Fix and flip investors looking for new acquisitions may want to consider the substantial volume of residential foreclosures and short sales currently on the market. Though price gains on existing single-family homes are expected to be more moderate going forward than they were in 2012 and 2013, banks’ backlog of foreclosures offers opportunities to buy these properties at substantial discounts, driving up potential returns.
Historically, some investors may have been reluctant to buy foreclosed properties as they can involve more repair work than occupied homes. Yet foreclosures and short sales can offer good value for the money, even taking into account higher rehab costs. In July, foreclosed homes sold at an average discount of 20 percent to market value, reports the National Association of Realtors (NAR). Short sales featured discounts of approximately 14 percent.
With growth in housing prices slowing down from its recent accelerated pace, buying distressed assets may offer investors a way to make up for lower price appreciation. Average gross returns on initial investment (ROI) in residential flips reached a cyclical peak a year ago, at 31 percent, according to housing data provider RealtyTrac. In the second quarter of 2014, gross ROI averaged 21 percent, or $46,000 per flip. “Flippers no longer have the luxury of 20 to 30 percent annual price gains to pad their profits,” warned RealtyTrac Vice President Daren Blomquist. “As the market softens, successful flippers will need to focus on finding properties that they can buy at a discount and efficiently add value to.”
RealtyTrac estimates that the average discount on sales of foreclosed residential properties in July was $72,400 per house. In some cities, including Las Vegas and Miami, the discounts have been higher. Investors took note — Redfin, the real estate search site, reports that last year bank-owned properties accounted for 35.2 percent of all residential rehab projects.
The catch is that with the U.S. economy on the mend, the volume of new foreclosures has been trending down and discounts on distressed assets are not as dramatic as they have been before. Lawrence Yun, chief economist with the NAR, has said that “rising home values are helping owners recover equity and strong job creation [is] assisting those who may have fallen behind on their mortgage due to unemployment or underemployment.” For rehab investors that means that if they want to boost their returns by investing in distressed real estate, they may be facing a limited window of opportunity.
A maxim of residential real estate investment is that profits are made not when investors sell the property, but when they buy it. Buying at the lowest possible price may generate potentially positive returns. Foreclosures and short sales generally require a lower initial investment than homes with mortgages in good standing.
In July, the average ROI on residential rehab projects nationwide was 21.3 percent, according to RealtyTrac. There was a correlation, however, between markets with the highest volumes of foreclosure filings and higher than average ROIs. This may be due to the fact that sellers in markets with many foreclosed properties are more motivated to offer discounts. For example, in Las Vegas, one of the epicenters of the housing crisis, the average discount on sales of foreclosed properties rose 69.5 percent between 2013 and 2014; in Phoenix, the increase was 23.8 percent; in Miami 49.1 percent.
Cities in California, which has also been hard hit by the housing bust, accounted for the highest average gross profits per flip.
Looking forward, investments in foreclosed properties and short sales could continue to offer decent returns. The median price on sales of existing homes is expected to increase by 4.4 percent next year, NAR forecasts. In Florida and Texas, housing prices may increase by up to 5 percent. In California and Arizona, prices will go up from 3 to 4 percent.
Investors should keep in mind, however, that opportunities to buy foreclosed homes at steep discounts are becoming more limited. The discounts are already five to 10 percentage points lower than they were in 2011 and 2012, according to NAR. And the number of new distressed assets on the market is shrinking. The Mortgage Bankers Association reports that in the second quarter the percentage of residential loans that entered the foreclosure process was 2.49 percent, the lowest rate since 2006, before the housing crisis began.
This is good news for the nation’s economy. But given these trends, investors shouldn’t wait too long to start looking at the distressed home market for potential acquisitions.