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How Flipping Properties Can Improve Housing Affordability—Here’s How
The U.S. housing market has seen a dramatic increase in home prices, with a 47% surge since 2020, according to the Case-Shiller National Home Price Index. As a result, housing affordability has become a pressing issue, particularly for first-time homebuyers. Only 17% of renters can afford the median-priced starter home, down from 42% in 2019, as reported by the National Association of Realtors.
While some blame real estate investors for exacerbating the shortage of affordable homes, with investor purchases making up nearly a quarter of low-priced homes in Q3 2024, not all experts agree. In fact, some argue that real estate investors, particularly house flippers, can play a positive role in improving housing affordability.
The Role of House Flippers in Affordable Housing
While it’s true that house flipping can drive up prices, it also helps increase the supply of homes, especially in markets where first-time buyers struggle to access affordable properties. Many homes that flippers target are dilapidated or outdated, often failing to meet the standards required for traditional first-time homebuyer loan programs. By renovating these properties, flippers not only improve the quality of housing stock but also make it accessible for buyers who might otherwise be priced out of the market.
Some flippers contend that they are providing an essential service by bringing homes up to code and into marketable condition. Joshua Ernst, in an article for MarketWatch, argues that flippers can be crucial to improving the affordability landscape, especially as part of a broader strategy that includes investing in existing housing stock rather than relying solely on new construction.
The Need for Investment in Distressed Properties
The U.S. faces a shortage of more than 7 million affordable homes, and new construction alone won’t solve the problem. In fact, no single policy can fix the housing crisis, according to researchers at the Urban Institute. Many homes in the existing housing stock are older and in need of substantial repairs. The median owner-occupied home was built 40 years ago, and approximately 12% of homes were built before 1940.
Furthermore, an estimated 9.5 million homes require serious repairs or lack basic utilities, and homes in lower-income communities are often the most affected. These homes present an opportunity for house flippers to revitalize and bring them back to a livable condition, serving the needs of first-time buyers who may not have the resources to tackle expensive renovations themselves.
Flippers’ Impact on Housing Affordability
While some argue that house flippers have driven up prices, especially in low-income neighborhoods, others suggest that flippers tend to target neighborhoods where demand is already increasing and revitalization is underway. Experienced flippers often enter these areas early, capitalizing on rising demand while contributing to neighborhood improvements.
However, the debate about whether flippers worsen or improve affordability is complex. For instance, in northeast Ohio, Jerry O’Reilly, a real estate investor, notes that while flippers have expanded the supply of starter homes, prices in those areas have often outstripped what many local buyers can afford.
Is House Flipping Still Profitable?
While house flipping can add to the supply of affordable homes, it’s not without challenges. The profitability of flipping has decreased in recent years. In the third quarter of 2024, the gross profit margin for typical flips dropped to 28.7%—a significant decrease from 48.8% in 2020.
Despite the lower margins, flippers still find profitability in cities poised for growth, such as Pittsburgh and Cleveland, as well as in high-cost markets like San Francisco and New York. However, the current high-interest rate environment poses difficulties for new investors, with nearly two-thirds of flips in Q3 2024 financed in cash. For those without cash reserves, financing options are available, though they come with their own challenges and risks.
Encouraging More Flipping to Improve Housing Affordability
To encourage more house flipping and help meet the growing demand for affordable homes, several policy changes could help. Ernst suggests that government initiatives could:
- Provide tax incentives for house flipping in opportunity zones, classifying investor profits as capital gains.
- Include house-flipping loan products in the portfolios of government-sponsored enterprises like Fannie Mae and Freddie Mac.
- Create small business loan products tailored to house flippers through the Small Business Administration.
In cities like Akron, Ohio, tax incentives such as a 15-year property tax moratorium for new builds or improvements on vacant lots have successfully encouraged investment in distressed properties, allowing investors to pass savings onto buyers.
Finding Affordable and Profitable Flips
Identifying the right market for house flipping involves more than just picking a neighborhood based on current trends. Successful investors like O’Reilly focus on areas with potential for growth, such as neighborhoods with rising demand due to migration patterns or corporate relocations. He suggests targeting properties near well-maintained homes, quality retail, and public transportation.
The key to a successful flip, according to experts, is having a solid plan, sourcing properties below market value, and keeping renovations modest but quality. Financing must be lined up before making an offer, and contractors should be secured prior to closing. Planning and sticking to the plan are essential for avoiding costly mistakes and ensuring a profitable project.
