Reality-star-turned-fraudster highlights the risks of house flipping

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A combination of low interest rates, tight inventory and a booming economy has created near-ideal conditions for house flippers who buy property, fix it up, then sell it for a quick profit. But prospects of a recession could quickly change that equation, experts warn.

"We're certainly reaching the top of the bubble," said Taylor Denchfield, a Washington, D.C.-area real estate broker, in an interview with CNBC's "American Greed."

Denchfield says he has been flipping homes since he was 17 (he is now 25).

Data from the first three months of this year suggests the flipping market has already begun to cool off.

Flippers turned around more than 49,000 homes in the first quarter, according to real estate research firm Attom Data Solutions. That represented 7.2% of all home sales for the quarter, which was the highest rate since 2010. But profits from those sales declined by nearly 10% from the same period one year ago. The average return on investment — 38.7% — was the lowest since mid-2011. And the number of flippers dropped 11%.

"Investors may be getting out while the getting is good, before the market softens further," said Todd Teta, chief product officer at Attom.

But Denchfield said that is no reason to panic.

"There is still some money to be made, but you have to be a lot more diligent in the deals that you're doing today," he said.

Calculated risk

The consequences of playing the market wrong can be severe.

In one of the most extreme examples, Phoenix businessman Scott Menaged set out to be the king of house flippers, buying up foreclosed properties with abandon following the 2008 financial crisis. He became so successful, he landed a spot on the Discovery Channel reality series "Property Wars" in 2012.

But when he became overextended in 2014, Menaged turned to fraud, lying to banks and other lenders in order to keep up his empire — and pay for his lavish lifestyle. In a ghoulish turn, he even took out lines of credit in the names of dead borrowers, stealing their identities using Social Security death records.

"Everything that was tied to Scott was tainted with some sort of fraud, some sort of lies," IRS criminal investigator Denise Lucero told "American Greed." "It just always seemed to be, does this guy stop?"

Even a downturn in the market was not enough to stop him, until authorities finally caught up to him. Now, Menaged is serving a 17-year prison sentence after pleading guilty in 2017 to conspiracy to commit bank fraud, conspiracy to commit money laundering, and aggravated identity theft. He was ordered to pay more than $33 million in restitution. But it tragically came too late for his primary lender, Densco founder Denny Chittick, who committed suicide in 2016 after suffering massive losses.

Flipping 101

As extreme as Menaged's case was, Denchfield said it offers lessons for anyone trying to play the house flipping market.

"It's best not to get in over your head. Don't bite off more than you can chew," he said.

That is especially true for beginners, whom he urges to go slowly.

"If it's your first flip, see it through to completion. Make your profit, move on to the next before growing your scale."

Denchfield said the most common mistake flippers make is not having sufficient assets to go through the process. In addition to having the funds to buy the property, you need to shoulder the carrying costs, including property taxes, insurance, homeowners' association dues and mortgage payments. Then there is the cost of renovations, as well as marketing and selling the property.

"The biggest mistake house flippers make is running out of capital," Denchfield said. "A lot of flippers underestimate exactly how much they're going to need to complete it."

Home renovation projects almost always turn up surprises. Predicting how long it will take for a property to sell is tricky at best. Successful flippers figure those variables into their budgets.

"In every deal there's almost always going to be budget overruns or delays," Denchfield said.

He suggests arming yourself with knowledge about home renovation and construction.

"Managing the construction and managing the timeline is the most valuable resource that you have," he said.

If you are serious about making a living flipping homes, consider getting a real estate license. Acting as your own agent means you will not have to pay commissions to someone else.

"You're saving typically 3% on the purchase and you're saving 3% on the sale, so that's 6% right there that you can add into your bottom line on the transaction."

Denchfield sees the growing recession talk not as a signal to jump ship, but a reminder to be disciplined.

"We're definitely on the horizon of a recession, but we're not quite there yet," he said. "Use time to your advantage and exit your positions before there's any change in the economy."

But he said it is increasingly important to have a contingency plan if the market goes south.

"You should always have a backup plan to be able to rent the home if you're not able to sell it for what you are expecting to be able to sell it for," he said.

See how real estate reality star Scott Menaged flips a successful house flipping career into a web of lies, deceit and staggering losses. Watch an ALL NEW episode of " American Greed ," Monday, Sept. 16, at 10 p.m. ET/PT only on CNBC.