Why investor demand is picking up even as home-flipping profits dry up.
After falling off in late 2018, the U.S. home flipping rate rebounded to a nine-year high in the first quarter of 2019, according to a recent report from ATTOM Data Solutions.
ATTOM’s Chief Product Officer Todd Teta concluded that the jump in home flipping was likely due to real estate investors “getting out while the getting is good” — especially given a corresponding decline in the average gross flipping return, which dropped to a nearly eight-year low in the first quarter.
That “getting out while the getting is good” sentiment certainly rings true among larger-scale investors, according to Jason Medley, founder of the Collective Genius, a mastermind group of high-volume real estate investors from across the country.
“They are naturally becoming more cautious,” said Medley of the group of about 120 investors that average about 100 flips each per year. “They are shrinking their buy box … compressing back to the good neighborhoods … your tolerance for what you are willing to pay is shrinking.”
Medley said many of the investors in the group, including himself, went through the pain of the last housing bubble bursting, and want to avoid a repeat of that experience.
“There is one thing that I am completely and absolutely sure of: I don’t want to start over. How do you make sure that doesn’t happen? You exercise caution,” he said. “If you have 30 rehabs going at once, and 30k into each one as equity on the loan, it may seem like you are a millionaire, but if the market takes a 10 percent haircut — combo of depreciation and bad rehab estimates — you are instantly broke.”
Caution is fueling Medley’s advice to members of his mastermind group: “Get back down to the basics: underwrite your deals better, get into a position of cash, look at your bottom 20 percent of homes that give you trouble, and liquidate your bottom 20 percent so that you have a cash position, so if foreclosures do surge you can participate as a victor rather than a victim.”
Increasing Investor Acquisitions
Medley’s perspective along with the shrinking profits data from ATTOM points to investors fleeing home flipping as an investment strategy; however, other data suggests that real estate investors are not just clearing out their flip inventory, but also ramping back up on their acquisition of investment properties.
The share of homebuyers purchasing with cash — a good proxy for real estate investors — increased to a three-year high of 25.9 percent in the first quarter of 2019, according to an Auction.com analysis of public record data from ATTOM.
Additionally, more recent proprietary data from the Auction.com marketplace shows an increase in demand from real estate investors buying foreclosure and bank-owned (REO) properties, following a slowdown in the second half of 2018.
The rate of sales to third-party buyers — primarily real estate investors — at the foreclosure auction increased to a 20-month high in April 2019 on the Auction.com platform, which accounts for more than 40 percent of all foreclosure auction sales nationwide. The foreclosure auction sales rate dipped slightly in May compared to April but was still up three percent compared to a year ago, marking the third consecutive month with an increase following seven consecutive months with year-over-year decreases.
Counting on a Comeback
A similar pattern played out back in February 2015, when the sales rate for foreclosure auctions on the Auction.com platform jumped to a 19-month high following 15 consecutive months of year-over-year decreases. That spike in demand at the foreclosure auction occurred even as average home flipping profits were trending lower — down on a year-over-year basis for the fourth consecutive quarter in Q1 2015.
But home flipping profits soon rebounded, increasing on a year-over-year basis for six consecutive quarters starting in Q2 2015. In this case, real estate investors started acquiring distressed properties at a higher clip before flipping profits had picked up, in essence speculating that the market would improve over the next six months it would take to renovate and sell the properties they were acquiring in the first quarter.
And the market did in fact improve, with home price appreciation accelerating from a post-recovery low of 2.7 percent in July 2014 to as high as 8.6 percent in May 2015 and continuing between five and eight percent for the remainder of the year, according to an Auction.com analysis of ATTOM data. That accelerating home price appreciation rewarded investors who had acquired homes to flip at the foreclosure auction earlier in the year, despite declining flipping returns at the time of acquisition.
Flippers Leading the Market
The 2015 pattern aligns with findings from an extensive home flipping analysis published by CoreLogic in April. The analysis looked at home flipping activity across the country between 2002 and 2018 and concluded — among other findings — that there is a causal relationship between home price appreciation and home flipping activity.
“As it turns out, both sets of Granger Causality tests show that not only can house price changes be used to forecast both the levels and change of flipping activity, but that higher levels and changes of flipping activity can also be used to forecast changes in house prices,” write authors Ralph McLaughlin and Arthur Jobe in the published findings from the analysis. “In other words, these results suggest that house price appreciation leads to increases in flipping activity, which then recursively leads to additional increases in home prices, that again leads to further increases in home prices.”
According to this line of reasoning, the increase in flipping in the first quarter of 2019 may in fact be a leading indicator of improving home price appreciation that leads to improved flipping returns for home flippers later in the year.
The buy-and-hold rental investment strategy provides investors more flexibility upfront on acquisition price, according to Lizell, who also has developed a training program to help investors purchase properties at auction. Lizell recommends that investors buy below full “after-repair-value” for fix-and-flip properties, but that upfront discount could be lowered if the property can be held as a rental.
“If I was going to flip the property I might be able to pay 80 (thousand) for it, but if it was a rental I might be able to pay 90 [thousand],” he said.