Is Nashville flipped out?

Real estate squeeze is making life tough for area house flippers

Friday, May 20, 2016, Vol. 40, No. 21
By Hollie Deese

It’s easy to watch a renovation show on HGTV or the DIY Network, see how much money can be made and think, “Hey, I can do that.”

And with a housing market as hot as Nashville’s, what could possibly go wrong?

Turns out, many things can go wrong if you don’t have experience.

One expert even suggests Nashville is getting close to “flipping out,’’ reaching a peak at which house prices are so high that not everyone, especially less experienced or new flippers, can make a profit.

But it’s the hope that things will go very right – like $100,000-profit-on-a-flip right – that makes it so appealing for those already lining up financing in their mind while watching at home with a bowl of popcorn and a glass of wine.

‘Nashville Flipped’ story

Nashville’s Troy Dean Shafer happens to be one of those creative contractors you’ve likely seen renovating old homes for a profit on TV. His show, “Nashville Flipped,’’ premiered in April on DIY Network, a division of Knoxville-based Scripps Networks Interactive.

On the show, he returns historic homes located in and around Music City, to their former glory, partnering with area designer Julie Couch of Julie Couch Interiors.

The show came about by chance (see sidebar). Shafer ran into Mike Wolfe of the Antique Archaeology stores and the “American Pickers’’ TV show at a Wal-Mart.

The result of the chance encounter was the creation of Shafer’s TV program, which has had nine episodes. No word yet on a pickup for a second season.

Like so many others, Shafer moved to Nashville to pursue music, arriving in 2005. After some success, he turned to renovating houses. His father had been in the new construction business in Erie, Pennsylvania.

“Although I never really saw it as being what I wanted to do, I guess, without really realizing it, I kind of fell in love with it,” Shafer says. “I learned a lot and didn’t even realize I was learning it.

“When I was forced with a task or needed to help a friend around their house or something would break, I’d realize that I always was able to troubleshoot and fix it, and redo it without paying somebody else to come and do it.”

He has always had a love for older homes, and he realized there was a need for them. He launched his real estate and contractor company, Nashville Flipped, eight years ago.

Shafer bought his first flip in East Nashville in 2008 for $28,000 and had a budget of $40,000 for renovations, something he was able to achieve with a combination of money he had saved and a loan from his parents he has long since repaid.

“They are definitely my biggest supporters, Mom and Dad,” he says.

It took months to sell that first house in such a rocky market, but when Shafer did sell, he cleared about $15,000 – a big enough chunk of change for him. He was hooked.

Shafer immediately rolled that profit into another house and then another one. Currently, he’s dealing with Nashville’s low inventory and high prices.

“My absolute goal would be about a 28 percent ROI, so if I have actually $100,000 invested, then I’d like to make $28,000 on that $100,000,” Shafer says.

“That number I could hit, and I did hit a lot, when I was only doing four or five a year because I was everything. I was project manager, bookkeeper, accountant. I saw every in and out of every project of every house.

“As the company has grown, I’ve had to acknowledge that it’s nearly impossible to keep ROI that high when there’s so much more output and then just Nashville, as hot as the market is.”

One of the homes Shafer flipped on his show was in Madison, a property he bought for $78,000, put $45,000 into and then sold for $169,000 the first day it went on the market.

He’ll take profits like that all day, even though he loves it when he can still snap up a home in East Nashville.

“It wasn’t like a grand slam as far as a ton of money coming in after Realtors and everything, but as far as an ROI, to only be into it for $125,000 and then to clear $25,000, that was a good ROI,” he says.

“I’m always thinking, ‘What’s next? What’s the next big area? Is it Madison? Is it Buena Vista? Is it Bellevue? Is it Hendersonville?’”

Striking at the right time

The timing might have seemed off to enter real estate investments, considering what the market was like in 2008, but it actually ended up working in Shafer’s favor as he used the slow times as a way to learn the basics of flipping, instead of floundering in a hot market.

