The investment house known for corporate takeovers [KKR} has agreed to pump another $250 million into Toorak Capital Partners LLC, which buys short-term loans made to real-estate investors who purchase, renovate and resell residential properties.
. . .Builders have struggled to produce homes affordable for many first-time buyers. The median sales price of newly built homes was $342,000 in April, according to the Federal Reserve Bank of St. Louis. That has left a big market for rehab specialists who can get their hands on physically distressed or out-of-date properties for peanuts. The median sales price of flipped homes during the first quarter was $215,000, according to Attom Data Solutions, a real-estate information firm.
According to a recent study by CoreLogic, 10.6 percent of U.S. home sales in the fourth quarter of 2018 were flips, close to the 2006 house flip rate of 11.3 percent. The market these days is quite different that the one that preceded the recession: flippers in the fourth quarter on average made a nearly 23 percent profit on flips, compared to 6 percent in 2006. Institutional investors comprise more than 40 percent of flippers today, with companies like Opendoor, Zillow and Redfin all placing big bets on the space.
The markets where this is popular seem to be quite different from the high-cost urban markets that get most of the media attention.
I think that this is a difficult phenomenon to explain. Why has there been a profit opportunity in buying a run-down house and fixing it up in Memphis, but new construction there doesn’t pay off so much (or does it)?
The WSJ has a subsequent article, focused on Phoenix. The WSJ also has this article, which says
Big private-equity firms, real-estate speculators and others that buy properties comprised more than 11% of U.S. home purchasers in 2018, according to data released on Thursday by CoreLogic Inc.
It used to be extremely risky to be residential property without a lot of local knowledge. Now, with more data available, these big companies believe they can buy in distant locations without running into adverse selection (aka the “lemons” problem).
It wouldn’t surprise me to see the profits from this activity quickly fall to zero–or less.
Permit costs are mostly prepaid for rehabs.
I own this rural property which I have not seen in years, I just collect a low rent, pay property taxes. It is almost a shack on two acres, but it has permits already in place. So a complete rebuild is about 20 grand less than an new. Most of the value in that house are permits, I can personally rehab the place for 20 grand if I use my skills. (I am actually too lazy and too retired).
New construction faces minimum standards that rehabs don’t. Try going into a township and applying for a permit to build below average housing for that area, they are going to send you packing most of the time, even average housing doesn’t get approved, you have to come in with plans to build above average units. My small township just saw a pair of old(ish) churches torn down and the property development on one has stalled out in the early stages (gas and sewer lines in, not much else) as new unit permits are being fought over with the township demanding higher end construction in an area with average incomes around the 50th percentile. The other hasn’t found a developer yet. All new construction in the area has been sold at a minimum of 50% over average prices and most of it 100%+ in the last 10 years.
Without new construction flippers have started up in earnest. One house was bought for $165,000 and is back on the market asking $325,000 in under 6 months. A house we had our eye on 3 years ago that went for $150,000 sold for $250,000 without significant improvements, another is back on the market 18 months later asking $45,000 more than they paid.
Living space for roughly a 5-10% increase in population for the town is sitting vacant while developers fight for permits and demand pressures hit elsewhere.
Despite all the TV shows, I still think house flipping has a limited long term potential and will stay with smaller local businesses.
1) I still say the reason why House Flipping has limited potential is current homeowners want to maximize their returns and not share the proceeds. For any house under 10 years old, it has to be small potential. I know my dad may sell his 40 year house which needs lots of work but he is not in cash crunch so why let the house flipper get the profit.
2) I agree local housing knowledge but also local repair vendor knowledge is probably even more important. Locals know 5 vendors they can call to fix the walls and then keep their cost down on each house. Large corporations will hire eggheads and spreadsheets and not be as effective. Also many house flippers have some home repair expertise as well and much better negotiators. (So they will know if vendor is over charging or over doing, while large corporations will have somebody negotiating on a couple pictures.)
3) Having experience wholesale auto sales, I did get to know a lot of auto brokers who were experts at buying wholesale vehicles, fluff and buff them, and sell to dealers to fill their used car lots. I noticed they all:
a) Very savy in local business
b) Understood how to fix on vehicle repairs and they performed them cheaply. (Often they had mechanics on staff.)
c) Well capitalized and they had enough to withstand a bad 6 months or so.
HGTV programming is near 100% flipping. That tells me we are at peak flipping. I’m waiting for a downturn. The risk is too high right now imo. Where I am at least.
In desert Cali, we knew somebody who sold to house flipper and it has remained on the market for 3 months so you know they are not making profit on it! So I agree with you.
If these firms improve the value and turnover of foreclosures, they might be a net positive for the mortgage industry.
If institutional investors are using their own money and not getting any kind of government subisidy/insurance what is not to like?
One wonders how many people seduced by the TV shows try doing fixer-uppers on their own and then wind up bailing on the project when it turns out to be beyond their abilities. Having institutional investors around who can step in and buy them out is not a bad thing either, I would think. Putting together crews of experienced, specialized fixer-uppers seems like a plus efficiency wise.