Conclusion
House flippers have the potential to play a crucial role in addressing the housing affordability crisis by renovating distressed properties and increasing the supply of homes. While the profitability of house flipping has decreased in recent years, strategic investments in emerging markets and thoughtful policies could help turn house flipping into a more significant solution to the affordable housing problem.
In the previous post: “Is Now a Better Time to Invest in Real Estate Debt or Equity?“
How Flipping Properties Can Improve Housing Affordability—Here’s How
Has the U.S. Housing Market Finally Begun to Thaw After the Pandemic?
It seems like the housing market might be showing signs of life. According to a recent report from Redfin, pending home sales in early October have seen their largest year-over-year rise since 2021, with a 2% increase in the four weeks ending October 6.
This news is likely to be welcomed by real estate investors who have felt the market has offered limited opportunities over the past few years. However, it’s important to take a cautious approach—one promising statistic doesn’t necessarily indicate a broader trend.
Is the Housing Market Truly Recovering?
Let’s explore the different factors at play.
Interest Rate Reductions: A Critical Factor or a Red Herring?
The Redfin report links the surge in pending sales to the Federal Reserve’s much-anticipated rate cut announcement in mid-September. According to Redfin, this announcement prompted buyers to re-enter the market in late September, despite mortgage rates having already been falling for weeks before the cut.
This psychological boost is crucial. Although buyers were aware of the falling rates beforehand, many seemed to be waiting for a formal signal to act. This could be attributed to a lingering fixation on the ultra-low rates of 3% to 4% that buyers enjoyed before 2022.
Any rate cut announcement serves as a nudge for prospective buyers, making them feel that now might be the right time to purchase, even if mortgage rates had been decreasing already. In an unstable mortgage market, such announcements hold significant influence.
However, mortgage rates are just one piece of the puzzle when analyzing housing market performance. As noted by Investopedia, the real estate market is driven by four primary factors: interest rates, demographics, economic conditions, and government policies.
Demographics: Shaping the Market
During the pandemic, demographic shifts had a profound effect on U.S. real estate, with major population movements like the Sunbelt migration fueling booms in cities such as Phoenix and Austin, which later became unaffordable for many.
Age is another key demographic factor, and the millennial generation’s pent-up demand continues to be a driving force behind the rise in home purchases. Despite the challenges of the past few years, millennials who have longed to become homeowners are now entering the market in greater numbers, as more properties become available.
Rising Inventory: A Sign of Stabilization
A key factor contributing to the market’s stabilization is the growth of housing inventory over the last year. The pandemic had a significant impact on the availability of homes, with sellers hesitant to list properties due to COVID-19 restrictions and, later, higher mortgage rates.
Some homeowners, particularly those upgrading to larger homes, found it financially challenging to sell and take on higher mortgages. Others, however, simply chose to wait for a more favorable market.
Although the latest Realtor.com report shows that inventory remains down by 23.2% compared to pre-pandemic levels, we are seeing an upward trend. For instance, new listings have been rising since last year, with a 5.7% year-over-year increase for the four weeks ending October 6.
As of September 2024, some states have even surpassed their pre-pandemic inventory levels, including Tennessee, Texas, and Idaho, with others, like Washington, close behind.
Vulnerabilities in Certain Regions
However, not all regions are showing positive signs. For example, some areas, particularly those affected by extreme weather, have seen inventory spikes not because of market recovery, but due to homeowners trying to offload damaged properties they can’t afford to repair.
For instance, regions like Florida and North Carolina, hit by hurricanes, have experienced increases in home listings, but these may reflect a response to climate-related challenges rather than market health.
Opportunities for Investors
Investors should be discerning when choosing markets, focusing on regions where inventory is growing due to increased home construction rather than climate-related distress. States like Idaho, Utah, North Carolina, and Texas, which are building new homes, offer potential, though caution is needed in areas prone to natural disasters.
The Midwest and Northeast, meanwhile, still face significant challenges in recovering to normal market conditions. These regions have lower rates of new construction, meaning inventory remains scarce, which could present both opportunities and difficulties for investors.
The Bottom Line
The U.S. housing market is showing signs of recovery, but the situation remains complex and varies by region. Interest rates play an essential role in unlocking the market, but investors should also consider other critical factors, such as homebuilding trends, climate risks, and government policies. While the market is heading in the right direction, it’s crucial to examine regional differences carefully before making investment decisions.
In the previous post: “Is Now a Better Time to Invest in Real Estate Debt or Equity?“