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Is House Flipping Dead?

by Michael LaCava on March 10, 2013 · 19 comments

  
house flipping dead

Believe it or not I have been hearing that house flipping is either dead or dying from quite a few people recently. I’m not talking about ALL house flipping. I’m specifically referring to foreclosure flipping to be specific.

Whether it’s an email from a blog reader or a comment here in the Bigger Pockets forum – it seems some people are worried that foreclosure flipping may be coming to an end. And the truth of the matter is that many of these people have valid arguments to think that house flipping of foreclosures is in fact on the decline. But it’s not due to what you might think.

Is it the encouraging economic data, the raw numbers of new foreclosures down, the better than expected unemployment numbers (released just this past Friday)?

Nope. Although all those factors probably pay a role. But it’s primarily due to a new player in town (and one that’s perhaps even IN your town):  the Hedge Fund.

Are Hedge Funds Causing the Death of Foreclosure Flipping?

Ah yes, the hedge fund guys…

They probably didn’t have enough money already in the equities world so they’re now (and have been for some time) invading the turf of the everyday house flipper.

Hedge funds are now dabbling with alternative real estate investing strategies like flipping foreclosure properties. To be even more specific, certain hedge funds are now  purchasing bulk real estate owned (REOs) from banks directly by the thousands. These are the very same foreclosures that you or I may be buying, fixing and flipping ourselves.

This is virgin territory for the banks, which have been over the past several years, slowly releasing foreclosed properties to individual investors.  Now these same banks are talking with the big guys, namely the hedge funds instead. And unless you have access to several hundred million dollars in ready capital like they do, you may not be able to compete.

Hedge funds are so large and so well capitalized, they have the unique ability to buy up hundreds – if not thousands of foreclosed properties all in one fell swoop….leaving the table scraps for us small (by comparison) investors.

Hedge funds have access to not just millions but in many cases billions of dollars in capitalization with seemingly bottomless deep pockets.

The Real Bigger Pockets Please Stand Up

You want REAL Bigger Pockets? No, not this BiggerPockets, though here you’ll find some of the best real estate investing information on the Internet.

However, if we are talking about big, deep pockets for investing…let’s talk about a hedge fund.

Just exactly how deep are their pockets, you ask?

During the calendar year 2012 the hedge fund Blackstone bought $100 million worth of foreclosed homes per week. Multiply that by 52 weeks and you get $1.5 BILLION DOLLARS in foreclosure purchases…go ahead, when you say that – do the little “Dr. Evil” thing with your pinky…

All told, Blackstone alone purchased around 10,000 properties last year.

That’s a lot of properties…putting us mortal house flipping guys to shame. How can guys like me who do on average one house flip a month (shooting for two or more in 2013 by the way) possibly compete with these behemoths?

That’s an uphill battle for sure…

How David Can Compete with the Goliaths

So what does all this hedge fund activity mean for individual real estate investor house flippers like you and I who are targeting foreclosures for our house flips?

Don’t get all doom and gloom quite yet, because believe it or not there could be some good that comes out of this. Here’s a few:

  • With hedge funds doing all this foreclosure flipping, while devouring the foreclosure inventory at a staggering rate, home prices may begin to rise…and they already have. If you just so happen to be doing some foreclosure flipping next to an areas where a massive hedge fund is purchasing properties, your property will likely appreciate in price.
  • If you lose out on a good deal in a bidding war with a hedge fund at a foreclosure auction, remember that these hedge funds are gonna want to sell these same properties again in a few years. They will surely sell them at a higher price, which could help the market there as well.
  • The hedge fund’s goal is pretty simple – buy and rent the property until the home appreciates to the point where it makes sense to sell. So if you’re a buy and hold investor in these markets you could see some rental pricing appreciation as well. Even though I’m a house flipping guy, I do have many buy and hold income properties. In fact, I just bought 13 of them just recently to add to my income portfolio.

The Downside of The Hedge Fund Incursion Into the House Flip Hood

The biggest thing that house flipping people are worried about is if all these hedge funds purchases of foreclosed properties will make the difference between the prices of a foreclosed home versus a market ready home extremely slim. The difference virtually evaporates.

Said another way, in certain areas of the country the difference in price between a foreclosed home and a market ready home is as small as 1%. One market where this is already happening in Las Vegas – which was one of the hardest hit markets in the Great Recession.

Needless to say it is pretty challenging to make money on a flipping a foreclosure without losing your shirt if the margins are only 1%.  Regardless, the old 70% Rule would be pretty tough to meet with margins like these.

The bottom line is this: only time will tell how hedge funds will affect your house flip markets.

How House Flippers Can Stay in The House Flipping Business?

One thing the hedge funds don’t have is boots on the ground and creativity. One of the most important things that house flippers can do is to be proactive in sourcing their house flips and get really creative when foreclosure flipping. As of right now, there’s still plenty of inventory out there to acquire and flip. Judicial states are backed up with inventory for as long as three to five years – which some say due to the complicated legal procedures required to foreclose.

My recommendation is to not be intimidated but instead get out there getting after it. One thing hedge funds are not is nimble. The individual real estate investor has that as their greatest asset.