Working in slow-growth cities like Memphis has advantages. People in such cities need and want housing as much as people anywhere else. Being in a lower price range does not mean houses don’t sell. Zillow for example, characterizes the Memphis real estate market as “very hot.” Their web site states:
“The median home value in Memphis is $86,000. Memphis home values have gone up 4.8% over the past year and Zillow predicts they will rise 2.1% within the next year. The median list price per square foot in Memphis is $69, which is lower than the Memphis Metro average of $97. The median price of homes currently listed in Memphis is $106,500 while the median price of homes that sold is $104,000. The median rent price in Memphis is $945, which is lower than the Memphis Metro median of $1,095” Flippers are not risking as much as new home builders in such a market.
Such a housing market no doubt appears very attractive to a lot of working class Americans. And Memphis may go slow, but it will likely go steady given some of its instutions. Nice zoo, botanical garden, and children’s museum don’t detract from it as a locaton to start a family.
On the education front, there are some elementary school attendance zones that would be attractive. At the upper levels, Rhodes College is always highly ranked and seems to do a great job of placing graduates. The University of Memphis is a fine tier 2 school and remarkabley affordable even for out of state students.
And don’t forget Tennessee’s attractiveness on the tax front. The Tennessee income tax does not apply to salaries and wages. Income from stocks, bonds and notes receivable is taxed at a flat rate of 6%. People older than 65 with a total income less than $37,000 for a single filer or $68,000 for a joint filer are exempt.
Fix it up and they will come.
I have seen a lot worse business propositions.
Putting together crews of experienced, specialized fixer-uppers seems like a plus efficiency wise.
Honestly, I think this is biggest piece necessary. You have to do home repairs, excellent work and low price are not easy and I believe it take someone with home repair experience and real business savy here.
However, I still see this a limited market. Just think the average Memphis house sells for $100K so a homeowner would get $94K after a sale. And most cases the homeowner probably spent $1 – $2K for carpet and housing cleaning a couple of obvious repairs. So unless the seller has a strong cash or time crunch, why would you sell below $85- 90K? And how much can home flipper spend on repairs and marketing the house and still get a profit of $5K.
It is probably more of business on the high end as the profit potential $400k is getting big enough.
“Income from stocks, bonds and notes receivable is taxed at a flat rate of 6%.”
It’s better. Since 2016 this “Hall Tax” is being phased out. It is now (tax year 2019) only 2% and should be gone by tax year 2021.
There is a much bigger issue related to that. Something I’ve been thinking about for a few years is whether developments in personaly activity surveillance / intelligence collection technology (which is especially, but not just limited to, online activity) – and the increasingly smart ‘big data’ techniques to analyze it and algorithms to exploit it – draw the whole Hayekian “local knowledge” argument against central planning into question. Not to mention that in the nature of things there are economies of scale from bigger data sets, and only a few actors are ever likely to have the capabilities, resources, and accesses necessary to acquire them.
The question is whether the assumption of whether ‘management’ has to rely on (time-delayed, and imperfectly reliable) aggregated statistics which lose granularity and are a kind of “lossy compression” that necessarily loses so much fidelity that decision-makers can’t possible achieve market levels of efficiency. This was more obviously the case in 1945, but will it be true in 2025 (or is it even still true today?)
Consider this often-quoted paragraph from Hayek’s famous “The Use of Knowledge in Society” article.
My point is that current data surveillance and information processing capabilities make it technologically possible to keep everything on the level of the “particulars”, and in dynamic real-time, so much so that even the hidden, subjective knowledge of individual preferences may turn out to be more transparent than we imagine, with certain entities knowing so much about us that they know a man better than he knows himself, to include accurate forecasts to anticipate what he will likely want in the near future before he even knows he wants them.
Think of the way Amazon, for example, collects tremendous amounts of data and uses it to constinuously re-optimize their logistics operations to ensure “Just-In-Time On Steroids” of millions of possible items as close as possible to likely purchasers and spending as little time as possible in storage. One can imagine trying to chart the theoretical maximum efficiency of such efforts over time given the technological capabilities available. The ‘statistics’ come in quicker, become more reliable, more granular, less lossy, more successfully ‘mined’ for insights and patterns (i.e., all knowledge that it is possible to act upon, is presented in actionable form for decision) and, at some point, one passes a threshold where the Hayekian argument starts to break down.
Socialist intellectuals (the “Modernist / Futurists” of their time) used to toy with this idea of computer-managed allocation and the “cybernetic” society and Allende actually tried to set up “Cybersyn” in Chile in the early 70’s, and while the project did not show any early indication of success, it was put to a premature end by Pinochet’s coup, so there are still some apologists out there that claim it could have worked.
Nevertheless, I think it is as least theretically possible that what was likely hopeless back then might be practicable fifty years later, and most economics have yet to seriously grapple with this development and consider its implications.
