For fix-and-flip investors, 2023 promises to be a very challenging year. Ideal market conditions for flippers include strong demand, limited supply and rapidly rising prices — conditions that existed in 2020 and 2021 and led to record numbers of flipped homes, record gross profits and rich profit margins.
The market shifted abruptly in mid-2022 as soaring mortgage rates pummeled affordability, removing many prospective homebuyers from the market. Flippers next year will continue to work through less-than-optimal market trends — weaker demand, a lack of supply and prices that have plateaued or begun to decline in many markets.
There was a flip profit margins declined at the fastest rate in 13 years. Tack on higher costs for materials, labor and financing, and it’s clear that there’s little margin for error for investors pursuing a fix-and-flip strategy. It will be more critical than ever to not overpay when purchasing a home to flip, not overestimate the ultimate resale price and not underestimate repair costs.
Some flippers have shifted gears and begun to wholesale investment properties they find to rental property buyers. Others have changed tactics and decided to fix-and-hold properties as rental homes themselves until market conditions improve.
This might be a good approach for 2023, as a significant number of prospective homebuyers have opted to rent instead since they can’t afford to buy the home they want due to today’s higher mortgage rates. It stands to reason that if these buyers were interested in purchasing a home, they might prefer to rent a house rather than an apartment. So the single-family rental property market, which has already seen tremendous growth over the past decade, might get another short term boost from these displaced homebuyers.
Neither flippers nor rental property investors are likely to benefit from an abundance of distressed properties next year. Mortgage delinquencies are actually lower than they were prior to the COVID-19 pandemic, and foreclosure activity is running at about 60% of where it was in 2019. The forecast is for foreclosure actions to remain below pre-pandemic levels until at least mid-to-late 2023.
Even then, investors shouldn’t be waiting for a surge of bank-owned properties to come to market. About 93% of borrowers in foreclosure have positive equity, giving them the opportunity to execute a soft landing by selling their house before losing it to a foreclosure auction. Auction sales are booming as well, with between 65-70% of the properties brought to auction selling at the event — roughly twice the percentage sold at auction historically.
The combination of fewer homes in foreclosure reaching the auction, and the overwhelming majority of properties at those auctions being purchased leaves relatively few for the lenders to repossess and bring to market as REO homes.
This trend appears to be supported by foreclosure data, which shows that foreclosure starts (the first legal notice received by a borrower in default) have returned to about 80% of pre-pandemic levels, while lender repossessions are still below 30% of where they were before the COVID-19 pandemic.
Despite all of this, there are still some positives for real estate investors. Demographics will continue to be a tailwind for residential real estate — both home sales and rentals — as the largest cohort of young adults between the ages of 25-34 reaches the prime ages for household formation.
There will also be less competition for the available supply of homes for sale from prospective homebuyers, and probably from iBuyers who have had to scale back their operations after experiencing huge losses as home prices declined in the second half of 2022.
The outlook for 2023 real estate investing? Opportunities will be there, but approach them with caution, and not without doing the most careful diligence possible.