One of the most significant risks related to house flipping is holding period market risk - it's the risk that during the time in which you're holding the property you intend to "flip," the property value will decline.
The decline in property value can be caused by a variety of reasons (macro recessions, localized events, etc.), but that's not the point of this short piece. The point being made here is that house flipping exposes the "flippers" to significant market risk.
Not taking this real estate market risk to which you're exposed to when pursuing a house flipping strategy into proper account and consideration may have some serious negative consequences. The negative consequences are rare - they only arise in market downturns, which happen once every number of years. But, although the chances of the risk coming to fruition are small, the severity of the negative consequences (should there be a real estate market decline) are severe. The consequences can be severe enough to wipe out investors that are not well-capitalized and in positions of strong liquidity.
This is pretty easy to see if we think about a hypothetical example. Let's say you're doing house flipping and you buy a $200,000 property. The timeline might look something like this:
The risk exposure continues until you sell the house. So, in the above example with the relatively rapid renovation and resale (likely in a good real estate market; very unlikely in a real estate downturn), the investor or flipper would be exposed to market risk arising from adverse moves in the real estate market for at least a few months. If the investor is new, inexperienced, or doesn't have a lot of capital/liquidity in reserve, things might be over in one serious real estate or economic downturn.
If you're holding a property that's worth less than you bought it for -- even with the improvements you made or might make -- you'll have to (1) either accept a loss on this investment or (2) you'll have to continue making mortgage payments on the note until the market recovers.
In the first case, you'd lose real money - you'd possibly lose your entire down payment and in the worst scenarios you might be so underwater that you'd have to add additional funds to be able to get rid of it. This isn't far-fetched. Many people all across the United States experienced this during the Great Recession that started in 2007/8.
In the second case, you'd avoid having a severe capital loss, but you'd have to outlay money every month to keep the mortgage note current. This can be costly, especially if this is done for many months or even many years.
Of course, you might have bought the house in cash - in that case, you still may experience a severe loss (you'll just never be underwater on the mortgage). Renting might also help mitigate the risk - if there's a downturn, you might abandon your initial house flipping strategy and put a tenant(s) in the property for several months or years to help with the mortgage payments.
A prudent house flipper or potential house flipper would take these risks into account. Everything is exposed to risk, so this article isn't attempting to say that real estate investing in general, or house flipping specifically, are imprudent investments or that there's undue risk in a house flipping strategy. The article simply attempts to highlight a particular type of risk that house flippers are and will be exposed to.
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