Creative Financing Reigns As Investors Head into Spring With Few Options
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Homebuyers aren’t the only ones entering spring and finding they have few options to choose from.
Investors are heading into spring facing a landscape with few distressed homes for sale, a difficult lending environment and a need to get creative in order to make a profit on real estate.
“Looking for deals is one thing,” said Charles Tassell, chief operating officer of the National Real Estate Investors Association, “being able to find them is another.”
In the absence of distressed homes to buy, fix and resell at a profit, and with an ongoing slowdown in rent growth, investors said they’re working with homeowners on ways to work together without actually buying or selling homes.
Rather than a renewal of the frenzy of activity that marked the first two years of the COVID housing market, spring 2023 marked a continued slowdown in activity.
“Now that they pulled back and stopped, that gets rid of what I would say is the less experienced investors that come in,” said Michael Del Prete, an investor in Phoenix. “A lot of that, the people just buying. Loans, low interest rates. Cash from a lot of Californians out here. All of that kind of stopped.”
In the face an ongoing slowdown seemingly affecting every sector within the real estate industry, investors reported a rise of so-called “creative financing.”
Here are the headwinds facing investors this spring and the strategies some are using to overcome them.
Where’s the inventory?
Real estate agents aren’t the only ones preparing for a spring buying season marked by historically lower housing inventory.
Investors are heading into spring facing a dearth of homes to choose from and a lending environment that makes generating profit quite a bit more difficult than it has been for the past several years.
There are 23 percent fewer homes in February than in October, according to the Federal Reserve. In some markets, like Phoenix, where Michael Del Prete is an investor, inventory was 30 percent lower in February than in October.
“Interest rates doubled, everything kind of pulled back,” Del Prete said. “It’s harder to flip because the interest rates and the market’s slower. We also have an inventory supply issue here as well.”
Spring isn’t necessarily the equivalent for investors, who often benefit from distressed sellers forced to list their homes in the slower winter months. But with lending difficult, sales slowing and rent dropping, the landscape isn’t rosy for investors, either.
The same standoff between buyers who are pinched by higher interest rates and sellers who remember what homes sold for a year ago is now affecting investors, said Jay Parsons, Chief Economist for the rental data firm RealPage.
“There’s this freeze in the market right now that really doesn’t have so much to do with supply and demand, it’s just to do with seller expectations,” Parsons said. “They want to still see last year’s pricing to sell. The buyers can’t make that work because interest rates and therefore the cost of capital have gone up so fast.”
“It’s just a stare-down contest that we’re in right now. I don’t think that’ll get resolved here until maybe the summer, second half of the year,” Parsons said. “If you don’t have to sell you’re just not selling. There’s no motivation to. Generally speaking.”
Foreclosures and equity
The pandemic initially brought foreclosure moratoriums that protected distressed homeowners from losing their homes.
That protection was followed by another layer of lasting protection: a spike in homeowner equity. If a homeowner runs into personal financial trouble, they can find ways to tap the equity in their homes to stay put.
Just 2.9 percent of all mortgaged homes — one out of every 34 — was seriously underwater in the final three months of 2022, according data from Attom, which tracks data on virtually all residential properties in the U.S. More than 94 percent of all mortgaged homeowners had at least some equity in their homes at the time, the firm said.
That equity buildup dried up a key source of houses for investors.
“No one is selling,” Del Prete said. “If they’re in a situation they can tap into equity and handle any situation.”
In Tassell’s view, that’s a good thing. With the financial sector on shaky ground following the collapse of two regional banks, more bad economic news could spell trouble.
“If the numbers start to come out on increased foreclosures right now, I think people would move towards more fear and panic, when it’s not really justified,” Tassell said.
That might be slowly starting to shift: after two years of historic lows, the foreclosure pipeline is starting to fill, even if slowly.
“In January we saw the most foreclosure auctions since March 2020,” said Daren Blomquist, vice president of market economics at Auction.com, which handles up to half of foreclosure auctions in the U.S. “But the January 2023 number was still at 55 percent of the 2019 monthly average (or 45 percent below the 2019 average).”
“Nationwide we’re not seeing an influx of foreclosures by any means,” Blomquist said. “We’re seeing more of a slowing rising tide, but that trend has been happening since the foreclosure moratorium ended at the end of 2021.”
Finding homes that can earn a profit are hard to come by, but sourcing deals isn’t impossible, investors say.
Real estate investors have revived what are known as “creative financing” strategies, or methods of acquiring mortgages on homes or agreements with homeowners to renovate and share profits after a sale.
“I always say the market predicts your investment strategy,” Del Prete said. “You have to be well versed in each strategy. You’re like a doctor, you’re diagnosing each situation.”
Last fall, interest rates spiked and the boom in traditional fix-and-flip investing quickly ground to a halt after years of relatively easy profits driven by a hyper-competitive market. Some investors who weren’t being cautious watched as their target sales prices fell and there were fewer buyers for their final products.
“A lot of fix and flip investors got caught with their pants down,” said Del Prete, who is executive director of the Arizona Real Estate Investors Association.
Investors started looking for new ways to work with owners without purchasing their properties outright.
One common strategy in a high-interest environment, Del Prete said, is subject-to investing. That’s where an investor will make payments on an existing mortgage on behalf of the owner. The investor and owner agree to terms and the investor can, say, begin renting the property and earning cash on the existing mortgage.
“As investors it’s all about leverage,” Del Prete said. “We’re able to leverage someone else’s financing for a period of time.”
Another type of creative financing that’s emerging in a high interest environment is a seller carryback, where a property owner has paid off a mortgage but doesn’t necessarily need or want to sell the house. The investor and owner agree to terms based on the ability for the property to cashflow.
“They could say, ‘I’ll sell this to you for $400,000. I’ll give you 15 years,” Del Prete said. “Then you two negotiate the mortgage rate based on the investor’s ability to cashflow.”
Economists expect the landscape to be difficult for the next year or two before rebounding.
“There’s an expression right now circulating: survive till ‘25,” Parsons said. “It’s tongue in cheek. I don’t think it’s necessarily going to be the reality for all investors.”
Parsons and others said the long-term trend looks favorable for investors. For the rest of 2023, there are too many uncertainties to say what could happen with the broader economy and its possible impact on demand, interest rates and real estate.
“The simple fact is people still need to put their head down at night and we’ve been under-building for 10 years. Because of that and the Millennial demographic bump coming through, there’s not a surplus of housing,” Tassel said. “That’s a benefit to the economy in that it will maintain and sustain a lot of the housing prices.”
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