Just make sure you don’t lower your standards and get into  house flips that don’t make financial sense (don’t ever forget your 70% Rule, MAO and ARV!)

How do you go about finding inventory you can actually purchase and at the same time uncover a few of those hidden “home run” deals despite the hedge funds?

It all comes back to the one thing that you and I have in abundance that the hedge funds do not have – personal relationships. If you’ve been reading anything here in the past nine months, you know the importance of team work when house flipping foreclosures or any other kind of house flips.

In my experience, my house flipping team members and wholesalers will continue to bring good house flip deals my way regardless of what the hedge funds decide to do.  I’ve even gone out an added both a wholesaler and an acquisition manager to my personal house flipping team for this very purpose.

Because it’s these relationships that will continue to keep me in business for a very long time flipping foreclosures or any other kind of ideal money-making flip and the hedge funds can just continue on their merry way, devouring inventory like a lioness gorging on a Wildebeest kill…

Foreclosure Flipping and Your Best Plan

If foreclosure flipping is your thing – your way of sourcing the vast majority of your real estate deals, – you may want to consider diversifying your deal flow stream into short sales, probates, tax lein’s and other kinds of distressed properties.  Due to all the new foreclosure laws being passed, banks are certainly motivated to sell, but only because they are afraid of being sued.  So it’s not all upside for the hedge fund guys.

Remaining ahead of the curve and using your personal network of contacts is the best way to beat the hedge funds to the best deals.  It is also a great way to ensure a long and lucrative house flipping career. As Wayne Gretzky once explained the key to his success is:

“I skate to where the puck is going to be, not where it has been.”

So what is the moral of this story here?  In my opinion hedge funds are just another challenge to overcome on your house flipping journey. Our country got itself into one interesting real estate situation, so we can expect more challenges ahead as it picks itself up and out of it.  As house flippers, if we want to remain in business, all we need to do is get creative and not let challenges like these or any others get in our way.

One other thought to leave you with: what will happen if the hedge fund plan fails?

As for me, I’m planning now to be there – picking up the pieces.

How about you? What’s your plan?

Please leave a comment below on what’s your plan for flipping in the future?

Photo: Cathy

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{ 19 comments… read them below or add one }

Amy Arata March 10, 2013 at 1:11 pm

It makes me wild with Frustration as a taxpayer when Fannie Mae offers bulk sales rather than offering homes to the public, which bailed out Fannie Mae! I even hold shares of Fannie Mae (worth about $2 now, lesson learned). You and I should have just as much opportunity to purchase these foreclosures as Blackstone.

On the other hand, managing rental properties is a lot of work and they may not be managed as well by a large company as they would be by a private owner. In the Northeast, deadbeat tenants will run out of oil and let the pipes freeze, leaving wrecks for rehabbers like us to buy! With the low cap rates these rentals have, they’ll probably be happy to sell to us rather than continuously repair these houses. I guess we’ll see.

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Michael March 10, 2013 at 1:58 pm

I agree with you Amy on all counts & I think they will have a hard time to manage this. Time will tell. Where you from and are you finding it difficult to find deals.

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Brock VandenBerg March 10, 2013 at 1:35 pm

Great article. In San Diego, we experienced a significant decline in available rehab product in 3rd quarter 2012. Today, there is nearly nothing available from REO’s. The focus for many rehabbers in the San Diego market these days is to target homeowners directly that are looking to short sale their home. These rehabbers will assist the homeowner through the short sale process in return for the property. However, even this strategy is starting to run dry as many underwater homeowners who haven’t already sold plan to stick it out, especially with the housing market so strong.

That being said, the fix and flip industry will shift back to the local contractors, real estate agents, and experienced real estate investors that have a good pulse on the market. There will be fewer deals but fewer players which should level out the available opportunities.

As for cash flow property, Southern California is a tough market to locate strong deals as the yields are too low. Not saying there isn’t opportunity, but a lot of cash chasing too few deals drives pricing up and yields down. You are better off targeting markets in Arizona, Nevada, Texas, Florida, and other states that have positive population growth and better investment yields. (Ohh no, I am going to get some negative comments from my fellow Michigan and Ohio investors!)

Lastly, any discussion on owning real estate assets with strong cash flow as a hedge against our upcoming inflation issue? With inflation comes a rise in property values and an increase in rents…

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Michael March 10, 2013 at 2:15 pm

Thanks Brock. It will be interesting to see how things evolve. You are right that if your looking for cash flow sometimes you have to move out of your local market. Of course with caution and doing your due diligence. Thanks for your comments.

