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To flip or not to flip?

By Ritchie Clapson CEng MIStructE, co-founder of propertyCEO

According to a 2021 report by Hamptons, the average flip sold during the pandemic produced a profit of £48,000. That’s a number that will likely cause a fair few folk to wonder if flipping a property is something they should become involved in this year. My advice is that flips, refurbs, or doer-uppers shouldn’t be a go-to strategy this year, mainly because of timing.

That was then, this is now

Hampton’s £48,000 profit figure is based on a period when we were at the height of a global pandemic and where we saw house prices rising at a rate of close to 10% per annum in a market stoked by the stamp duty holiday – circumstances that motivated many people to move house. A bright, shiny time for flippers. If they purchased a property for £250k and sat on it for 12 months, that property would go up by £25,000 without them lifting a paint brush. That’s a huge chunk of Hampton’s reported £48,000 profit average – more than half.

But this year the housing market is certain to be a different place. Most experts are predicting that house prices will fall in 2023, and while the estimates vary considerably, the general feeling is that we could see an adjustment of 5-12%, with house prices not increasing again until later in 2024.

So, let’s move the £48k flip from mid-pandemic (etc) to 2023. If house prices reduce by 10%, that £250k doer-upper’s value decreases by 10% over the time the flipper owns it; instead of a £25k boost, there’s a £25k deficit.

Ouch.

Adding £23k’s worth of value (as they did in the previous example) means a net loss of £2k instead of a profit of £48k.

Double ouch.

Yes, there are many variables (including the property’s value, the timing of the flip, and so on), but it is clear that flipping is a fair-weather strategy. That’s not the forecast for 2023 – the chances of seeing a strongly rising market are, by all accounts, slim.

Another way to go

One of the interesting dynamics of the current market situation is that what’s bad for flipping a single residential property could be very good for converting a single commercial building into multiple flats. Although ‘small-scale development’ is just one rung up the development ladder from a flip, it can be worlds apart when it comes to profitability.

Three costs are critical to anyone that develops property:

1. How much you pay for a property

You tend to make your money when you buy, so it’s important to get good value. Converting commercial property could involve changing an office or industrial building into apartments or simply putting flats above a shop. So, what will happen to commercial property prices in 2023? No one has a crystal ball, but it would be logical to assume that prices will come down. Firstly, we have a significant oversupply of unused commercial property that’s ripe to be converted – how many empty sites have you seen in your local area? Secondly, the

recession will force many businesses to close or sell their property assets. And finally, we have a lot of commercial property owners who have been holding out to get top dollar for their buildings by selling them to developers. For this latter group, the tide is going out fast. The value of their asset will be going down while, at the same time, the costs of maintaining it (mortgage rates, energy, security, business rates, etc.) are all going up. It’s hardly surprising, then, that many people are predicting a significant market dip for commercial property in this year, which would make it a great time to buy.

2. How much you pay for development work

Labour and materials costs have certainly seen a few ups and downs recently, but while this has been happening, the housing market has been rising. However, most commentators predict that house prices will decrease by 5-12% this year, and the prospect of falling house prices has some interesting side effects. The volume housebuilders immediately start to pull back on production – they’ve no interest in releasing properties into a falling market and will want to slow things down so they can minimise any negative impact. Because these players make up a significant slice of the labour and materials market, we suddenly end up with lots of tradespeople out of work and materials not being sold. This, in turn, makes both resources a lot cheaper to buy – supply and demand. If you purchase a commercial property in mid-2023, you’ll likely be looking to get quotes from contractors in late 2023. Given that the housing market will still likely be in the doldrums then, the major housebuilders will still be going slow, allowing you to buy labour and materials far more cheaply.

3. How much you sell for

If you buy a commercial property in mid-2023 and start works in late 2023 or early 2024, you should be ready to sell in late 2024 or early 2025. And this is when even the most pessimistic forecasters predict that house prices will rise again. Even the Office for Budget Responsibility (OBR) reckons house prices will increase in late 2024 and throughout 2025, so you’ll be entering a sellers’ market.

Ah, but what if circumstances change and those changes aren’t as kind? One of the significant advantages of small-scale projects is that you always have the option to hold on to the flats you’ve built and rent them out. As we’ve recently seen, a lack of affordability puts downward pressure on house prices, but it puts upward pressure on rental costs as people look to rent rather than buy. Consequently, you can rent out the units you’ve built until the market moves on and you’re in a better place to sell.

Apples and pears

How big is the difference between doing a flip and a commercial conversion? Considerable.

A small-scale development should net you between £100k and £500k profit. A flip could see you lose money in the year ahead. The workload is different too: small-scale developers have a bigger budget, so they can afford to hire a professional project manager to oversee all the construction work on their behalf (developing property this way can be done in spare time). And there are no DIY skills required, just the ability to oversee operations at a high level while a team of professionals does the heavy lifting for you.

The amount of money needed to invest is also very different. Many flippers will see a 25% deposit and the cost of the refurbishment work come from their own savings. For small-scale developments, most of the funding is borrowed from specialist commercial lenders who generally require the developer to put in a much smaller proportion of the required funding themselves.

Of course, any would-be small-scale developer needs to do their own research, taking into account any special circumstances in the area the project will take place, but more profit for less cash invested and less work is an attractive combination.

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