“I knew a little bit about construction, but I didn’t know the business of it,” says Shafer, who has a business degree from Penn State.

“I didn’t know the ins and outs of buying a house, selling a house, dealing with clients, codes and permits, the sub-contractors. I didn’t have any plumbers, any electricians. I saw it as a blessing, really, for it to be such a bad market.”

He flipped three houses that first year and says the number was just right to help him learn how to do everything while building meaningful relationships with contractors and sub-contractors.

“Every year after that I would just get a little bit more and more busy, and profit a little more and more, and then it was probably about five years ago when I was able to really start focusing on what I really loved, and that was the truly historic homes,” he recalls.

“The first couple years of the business, I couldn’t really cherry pick. I had to just buy what I could afford.”

Is now a good time?

Ralph McLaughlin, chief economist with the online residential real estate website Trulia, agrees there are certain times in a housing cycle that are ripe to get into flipping. And while 2008 was great, he says, now is definitely not the right time to start flipping in Nashville – at least for people who want to learn on the job like Shafer did during the recession.

“Whether or not flipping a house is a safe bet really depends upon the experience of those who are doing the investing, so for a professional or experienced investor who has a track record of flipping homes it’s probably not a terrible time to flip,” McLaughlin says.

“But we are far enough along in the cycle that if inexperienced flippers are interested in getting into the game, now may not necessarily be a good time.”

From a broader economic perspective, McLaughlin explains, we are mid-cycle, maybe starting to get towards the end of the current economic cycle that lasts about 10 years.

“That’s not necessarily a time you want to be investing in homes if you don’t know what you’re doing,” he explains.

A top flip market

Trulia released a report earlier this year on the percentage of flipped homes in the top 85 largest markets, Nashville included.

Clearance flips bought at foreclosure, followed by a resale at market rate were not included, but homes bought at market rate and sold at a higher market rate in a 12-month window were.

Nashville was tied for the No. 7 spot on the list behind other current flipping hotspots like Las Vegas and Washington, DC, with 6.6 percent of homes flipped in the third quarter of 2015, then a jump to 8.3 percent of homes flipped in the fourth quarter.

“What we’re seeing in the data is that basically Nashville is approaching its peak flipping point, which occurred back in 2006,” McLaughlin says.

“In 2006, about nearly 12 percent of all transactions were flips, and just in the last quarter of 2015, it was 8.3 percent, so it’s getting close to flipping out, so to speak, in that it’s approaching the peak level of flipping that was occurring before the crash.”

The big question is whether or not that is indicative of a bubble because a rise in house flipping can be considered a sign of an overheated housing market.

According to Trulia, flips made up five percent of all home sales in 2015, mirroring a steady increase in home prices. But hot spots like Nashville could bring some concern as rapid price growth may be making that initial buy too costly for house flippers.

But McLaughlin says they are not concerned about Nashville or any other hot flipping markets experiencing a bubble.

“There was a sharp increase in flipping activity in Nashville since the recovery started,” McLaughlin points out. “It looks like things are flattening out, so it doesn’t look like Nashville will totally flip out.

“In other words, it won’t probably reach its peak any time soon, because it looks like the trajectory is flat. But again, if the market does go through another expansionary phase in Nashville, that number could pick up.”

McLaughlin says flipping is a unique housing market metric because it has historically occurred at high rates just before a market peaks. Plus, a flip generally means bumping a home from one price point to a higher one after renovations.

Still, when home prices are rising like they are in Nashville, flippers have a better chance to come out ahead – even if the project doesn’t go according to plan.

“It is probably more difficult today to initiate a flipping project because there are fewer bargains to be had,” McLaughlin explains. “In 2012, 2013, there were still a lot of bargains to be had in Nashville, as well as in other markets.

“There were still foreclosures that were coming on to the market. Today, foreclosures are down. They’re down a lot, which means it’s tougher for flippers to find these bargains to add value to.”