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David Driscoll March 10, 2013 at 5:18 pm

My prediction is, the hot housing market cannot continue. Employers are still cutting hours and moving full time people to part time. The economy is in a no growth pattern. The full effect of National Health care have not even begun to kick in. The middle class is living pay check to pay check and now lenders are qualifying borrowers at 50% of debt to income, that’s tight and credit scores as low as 610. Sure the employment stats are on the rise, due mostly to people leaving the job market. The jobs that are being created are low wage jobs. The high paying jobs are going begging due to lack of an educated work force. These jobs will soon be shipped off shore. The stock market is breaking all historic levels due to the Feds printing baskets of money. The Fortune 1000 companies are lean and have lots of cash but will refuse to spend until “certainty” enters the market. From where I’m sitting I’m seeing a run up to another bust, this time it will be much larger than the last. This time there will be no bail outs. U.S still owns the software development market, but manufacturing is going to China and engineering and design is going to India. FYI in my area, Venture County CA, Hedge Funds are not buying anything build before 1995

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Michael March 10, 2013 at 7:09 pm

Thanks for your comments David.

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mike March 10, 2013 at 8:13 pm

I heard that the big companies are buying up thousands, getting them up and rented then pooling all the rental agreements and selling them like MBS and derivatives just like the boom market.
They made too much money the last time, and this time they’ll make a fortune also doing it that way.

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Michael March 11, 2013 at 7:50 am

We will see. Be ready to pick up the pieces if that happens again.

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Dale March 10, 2013 at 8:51 pm

“(don’t ever forget your 70% Rule, MAO and ARV!)” I’ve been reading these terms quite a bit. Could you clarify? Thanks. Dale

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Michael March 11, 2013 at 7:53 am

MAO= maximum allowed offer
ARV= after repair value
70% rule= what you would pay before repairs based on ARV
EX. – ARV= $200,000 x 70% rule = $140,000 minus repairs of $40,000 = $100,000 MAO

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Dale March 12, 2013 at 7:39 am

Very clear! Thanks for clarifying.

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Michael March 12, 2013 at 9:11 am

Your welcome Dale

JGalt March 11, 2013 at 9:38 am

Be careful not to mix up guru hype (esp. Preston Ely) with fact. Even if hedgers are buying up REO bundles, and I don’t doubt they are, it’s not happening in all markets. I know it’s not happening in mine. If it is in yours, don’t despair. As soon as they cherry pick the best from their latest bundle, they’ll be dumping the rest–which they lack local contacts and connections to rehab efficiently, it may not even be part of their model–and those properties will be back on the market for the rest of us to snap up and profit from.

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Michael March 11, 2013 at 10:43 am

Point well taken & you are correct and it may not happen in all area’s. That being said it is happening & if you are affected by it then you just need to plan accordingly.
Thanks for your comment JGalt.

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James Hiddle March 11, 2013 at 9:31 pm

Just to correct your math Mike. $100M X 52 weeks = $5.2B not $1.5B.

As far as the hedge funds. I soon rather team up with them instead of competting or try to compete with the. But you’re right this whole real estate hedge fund doom and gloom is just fear tactics that gurus are now tapping into!

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Michael March 12, 2013 at 9:15 am

Good catch James. Thanks for pointing that out. I agree if you have an opportunity to make some money working with or competing with hedge funds then go for it. The point is to recognize what is happening in the markets you invest in and adapt to the changing environment if that is the case.

Thanks for your comments.

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Shaun March 24, 2013 at 11:25 pm

The Hedge Funds are a new player for sure.
But as others pointed out they aren’t playing in every market so unless they are hitting yours there isn’t much to be scared of at this point.
My personal thought is they will just have to hard of a time managing them and they will get to many total POS properties that will be difficult to fix up for them to stay long term.

Really even if they do unless a lot more get into it and really ramp up what they are doing they aren’t going to be a big factor outside of the few markets they have in their cross hairs.
Aren’t there something like 350K REOs in the US and something like 900K in some stage of foreclosure, and over a million seriously delinquent mortgages that the banks just can’t get around to taking back?
The hedge funds are out there and buying stuff, but in reality their current activities are barely a drop in the bucket.

Personally I think around here the thing that is killing REO inventory are too many newbies that are all excited about the “hot” market and want to get into investing.
So they are bidding on these places with ARVs that are too high, Repairs that are too low, gambling on an appreciating market, and thinking that making $10K on a rehab flip (While forgetting to take into account most/all of their soft costs) is a good deal.

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Michael March 25, 2013 at 11:00 am

That is so true Shaun. Not just the newbies getting into investing but even “experienced” investors.
Experience doesn’t necessarily mean good evaluation. We are finding it very competitive especially MLS listings. I agree the hedge funds will vary from market to market and how it effects your market is key. All and all it should produce upward momentum as inventory drops regardless of how it drops. Less inventory = higher prices.

Thanks for comments!

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Ronnie March 8, 2014 at 9:56 pm

In Nashville TN the Hedge Funds are here. Top that off with a HOTT market, Investors/rehabbers are having a difficult time finding deals. I have worked my butt off for 3 weeks (combination of MLS, wholesalers and mailouts) and can’t find a deal. Even the wholesalers are struggling to find deals.
Foreclosures are selling at darn near market value and gone in the 1st few days. It’s insane here.
Our local REIA sent out a email blast that some big Hedge Fund was looking for 500 homes in the Nashville area that meet certain qualiifications and to contact so and so if you have something to sell them.
I’m thinking I should just apply at Wal-Mart for a greeter position :(

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