fully committed to the ideal of an American homeowner. And it uses the tax code to promote it:

  • There is no Federal transfer duty on the sale of residential property. There might be a state tax on the sale (depending on where you are); but even then, these are usually tiny (in the points of a percentage point region).
  • Interest on mortgages is tax deductible.
  • In 2003, the Bush tax cuts came into effect, lowering the capital gains tax rate to 15%, and 5% for people in the lowest two tax brackets.

From this, you could spin the narrative:

  • The incentives made house-flipping attractive to the average American (as intended)
  • More transactions in the housing market gave the banks free licence to relax their credit rules for mortgages
  • Which made it even easier for your average American to house-flip
  • Which meant that the credit rules could be relaxed even further
  • And so on into Financial Crisis and beyond.

But that’s actually not that important – the real question is whether this is feasible in a South Africa for your average South African.

The South African Obstacles

Some points:

  1. Transfer Duty – we have it. And it’s scaled. So if you’re looking at houses above the R1.5 million range, then expect to pay transfer duties of 8% on the excess.
  2. Unfortunately, South Africa doesn’t have teaser rate mortgages where you pay no interest for 3 years or whatever. So you’ll be paying interest off the bat. In the 9% plus range. If you even get a mortgage.
  3. The interest isn’t always going to be tax-deductible.
  4. Estate agent commissions (can be up to 7.5% of the value of the transaction in South Africa). And conveyancing fees.
  5. It also takes 3 months for the bank to retrieve a title deed from storage. I do not know why. I just know that’s what they tell you: “Right, those are all the documents that we need – just come back in 3 months”
  6. Also, if you need to get municipal permission to make alterations, expect to wait for them.

Let me give you a numerical example. You buy a house for R2 million, and you plan to spend R200,000 on renovations over the next 12 months, and then sell it. You get a 9.5% 20 year mortgage that requires a 20% deposit. Your costs:

  • Renovations: R200,000
  • Transfer Duty: R77,000
  • Interest for 1 year: ±R150,000
  • Estate Agent Commission: R150,000
  • Rates and Conveyancing: ±R30,000

Meaning that your house value will need to appreciate by at least 30% in real terms by the end of the year before you break even. And that’s not counting the cost of the time that you will put in, the capital gains tax you will pay on your gains, or the fact that you’ll probably blow your budget.

Can it be done? Of course. Very successfully. But by people that don’t need estate agents, and who look at the housing market and can see where prices are cheap.

For the rest of us, we should just put our money into exchange-traded funds.

And then just spend our time doing nothing. For free.