Factors Affecting Fix and Flip Investors
But Help Is on the Way…Eventually
by Rick Sharga
Most fix-and-flip investors will agree that a housing market with high demand, low supply, low-cost capital, and rising prices is their ideal scenario. And generally speaking, that characterizes today’s market. But like many generalizations, this one does not hold up well upon further scrutiny.
Partly, this is due to excesses in all the categories mentioned above.
Supply of homes for sale—both new and existing homes—has never been lower. Homebuilders have under-built for the last decade, and existing homeowners have been staying put longer and longer: the average tenure of a homeowner today is almost 12 years, more than double the length of time a homeowner stayed in place a decade ago. And consumer psychology has also played a role, since prospective home sellers first hesitated to list their home during a global pandemic, and now are concerned that if they sell their home there is nothing for them to buy.
At the same time, demand has been driven to a high level by demographics—namely, the largest cohort of Millennials (the largest generation in U.S. history) is rapidly approaching the prime age for home ownership. The COVID-19 pandemic played a role as well, accelerating the movement of urban renters to become suburban homeowners.
Also driving demand were historically low mortgage rates. Sub-3% rates on 30-year, fixed-rate loans bolstered affordability, and in many cases made it less expensive to make a monthly mortgage payment than to pay rent.
This huge supply/demand imbalance led to bidding wars, which in turn led to massive price increases (15% year-over-year), and to properties spending almost no time on the market. The median number of days-on-market dropped from almost 60 in June 2020 to 37 in June 2021 according to the Federal Reserve Bank of St. Louis. And in many markets, the actual days on market could be measured in weeks…or even days.
So, all the factors that normally play out in favor of fix-and-flip investors have been so extreme that they have made it extraordinarily difficult for flippers to prosper. Limited supply is good; virtually no supply makes it hard to find anything to buy. Rising prices are good—they make it easier to capture ROI; prices that rise so fast they eat away all the margins are not so good. Low-cost capital is useful unless it turns traditional homebuyers into well-funded competitors for this limited inventory.
Home Flipping Falls to Lowest Level in 20 Years
It is probably not a surprise that the fix-and-flip market has flopped in recent quarters. According to a recent report from RealtyTrac’s parent company ATTOM Data Solutions, flips accounted for only 2.7% of home sales in the first quarter of 2021—the lowest level since 2000. This was down from 4.8% of home sales in the fourth quarter of 2020 and 7.5% of sales a year ago.
The number of homes flipped dropped significantly, and so did the gross margins, due at least in part to the rapidly escalating cost to purchase a home. According to ATTOM, the gross profit on a flip in the first quarter of 2021 was 37.8%. This was down from 41.8% a year ago, and is the lowest margin reported by ATTOM since 2011. Unsurprisingly, ATTOM noted that the percentage of homes flipped dropped in over 70% of the markets covered in its report.
There were two other interesting items in the ATTOM report, both of which reflect the reality of the current housing market. First, the percentage of homes purchased with cash by fix-and-flip investors jumped to just over 59%, highlighting the importance of being able to move immediately on a potential property without having to wait for financing. Second, the length of time between purchase and flip dropped to 159 days—the fastest turn times since the third quarter of 2013, and an indication of how strong demand from homebuyers is today.
Help is on the Way…Eventually
One of the factors undoubtedly hampering fix-and-flip investors today is not just the lack of inventory, it is the lack of foreclosure inventory. While foreclosure activity was running well below historical levels prior to the pandemic, the federal government’s foreclosure moratorium and CARES Act mortgage forbearance program effectively stopped almost all foreclosure actions over the past 18 months. In its mid-year foreclosure report, ATTOM concluded that foreclosure activity was down by 61% compared to the first half of 2020, and 78% compared to 2019.
Fix-and-flip investors have historically been ideal buyers of foreclosure inventory, and part of a win/win situation for the housing market—buying below-market properties that needed repairs, getting the properties ready for occupancy, and selling them, often to first-time buyers. While there are other types of properties that fit this buy/fix/flip model such as homes from probate sales or bankruptcies, homes in previously underserved communities, and homes where the owners simply have not kept up with maintenance over the long term, foreclosure properties have been a mainstay for most flippers, and have been in increasingly short supply during the pandemic.
That situation may be on the verge of changing. The Biden Administration has indicated that the foreclosure moratorium will have ended by July 31. The Consumer Finance Protection Bureau (CFPB) which regulates how mortgage servicers execute foreclosures, had been expected to put rules in place which effectively would have made it impossible to initiate foreclosure proceedings on defaulted borrowers until the end of 2021. But, somewhat surprisingly, the CFPB rules actually included several carve-outs that should result in foreclosure properties entering the market over the second half of the year. Specifically, the Bureau stipulated that loans that had been in foreclosure prior to the moratorium—some 250,000 in all—would be eligible for immediate processing, as would vacant and abandoned properties. The CFPB also allowed foreclosures to begin in cases where the borrower was “unresponsive” to servicer outreach, or where the servicer had exhausted all loan modification options unsuccessfully.
At RealtyTrac, we are now expecting to see several small waves of foreclosures—one shortly after the moratorium expires, made up mostly of the loans previously in foreclosure; one after the CFPB’s new servicing rules expire at the end of the year; and one in mid-2022, when servicers have exhausted loan modification options and the last of the borrowers have exited the mortgage forbearance program.
Between the loans that were in foreclosure before COVID-19, the loans exiting the forbearance program without a plan in place with their lender, and loans that would likely have defaulted over the past year-and-a-half, it is likely that between 800-900,000 loans will enter foreclosure over the next 12-24 months. Fix-and-flip investors interested in purchasing these homes will need to move quickly, reaching out to financially-distressed homeowners early in the foreclosure process (the phase we call “pre-foreclosure” on our RealtyTrac website), since with record levels of equity and continuing high demand, it’s likely that most of these properties will be sold before the foreclosure auction even takes place, and only a handful will be repossessed by the lenders.