“and Allende actually tried to set up “Cybersyn” in Chile in the early 70’s, and while the project did not show any early indication of success”
Thank you for bringing this up. I could not stop laughing. Until I realized that we are all supposed to “know” that Allende was a popularly elected leader, on his way to making Chile a prosperous Democracy, until the CIA and the University of Chicago derailed his efforts.
All projects undertaken by utopian socialists have fancy names. Their outcomes have folksier ones. See “Cazerolazo.”
Other than regulatory issues, maybe cities where flipping is profitable but building isn’t aren’t experiencing much population growth but are experiencing fast increasing incomes, so demand for higher quality housing is there if not demand for new housing? Also, cities with low quality housing in general might see a lot of renovation and flipping but not much new building.
Matt Young has it right, but only says part of it. To build new is to dance through a hundred hoops, each with a fee. New houses are built to new codes, which evolve faster than a builder can keep track of. Impact fees, permits, delays. Licenses! A licensed plumber gets $125/hr!
Or how about this: buy an old house, tune it up, sell it. With no licenses, no permits, no employees, not even a business of record. No client saying she doesn’t like the color after all. Learn how the real estate stuff works, or partner with somebody you’re related to who won’t demand the 5% both ways.
It’s the government.
The United States, net, produces about a million new housing units a year, in a good year. Whole regions of the country suffocate new housing production through property zoning.
No one seems to know what is the true state of immigration into the US. By one account there are 11 million illegal immigrants in the US, and by another account, by MIT, there are about 20 million.
In any event, housing production is constrained. If there is population growth in the US, I suspect housing will be a good investment. With Zillow and other services, and coordination with local partners, I see no reason why profits cannot be made in house flipping.
As someone who works in private equity real estate, here are my 2 cents on your questions:
1. Can these firms overcome the “lemons” issue? Yes, but in my experience, the “lemons” phenomenon was never a big problem. that has historically been only half of the problem . The bigger challenge when buying and managing residential real estate in distant locations is property management (See Commenter Collin’s excellent comment above). Without local vendors, and direct oversight, it is difficult to keep operating expenses (including repairs) under control and maximize rents. I think today’s technologies, including things as simple as running searches on Google, help a lot. Also, many of the “big boys” in this sector have developed their own in-house management that is taylor made for single family homes. Distant management is still challenging for these folks and others, but easier than it used to be.
2. Why did KKR pump another $250 million into Toorak Capital Partners LLC? This strikes me as a good idea actually. Servicing loans is much easier, and requires less boots on the ground, than managing properties. Underwriting standards in the 1-4 residential market tightened extensively after the crash, and are still recovering. So I’m guessing that there is probably a good lending niche in lending money to house flippers, provided of course that there is proper underwriting and good back office infrastructure. Like many financing opportunities, this one will probably turn bad at some point, but probably not just yet.
3. How is it that house flippers can make money in markets where there is little appetite for new home construction? This is a common phenomenon actually. It is very common, especially after a market crash, to have a divergence between replacement cost, and prices of existing homes, even after adjusting the prices of existing homes for wear-and-tear. Such divergences, and specifically when the prices of existing homes sell at a discount to replacement cost, usually represent the best buying opportunities. When existing homes sell as these discounts, new home construction tends to be low or almost zero, because nobody in their right mind would build a new house which would then compete with existing homes for sale selling for large discounts. So I would guess that market with the best marked fundamentals for house flippers are those markets that are still in recovery mode. For example, Stockton and Modesto California probably have decent fundamentals for house flippers, precisely because the prices are still slightly depressed and there is little resale competition from new homes. I’m confident that the new home construction in these markets is extremely low.
4. Will profits from these activities fall, or become less than zero? Yes, but probably not yet. This is likely a profitable opportunity for some. My guess is that the substantial profit opportunities have passed us by, now that the 2008 crash is fading into the distance, and as prices for existing homes flatten out. So “flipping” is probably no longer profitable for large firms that must contend with the “lemons” issue and that don’t have strong local management. However, this activity is probably marginally profitable for smaller local players. At some future date, that will change also.
“The markets where this is popular seem to be quite different from the high-cost urban markets that get most of the media attention.”
San Francisco, Los Angeles, New York, and Chicago are yesterday’s news. People are choosing affordability:
“Millennials priced out of popular big cities are flocking to Frisco, Texas, Nolensville, Tenn., Lakewood Ranch, Fla. and Scottdale, Ga.—not exactly household names but among the fastest-growing destinations in the U.S.
“The back-to-the-city trend has reversed,” said William Frey, a demographer at the Brookings Institution, citing last year’s census data.
Millennials, the generation now ages 23 to 38, are no longer as rooted as they were after the economic downturn. Many are belatedly getting married and heading to the suburbs, just as their parents and grandparents did.
What is different from the postwar boom of 1950s and 1960s is that growth is far more selective—limited to suburbs blessed by good weather and good jobs, largely in the Sunbelt, where they are growing more than twice as fast as their neighboring cities, Mr. Frey said.”
https://www.wsj.com/articles/american-suburbs-swell-again-as-a-new-generation-escapes-the-city-11561992889