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The Sell or Rent Decision for Rehab Investors
February 3 | 2015

Fix-and-Flip Projects

In planning real estate projects for 2015, rehab investors often tackle fix-up projects of foreclosed and older homes.  After the repairs are done, though, should investors "flip" -- sell -- the property, or hold it and rent it out?

A successful fix-and-flip project can provide flippers a substantial return on investment.  Distressed or foreclosed properties can sometimes be purchased at a fraction of the cost of nearby comparable real estate.  After adding some modern touches to the fix-up property to appeal to today's homebuyer, flippers can hopefully sell the property at current market rates and reap a decent return on investment. 

That dynamic changes a bit, though, if renters remain the dominant force in the housing market.  

Smaller Selections of Distressed Properties

Foreclosures have helped increase the number of flipped homes in the housing market in the past, but the inventory of foreclosed properties could be lower going forward.  The U.S. had 1.1 million properties with foreclosure filings in 2014 - the lowest level seen in eight years, according to RealtyTrac.  The figure represents an 18 percent drop in 2014 from the previous year.  This historically low level of foreclosure activity means that the recent foreclosure boom is, to some extent, winding down.

It's thus more important than ever that rehab investors collect as much information as possible about foreclosed homes and the resale market for them.  Depending on when they were built, older homes tend to have somewhat lower selling prices than newer houses, so even with the addition of amenities, a solid assessment of potential resale prices is vital.  Older homes can also be out of compliance with certain safety or building codes, which issues may come up during a rehab.    

Some older homes offer real value, however -- historic homes like Victorian structures, for example, are often prized for their age and the design features that were specific to that era.  When flippers find such a home in a desirable location and with good bones for a rehab, the project can be a good one.  Additionally older homes can out of compliance with certain safety or building codes. Flippers could find themselves spending a considerable amount of money bringing these houses up to code, which could include following energy efficiency, heating and cooling or other standards. This means more money paid out to contractors for labor and materials, which could ultimately increase the cost of the rehab. 

Making the Right Offer - with the Right Financing

As always, before buying a property, rehab investors should consider factors important to their projects' success, including the offer they make, the projected repair costs, and expected resale value.  The property should generally still have good "bones" -- getting involved in foundation repair, for example, can quickly endanger the economics of a rehab project. 

With lower inventories of foreclosed properties, bidding competition will likely increase.  Having ready cash is key -- and for this, the use of an online lender may be key to a flipper's success.  They’re great for fix and flip homes, and can also be useful to long-term investors who need fast financing NOW before turning to a more traditional source later on.  Rehab loans generally cover rehab costs as well the property’s purchase, although they sometimes disburse the rehab amounts through draws while the rehab is being completed, when the lender has evidence of some of the completed repairs.  

Realty Mogul is a leading online real estate lender, one whose mission is to use technology to make fix-and-flip rehab loans simple and FAST.  Our application process is straightforward and simple.  Rehab investors simply provide us with a few key parameters – the location of the property, the purchase price, the rehab budget, their own income & net worth, and a few other items – and our technology helps take care of the rest.

The Sell or Rent  Decision

With younger "millennials" now getting their finances in order, and housing affordability increasing due to changes in federal lending policies, those younger buyers will help to drive the future housing market. For now, some of those younger buyers may be in a position to buy rather than rent.  If supply begins to become an issue and housing prices begin to climb, however, then this demographic may be a better bet as a base of potential renters. Investors will need to study this demographic's effect on the housing market to determine whether the better exit strategy for rehabbed homes is a sale or rather a refinance and rental of the property to persons in this younger demographic. 

Between 2004 and 2013, homeownership rates declined among all age groups; however, rates for demographics 34 and younger dropped the most, according to an analysis of U.S. Census Bureau data by Harvard University's Joint Center for Housing Studies. The JCHS report found the homeownership rate for 34-year-olds and younger dropped 13 percent - about 4 percent higher than the almost 9 percent decline experienced by 35- to 54-year-olds. 

The force of the Great Recession cause some young people to go beyond reverting to rentals -- they moved straight back in with their parents.  The recently improving economy has now, however, increasingly helped millennials move back out of their parents' homes and into their own abodes. The Washington Post recently noted Trulia's research finding that the percentage of 18- to 34-year-olds living with their parents recently dropped, Furthermore, millennials' wages have started to stabilize, which could help them save and build up their finances to either purchase a home or move into their own apartments. 

Flippers might, then, use a strategy of rehabbing homes in less expensive neighborhoods with a significant millennial population, with that demographic now hopefully ready to become buyers of such homes.  However, according to Trulia, home prices in housing areas preferred by millennials aged 20 to 34 rose 6.1 percent year-over-year in November 2014 - a slightly lower percentage compared to housing markets favored by older generations. This shows that there is still a bit of a mismatch in where young adults prefer to live versus where they can afford to buy a home.  For many millennials, homeownership will still require moving to a cheaper market.   

The Case for Holding (or Selling) as Rental Properties

If millenials prove reluctant to move from their currently preferred neighborhoods to become home buyers, then investors may want to focus more on that demographic group as a potential rental market.  The JCHS report found there was a 25 percent growth in millennial renter households between 2005 and 2013. Certain markets in the U.S. can still result rental return rates of 15 percent or higher, according to RealtyTrac. Daren Blomquist, vice president at RealtyTrac, noted that with homeownership rates at their lowest in 20 years, the rental opportunity may be the preferred option.  

The RealtyTrac report found some of the best markets for buying residential rental properties in the first quarter of 2015 include the Atlanta, Baltimore and Philadelphia areas. Not only did these markets feature low median home prices in November 2014, but they also reported high annual cash flow for investors.

This dynamic doesn't mean that the only exit strategy available to flippers is to hold them as rentals; it merely means that marketing efforts may need to be more aimed at buyers who intend to be long-term landlord investors, rather than purchasers intending to themselves occupy the residence.  The long-term cash flow potential of the property will become key, and flippers may choose to focus on the anticipated greater rental housing demand and decide to renovate houses accordingly, with an eye to the tastes of prospective tenants. 

 

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