How Real Estate Investors Can Pivot in a Tight Inventory Market
A New Paradigm in Acquisition and Disposition Strategies
by Nate Trunfio
The U.S. housing market is currently experiencing an unprecedented and severe housing shortage. In 2020, the national housing inventory declined by nearly 40%—leaving 449,000 fewer homes for sale compared to December 2019, according to Realtor.com.
In May 2020, the national inventory had a 4.8-month supply of homes, according to the National Association of Realtors, but that number steadily dropped throughout the duration of 2020. By December 2020, there was a 1.9-month supply of homes, the lowest number ever recorded.
The Major Challenge of Inadequate U.S. Housing Supply, a recent study by Freddie Mac, estimates that 2.5 million houses need to come on the market in order to combat the shortage.
In addition to the record-breaking low inventory, the country also experienced extraordinary
buyer demand. Of course, low inventory and a high demand combine to create an increase in housing prices. As of December 2020, the national median price for a home was $340,000—an increase of 13.4% from the previous year.
Changing the approach to investing
Simply put, the housing shortage is forcing investors to rethink the way they do business. As a result, many are being forced to find and use different deal strategies.
One example of this is many investors are going into deals with multiple business plans. For example, an investor could close a deal with two strategies: renovate a home with a B.R.R.R.R. strategy where they have intentions to hold the property long term while also analyzing the profitability of flipping the property by selling it to a retail buyer. Having multiple strategies allows an investor to be prepared for any changes in the market conditions.
Another route investors are pursuing is more heavy construction projects and scrape-and-builds. These approaches are typically used because the replacement costs of many homes are comparable to what the building costs are. Also, many times more value is created when you re-build a property, or expand its footprint, compared to simply doing renovations on the home.
On the other hand, some investors are doing the opposite—they are doing lighter rehabs which allows them to acquire assets at higher prices to compete with other buyers. Since there is so much demand for housing, end buyers are paying premium prices for homes with lower-end finishes, so investors are cutting construction costs to keep their margins.
Investors are also beginning to transition away from fix-and-flip projects, turning to new construction projects instead. One reason for this change is that investors are finding more opportunities to buy land and build a new home at a lower basis than buying an existing property that needs renovations. Also, construction costs and budgets are much more reliable with new construction than fix-and-flips.
The build-to-rent market is a tremendous strategy for investors. Rather than buying rental homes, investors are choosing to build rental homes because they will rent for higher amounts to better tenants with less maintenance costs. Build-to-rent is one of the hottest trends in real estate investing, and this trend should continue for quite a while due to the rental housing shortage and desire of tenants—especially millennials—to rent new homes versus being locked into buying a property.
Where are investors going?
The crunch on housing inventory has also caused some investors to expand into new markets. They are growing their “territories” in order to cast a wider net – moving from primary to secondary and tertiary markets where there is seemingly less competition.
Many investors are following the “urban flight” migration trends. A mass exodus from urban areas across the country during the pandemic created excellent investment opportunities in the suburbs. As a result, investors are taking deals with lower margins. (It is not ideal, and we do not suggest it. But it is happening).
Investors who focus on secondary and tertiary real estate markets have been laser-focused on this demographic trend pre-and-post-COVID. The trick is to not overpay for available suburban investment property, which is difficult to achieve during a housing shortage—especially with the competition also vying for investment properties.
The trend of urban mass exodus and an increase in suburban demand is also affecting new construction. Subdivisions and small housing developments are popping up on just about every available plot of land to support the demand.
How are investors finding acquisition opportunities in this market?
The best real estate investors know that the real money is made on the acquisition when buying properties at a discount. But whether it is a rental property, a fix-and-flip, or land for new construction, investors are having a harder time than ever trying to buy properties at a discount due to the tight inventory levels.
One way that investors find properties at a discount is by marketing directly to potentially motivated sellers. Operators are trying new marketing strategies and campaigns to get in front of motivated sellers. Still, their cost per acquisition from a marketing perspective has continued to rise due to other investor and retail buyer competition. This means investors either need to spend more money on marketing or expect less acquisitions with their previous budgets.
Why and when are investors selling?
Dispositions and when to sell has also changed. Many investors who previously intended to hold their properties long term are now deciding to sell since home sale prices and demand are so high. As home prices have risen, home equity has multiplied, creating an incentive to sell earlier rather than later.
Some investors are on the sideline waiting out the housing shortage. Rather than continuing to invest, they are selling their assets to accumulate liquidity for future distress in the market—perhaps when eviction and foreclosure moratoriums expire.
What to expect in 2021
The 2020 housing market was largely unbalanced. It was a huge sellers’ market that left little room for buyers. The real estate market always tries to reach equilibrium, but finding a perfect balance between buyers and sellers takes time.
As a result, there has been larger separation of the wealth gap among real estate investors, meaning less experienced operators are not doing as many deals because they do not have the infrastructure to do so. More experienced investors are doing just as many deals because of the infrastructure they have built up. Simply put, more experienced investors have not taken too many steps back in regard to how much they are acquiring, yet less experienced investors have been affected. For better or worse, we expect this trend to continue – there are not as many tailwinds assisting newer investors, while the more experienced operator can weather the storm and headwinds.
2021 will be the year the market tries to achieve a balance. Investors can expect to continue to experience low inventory, a high demand, rising prices, and low interest rates.
Experts predict that the supply of existing homes on the market will remain low. In addition, the supply of newly built homes will also remain low. Builders are poised to begin more housing starts, but right now it is uncertain how rising costs of materials will affect those builds.
Since October, crude oil, a starting point for paint, drainpipe, roof shingles, and flooring, has shot up more than 80%. According to the Bureau of Labor Statistics, the prices for granite, insulation, concrete blocks, and brick have all reached record highs in 2021. The prices of drywall and ceramic tiles have also climbed.
In a recent report from the National Association of Home Builders, Chairman Chuck Fowke noted that supply shortages and high demand have caused lumber prices to jump “about 200%” since April 2020.
“The elevated price of lumber is adding approximately $24,000 to the price of a new home,” Fowke said. “Though builders continue to see strong buyer traffic, recent increases for material costs and delivery times, particularly for softwood lumber, have depressed builder sentiment this month. Policymakers must address building material supply chain issues to help the economy sustain solid growth in 2021.”
All in all, the disruption in supply chain will likely continue to cause construction materials to be priced higher than pre-pandemic levels for quite some time.
Conclusion
Heading into Q2 of 2021, investors can expect to see home prices stay high as inventory remains low. It will take time, and it may not be in 2021, but eventually more homes will come to market and inventory levels will normalize.
This may happen as more homeowners are put into stressful situations when loan modifications conclude, less government stimulus is offered, and the eviction and foreclosure moratoriums expire. Combined with rising interest rates, the housing market should start to level out.
No question, the US is facing some unprecedented times. Investors are seeing a housing shortage the likes of which we have never seen. The shortage will continue to create a challenge when it comes to buying property, and economists expect prices to remain high throughout spring 2021.
In the end, investors will continue to find ways to operate and acquire more homes. After all, there is not a bad time to invest in real estate as long as you are diligent about your investment decisions and strategies. Happy and safe investing!