$50,000 minimum

Husband and wife team David and Wendy McKinney of The 404 Company flipped their first house in 2011, also after the onset of the recession but before the market had really started recovering.

“The first one that we did sold very quickly,” David McKinney says. “That was really kind of when the flip and growth of Nashville was just really starting.”

Both children of DIY renovators, the couple met in 1994 when they were both real estate agents.

Their first home was a real fixer-upper, and they lived in it for two years while they fixed it up. They sold it, moved into a slightly larger fixer upper, lived in it for a few years, sold it again until they adopted their son.

That was when they decided to stop living on a construction site and flip another property instead. That first home was a 1930s brick home in Inglewood, and they made around $30,000 on the flip. These days they aim for a minimum of $50,000.

“If he does the numbers on something he wants to make an offer on, and it’s not looking better than that, then he’s going to probably go for something else because we want to make it worth the while,” says Wendy McKinney.

“I know some flippers like to make $100,000, and then other flippers are happy with $20,000-$30,000, but you’ve got to [flip] a lot more in a year if you’re only going to make $20,000-$30,000 a pop.”

Inventory down, prices up

A hot housing market doesn’t necessarily translate into a slam dunk for flippers. In fact, when inventory is down and prices are up, it only means less to be made for the middle man.

McLaughlin says inventory is the big issue they have been following in Nashville, especially for those looking to buy starter homes – to the tune of 79.5 percent.

“Inventory is down 79.5 percent – that’s pretty large,” McLaughlin says. “Nashville has seen large decreases in inventory over the last four years. The impacts on median, middle-class buyers and upper-class buyers hasn’t been impacted that much, but starter home buyers are starting to see a situation where affordability is creeping up more towards the unaffordable range.”

In fact, McLaughlin says the share of income that a home buyer would need to spend on a starter home in Nashville is about 27 percent. The federal definition of what is considered affordable is 30 percent.

“Not quite there yet, but getting there, and if prices continue on the pace at which they’ve been growing at, which is about 7-8 percent in the next year or two they could hit that 30 percent unaffordability mark.”

Real value now in land

David McKinney says the value of property has gone up so rapidly all over that it makes it difficult to find a flip property that is worth the return on investment. East Nashville and Inglewood are especially hard places to make a decent profit right now.

“Now the land’s more valuable than the house and property were just a short time ago, so that’s why so many of them are being torn down and two to four are being built in their place,” he says.

“The people who’ve been there are a long time, some of them are asking amounts for their property that they don’t necessarily think they’ll get and, lo and behold, someone ponies up the paycheck for it. It’s causing the property values to go up exponentially.”

And it’s causing flippers to look anywhere and everywhere for a property to work on that will give them the return on investment they are looking for.

Wendy McKinney says the competition to buy homes worth renovating is not only coming from local longtime flippers, but investors from out of state with all-cash offers that are driving up prices to the point they won’t bid on properties they easily would have just a few years ago.

“There’s so many people buying that it’s hard to get your hands on something, and I think profits are shrinking for a lot of people,” she says. “They’re paying too much for what they’re buying, and then they can’t afford to really spend a whole lot of money renovating it because then there’s no money left to be made.”

McLaughlin says foreclosures in Nashville are down, which means it’s tougher for flippers to find these bargains to add value to.

McLaughlin adds one of the things Trulia constantly keeps an eye on is affordability metrics, and Nashville still looks pretty decent compared to the rest of the country. But that could change.

“The percent of income for a middle-class household to buy a middle-class home is only about 20 percent, and that’s not too high, it’s not too low. It’s kind of just right, and it’s indicative of a healthy market,” McLaughlin adds.

“If you were to compare that to some other places, such as LA or San Francisco or New York, that’s more like 40 or 50 percent, so it doesn’t look like Nashville is in bubble territory, but that said, all housing markets go through cycles, and usually those cycles are tied to the national economic cycle.”

The current cycle is getting mature, but McLaughlin says when the next cycle hits they don’t predict anything like what happened a decade ago.

