With the real estate market continuing to experience instability due to fluctuating interest rates, low inventory and a looming recession, the best thing that commercial mortgage originators can do is to diversify their product offerings. This will help them appeal to a larger swath of clients and keep business flowing.

Originators have likely seen an increase in borrowers seeking long-term financing due to increased demand for single-family rental homes. Fix-and-flip investor activity, which relies upon short-term loans, also has been steadily improving despite market challenges.

“On the post-flip side of the equation, originators who are dialed in with investor clients also have a great opportunity to place buyers in homes that have been renovated.”

The fix-and-flip market presents a unique opportunity for originators who have yet to consider loan programs that cater to this space. For the mortgage brokers who aren’t already convinced of the strength of the home renovation market, recent trends in this sector reveal real opportunities and ways to capitalize.

After interest rates plummeted in 2020 due to the COVID-19 pandemic, flip activity skyrocketed in 2021 and 2022. Investors seized the opportunity to revamp older homes and benefit from the high demand in the housing market. According to Attom, flips accounted for 5.9% of all single-family home sales in 2021 and 8.4% of sales in 2022. But in spite of these transactions reaching a 17-year high point in 2022, investors faced notable challenges in terms of profitability.

Exercising caution

Last year, investors in the fix-and-flip space saw their gross profit margin plummet to an average of 26.9%, the lowest level since 2008, according to Attom. The data analytics company also reported that flipped homes in 2022 generated a typical gross profit of $67,900, but the margins tightened toward the end of the year.

The decline in profits forced investors to exercise caution when selecting properties for renovation. A few missteps in budgeting for a rehab project, or holding onto the property for too long before reselling, can have dire consequences and potentially lead to financial losses.

The root cause of the recent drop in profit margins was the slower increase in the median value of the homes being flipped compared to the median price that investors paid to acquire these properties. In light of the shrinking margins, there were questions as to whether investors would continue to flip homes or take a step back and wait for housing market conditions to improve. But data from first-quarter 2023 showed that fix-and-flippers were not scared away by market challenges.

Despite the profitability issues of 2022, more recent data found that conditions are improving. Attom reported that 72,960 single-family homes and condominiums in the U.S. were flipped in Q1 2023, representing 9% of all sales. This figure might seem like a small sliver of the home sales pie, but the level of activity was the second highest for any quarter since 2000, trailing only the 9.4% share recorded in Q1 2022.

Investors have also seen improvements in profit margins in 2023 after facing nearly three years of continuous declines. From January through March, the nationwide gross profit for a home flip increased to an average of $56,000, or a 22.5% return on investment (ROI) compared to the initial acquisition price. The ROI figure represented an increase of 80 basis points from fourth-quarter 2022, although it was still below the 26.9% average for all of last year.

Areas of opportunity

Home flippers can attribute the modestly higher profits to rising median resale prices, which gained momentum at the start of this year. Other areas of the housing market continue to face challenges, such as wavering values. As of this past June, U.S. home values were up slightly year over year, but they were down from year-ago levels in more than half of the country’s 50 largest metro areas. The increase in ROI for home flips bodes well for the sector.

Commercial mortgage brokers may be wondering how to take advantage of activity in the fix-and-flip market. First and foremost, originators should begin offering loan programs that appeal to these investors. While flippers often utilize cash to purchase properties, Attom reported that nearly 34% of homes flipped in Q1 2023 were initially bought with financing.

Originators should look to offer short-term loans that fund both the acquisition of the property and any renovations, which will appeal to the portion of the fix-and-flip market that utilizes financing. Also, speed is key in these cases. For originators seeking to gain investor market share, fast closings will make all the difference as these borrowers must move quickly due to the current state of the real estate market.

When trying to find this type of client, it is important for originators to know where to look across the country, since short-term investors are more prevalent in certain areas. This could mean expanding the geographic areas they typically work within, but it could also pay dividends if this is the client type they’re looking to capture.

Home flip rates in most parts of the nation are trending up. In 128 of 172 (74%) of the major metro areas analyzed by Attom, home flips as a portion of all sales saw an increase from Q4 2022 to Q1 2023. And while many metros saw quarterly increases of 2% or less, there were many others that posted substantial gains. Some of the top metros for originators to keep an eye on include Macon, Georgia, where flips accounted for 16.8% of all home sales in Q1 2023. Atlanta (15.3%), Jacksonville (15.2%) and Memphis (14.4%) also led the way for high shares of home flip activity.

Post-flip sales

On the post-flip side of the equation, originators who are dialed in with investor clients also have a great opportunity to place buyers in homes that have been renovated. Of the 72,960 U.S. homes flipped in first-quarter 2023, 11% were sold to buyers who used loans backed by the Federal Housing Administration (FHA).

This marked the third straight quarterly gain for flips sold to FHA buyers. Among the metro areas with at least 200,000 residents and at least 50 home flips in Q1 2023, the highest shares of flips sold to FHA buyers were in the California cities of Modesto, Bakersfield, Visalia and Stockton, as well as Lakeland, Florida.

Flipped properties are appealing to first-time homebuyers, many of whom utilize FHA financing due to the low downpayment requirements. Plus, these homes have been updated with modern finishes and are in move-in-ready condition. FHA loan programs are typically in the wheelhouse of residential mortgage originators, so those who expand their clientele to include investors will not only benefit with more business on the front end, but it often results in funding the resale of the property to an owner occupant.

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Despite fix-and-flip investment challenges in today’s real estate market, things are continuing to trend in a positive direction, creating tremendous opportunities for commercial mortgage originators who want to increase their production. Brokers should be aware of the cities and states that provide the best returns for flippers if they’re looking to expand loan offerings to meet the needs of this niche market.

It’s important to keep in mind that profits for fix-and-flippers are still limited despite the positive market improvements early in 2023. Still, originators who take on these types of clients can see increased business by providing financing for the actual flips and for the sale to an end buyer. Many of these homes are being snapped up by people looking for a primary residence in a low-inventory environment. It will be interesting to see how trends play out for the remainder of 2023, but market factors continue to look promising. ●