It’s getting increasingly difficult to turn a profit in the house flipping business these days. At least that’s the story making the rounds in the press recently. Some of the reasons given: home prices are high, there are fewer distressed or foreclosed properties available to buy inexpensively, and the competition among investors is substantial. There is also the suggestion that the increasingly competitive fix and flip-it business is a sign of a weakening real estate market. We aren’t so sure about that.
In a recent article U.S. Home Flipping Returns Drop to Nearly Eight-Year Low in Q2, Todd Teta of ATTOM Data Solutions 2019 said:
“Home flipping keeps getting less and less profitable, which is another marker that the post-recession housing boom is softening or may be coming to an end. Flipping houses is still a good business to be in and profits are healthy in most parts of the country. But push-and-pull forces in the housing market appear to be working less and less in investors’ favor. That’s leading to declining profits and a business that is nowhere near as good as it was a few years ago.”
That the fix-and-flip business isn’t as easy as it was several years ago, shouldn’t come as a shock to anyone. That’s because in the aftermath of the worst financial crisis since the Great Depression, there were huge numbers of foreclosed, vacant and cheap houses available to be refurbished and resold.
Now that the “low hanging fruit” has been harvested, home flippers must work harder to find properties. It’s more difficult for a flipper to add some superficial cosmetic upgrades to a distressed purchase and then quickly sell it for a profit. In today’s environment, investors must fine tune their operations and pricing models and deliver high quality, and in some markets more unique homes in order to compete. As a result, many astute fix and flip investors have migrated to markets with the most attractive fundamentals.
In Q2 2019, five markets had gross Return on Investment (ROI) flipping profits of more than 100 percent: Scranton, PA (134%); Pittsburgh, PA (132.5%); Reading, PA (129.3%); Kingsport, TN (104.1%) and Augusta, GA (101.1%). Along with Pittsburgh, metro areas with a population of at least 1 million and the highest gross flipping ROI included Philadelphia, PA (99.9 percent); Cleveland, OH (98.3 percent); Baltimore, MD (91.5 percent) and Buffalo, NY (85.5 percent).
The typical gross flipping profit of $62,700 in Q2 2019 translated into a 39.9% return on investment compared to the original acquisition price, down from a 40.9% gross flipping ROI in Q1 2019 and from a margin of 44.4% in Q2 2018.
Of course, as we have written about recently, mortgage rates are historically low for bank lenders, and private lenders are eager to deploy their cash somewhere other than the volatile stock and bond markets-these trends are helpful for professional real estate investors who flip homes. The dollar volume of financed flip purchases in the second quarter of this year jumped 31% annually, from $6.4 billion to $8.4 billion, according to ATTOM Data Solutions. That is the highest level since the third quarter of 2006. Today’s real estate investors continue using loans and non-bank financing like Aloha, ostensibly to augment their returns. Flipped properties originally purchased by the investor with financing represented 41.0 percent of all home flips in Q2 2019, up slightly from 40.8 percent in the previous quarter, but down from 45.9 percent a year ago.
Concerned about the overuse of financing in fix and flips? It’s worth further consideration. The use of leverage to flip houses remains well below the peak seen in 2005, though it has increased since 2011.
And we aren’t buying the idea that tightening house flipping margins are an indicator of softening real estate markets overall–these are best researched on a case by case basis. We think that the flipping business may simply reckoning with the overriding reality of residential real estate today: there remains a shortage of homes available, especially in the mid-to-low price range. We have written about this in prior letters as well. As long as the supply of houses remains crimped, while demand from home buyers is firm, expect enterprising, disciplined fix and flippers in the right markets to make good returns.
The Fund’s fifty-six month run of positive performance since inception continues. August’s return was the highest since back in July of 2015! Further, it’s the Fund’s fourth best monthly return overall. This is due, as was also the case in June of this year, to Aloha receiving a performance bump on resolved non-performing loans, which added to interest received, on top of the Fund’s standard income stream. Our track record thus far, in dealing with non-performing borrowers and notes, has been solid. We appreciate our valued investors and put much time and effort into producing the best results we can on your behalves.
As always, please reach out with any questions. Aloha Capital is grateful for the opportunity to serve you through this excellent investment–Aloha LTD Income Fund.