The Principles of Flipping Remain Constant
Avoid the Temple of Doom and Go to the Holy Grail of Profit
By Nathan Trunfio
Real estate investing is an adventure, and nowhere is this truer than with fix-and-flips. Flippers are in many ways the archeologists of real estate, looking for forgotten properties left in distress so they can return them to the value and prominence these treasures deserve. Kind of like Indiana Jones searching for the lost ark, just without the bullwhip and the fedora.
But in today’s market, real estate investors may wish they had Indy’s dial of destiny to turn back time and go back to the market conditions they enjoyed just a few years ago back in 2020.
No doubt about it—the housing market is very different for fix-and-flip investors than it was right before the pandemic. Looking at all these differences begs the question — how can you succeed when things have changed so much, so fast?
The good news is that the basics behind a successful fix-and-flip business in 2020 still apply today. These strategies may require different tactics, but the fundamentals are the same.
Let’s survey the changes in the fix-and-flip market since 2020, and then see how three fundamental strategies for successful flips still apply in the current environment. All data is from ATTOM Data Solutions’ quarterly and annual releases.
Changes in the Fix-and-Flip Market
Flips continue to gain market share because the overall real estate market is slower
The flip rate right now is 9%, meaning that 9 of 100 home sales were flips. That rate, which is the second highest this century, was under 6% in 2020 and 2021.
One interesting callout — the five metros with the highest flip rates were all in the southeast, including Atlanta, Jacksonville, and Memphis.
It is worth noting that the number of flips seems to be flattening out. After increasing from 242,000 in 2020 to 357,000 in 2021 to 407,000 in 2022, the flip rate dipped by about 10% in the first quarter of 2023. This decline is not a red flag for investors, however, first because of winter seasonality, and more significantly because this rate of decline was less than the rate of decline across all home purchases. This important distinction shows that real estate investment transactions continue to be more durable than the homebuyer mortgage market.
The market share for flips should give real estate investors confidence that deals still can be found even in a market defined by tight inventory and higher interest rates.
Flip profit margins have compressed, but the worst is over
Back in 2016 and 2017, flip profit percentages surpassed 50%. In 2020, the profit percentage still surpassed 40%. But things have changed. So far in 2023, the average flip profit percentage is just 23%, a slight increase over all-time lows in late 2022. This stat clearly shows how rapidly rising purchase prices plus additional rehab costs (both in terms of materials and labor) have significantly compressed profit percentages for flippers. But while percentages have dropped, actual gross profits are consistent, sitting between $65,000 and $70,000 in each of the past three years.
Now that we have a good picture of what is happening in the fix-and-flip market, let’s look at the investment strategies that the best investors are using to profit today. As we do, we will see that the fundamentals of flipping remain the same—giving investors confidence in their path toward profit.
Fundamentals of Flipping that Remain Unchanged
Buying right is more important than ever
Experienced flippers know that the best way to profit from a flip is to buy the distressed property at the right price. That is even more true in an environment where it costs significantly more to purchase a house. The right initial purchase price sets an investor up to benefit from tight inventory and higher prices on exit, locking in profit. On the other hand, overpaying for a distressed property in a tight profit environment can lead investors into trouble.
The best way to put yourself in a position to buy right is to find the most effective marketing mediums that give you opportunities to buy properties directly from sellers. Numerous marketing strategies can help you do this, from tried-and-true direct mail to using text messaging, digital advertising, or social media to drive leads and referrals.
It is also important for investors to remain disciplined. If the purchase price is too high, slim profit percentages will make it very difficult to profit on exit. This is another reason to avoid bidding wars and remain focused only on the deals where the numbers work.
Decide on what is most important to your strategy—gross profit or profit percentage
Today’s smaller profit percentages show us that flippers must invest more money to achieve the same profit on average. So investors need to decide what is more important to them—making more dollars or getting a better percentage return on their money. Both are legitimate strategies driven by risk tolerance and an investor’s ability to flip at volume.
If you want bigger profits, lean into larger primary markets with higher home prices. Boston, New York, and California’s Bay Area top the list in terms of the highest gross profits—each well over $100,000 per flip. Investors who choose this approach should expect to spend around $1 million to purchase and rehab properties. That increases risk because it requires a larger capital investment, but it can yield more overall dollars on the bottom line.
On the other hand, flippers who specialize in volume may choose smaller deals that provide healthier profit percentages of 70% or above. These deals give investors (especially less experienced investors) a less risky path to profit. The target is to look for properties with purchase prices below the national average of $250,000. The Rust Belt is full of markets where it is easier to find and flip these properties. For example, Pittsburgh flips offer a 110% profit percentage because of a low $87,000 initial purchase price. Buffalo and Detroit offer similar types of deals.
As investors consider larger versus smaller deals, it is imperative that they also balance the amount of value they want to add to a property with the market. Properties in more disrepair will need more construction work, and investors considering these deals need to be sure they can handle this level of complexity. The good news is that these types of deals typically have higher margins.
At Lima One, we are seeing experienced flippers plan more heavy renovation deals in which they add square footage, additional bedrooms and bathrooms, or ADUs (accessory dwelling units) to the property.
The heavier the renovation work, the more value an investor can add to the property—which can lead to more profit. But these deals take more time and expertise to complete, and heavier renovation also adds more variables that make it more difficult to execute because so many more things could go wrong. Investors also need to ensure that the level of rehab they are doing meets the desires of homebuyers in the market, so that they can maximize profit from the value they have added when selling a property.
Develop flexible exit strategies with flexible financing options
With profit percentages compressed, many flippers choose to hold completed projects in their portfolios as rentals instead of selling them. The fact that rents remain at all-time highs makes building a single-family rental portfolio more attractive. Run the numbers to see if this makes the most sense for your flips.
One key to this optionality is working with a lender that offers maximum flexibility. Can your lender offer long-term financing for a rental in addition to fix-and-flip financing? Do you get discounts on these kinds of refinances? Does the lender offer interest-only bridge loans that let you keep the property while waiting out interest rates, or to let you get cash out for your next cash offer on a distressed property?
The right financing partner will set flippers up to succeed by offering maximum options. With this kind of lender, you can follow the numbers for the best strategy instead of being constrained by limitations.
The Last Word
Flippers can be confident that fundamentals will help them avoid the temple of doom and lead them to the holy grail of profit despite the changes in the housing market since 2020. Investing by these solid strategies will lead investors to succeed in any market—so make sure your present-day flip plan includes these time-tested fundamentals.
Since its inception in 2010, Lima One Capital has been recognized as the nation’s premier lender for real estate investors and has funded over $7 billion in business purpose real estate loans. With a reach across 46 states, Lima One operates as a capital partner for both real estate investors and brokers by financing residential investment strategies including fix and flips, rental, new construction, and multifamily. For more information, visit limaone.com.
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