“We don’t think the housing market, in Nashville or anywhere else really, is going to see a collapse like we did 10 years ago,” he says.

“That’s primarily because the lending practices that were in place 10 years ago are not in place anymore, so lenders are actually being quite responsible when it comes to lending money.”

Risks add value

McLaughlin says selling a property for a gain over a short period generally requires modest price growth at minimum, so as flippers are adding value by improving the quality of a home, the surrounding rising home prices are providing them with a sort of safety net when taking on a project. And the work they do is good for the economy.

“There was a lot of deferred maintenance, and then they were bought up at bargains by investors and they were able to actually get them back into good shape and then sell them again. We don’t think that’s a bad thing,” McLaughlin explains.

“Where the investor’s actually improving the housing stock by fixing them up, that’s a good thing for an economy. It’s a good thing for the housing market. What you don’t want is a situation where investors are buying them purely for price speculation.”

McLaughlin says the large number of flips going on today are adding value that also helps keep the real estate bubble at bay.

“That’s why we don’t think it’s necessarily a bubble of flipping going on in Nashville, but really more opportunistic investment opportunities from flippers,” he says.

“Certainly prices are growing fairly solidly in Nashville. They’re growing about 7-8 percent year over year, so that does allow opportunities for investors, especially if they are adding value to the house.”

And when it comes to making real money on a flip, it can be worth it to go for the one that needs the most work. But it can be a real labor of love.

“There’s nothing I stay away from,” Shafer says. “Five years ago I would have said, ‘I stay away from asbestos, I stay away from mold, I stay away from foundation issues.

“At this point, I’ve taken houses that were condemned – literally the city was about to bulldoze, and I would go and argue to save that house. There’s nothing I stay away from, other than a really bad deal.”

A bad deal to Shafer is a property that has so many multiple offers on it that there’s just no way he could break even on renovating it.

Still, Shafer admits he’s guilty of paying too much for some houses simply because of his desire to save them from being destroyed, and possibly replaced, with out-of-place infill.

“It’s not a great business practice,” he says. “I guess if I wanted to be the most profitable contractor in Nashville, I wouldn’t be doing historic homes. I’d be tearing down. I’d be doing new construction, because that is much more profitable and much less headaches.

“You can budget it. You know exactly what it’s going to cost to build something new construction, vs. you have no idea what it’s going to cost to renovate a 100-year-old home. You can guess, but chances are you just don’t know.”

Labor and other risks

And that’s the thing with flipping houses – there is always a risk involved. Costs add up beyond the purchase price, including insurance ($500-$2,000), property taxes ($500-$3,000), maintenance ($250-$1,000) and selling costs ($10,500- $15,000), so it’s important for flippers to do their due diligence – and then expect a surprise or two.

“You have to kind of evaluate what you’re starting with and estimate what it would cost to produce a finished product and make sure that you can make a profit on it,” David McKinney notes.

“I’m game to look at anything, but if you can’t make at least $50,000 it’s not worth the risk because you always have to have a contingency. There’s always the unexpected costs that pop up that you need to be prepared for.

“If you go into it with the intention of making $50,000 and that’s your goal, you’re not necessarily going to make it.”

Cost of labor is one factor right now, he says. New flippers should be wary as activity drives up sub-contractor rates and inexperienced workers try to take advantage of increased need.

And people who are tackling a renovation on their own don’t have the experience to foresee challenges they might face when doing the flip.

“All things can be overcome with money, but it eats into your profit,” David McKinney says. “Availability itself is probably the greatest factor right now. Everyone is so busy that finding the skilled labor to do things is difficult.”

The McKinneys made $70,000 on the last home they sold and are currently working on a rebuild on North Second Street after the original house burned to the ground.

The goal is to build something that fits into the neighborhood, makes money for them, and keeps them on the path in which Wendy can eventually leave her mortgage job and join David in the company full-time.

“It’s scary and exciting all at the same time,” she says.