How to Invest in Volatile Housing Markets

by Steve CookJanuary 16, 2019

Residential real estate is one of the least volatile investments. Real estate values usually change direction very gradually and with plenty of warning, because real estate values result from predictable economic and demographic factors.

A property investment concept with a small home model beside stacks of coins and money bag models.

Most owners are more concerned about their homes as places for their families to live than their value as investments, so the fact that they change value slowly is a good thing. In recent years, however, investing in residential real estate, especially single-family homes, has become increasingly popular. Many people, especially those who have the skills and time to fix up aging homes, are successful at finding good investments in neighborhoods they know well. About one out of every ten homes sold today is bought by an investor who plans either to rent it out or “flip” it at a profit.

For landlords, who make money from both rental income and the appreciation of their holdings, volatility is not ideal. Rental investments do best in markets where there’s a steady supply of tenants as well as buyers. Flippers, on the other hand, usually want profit quickly by selling a property in which they have invested.

Volatility and Real Estate Prices

Many homeowners depend on metro-wide or “national” price reports to track home values. However, all residential real estate is bought and sold at the local level. “National” market reports are averages or medians calculated from thousands of local transitions. This process can mask price trends at the local and hyper-local levels. So, consumers who rely on national reports may be living in markets where prices are changing more rapidly than they realize. Home prices at the neighborhood level may react significantly to a local event, such as the closing of a factory that costs dozens of jobs or the opening of a new commuter line. Neighborhoods in the same metro or even the same zip code may be too far away to feel the impact of these events. Hurricanes, floods, fires, tornadoes, and other natural disasters have an immediate and major impact on hyper-local markets, but little or no impact nationally.

While there’s no national real estate market, national events, such as changes in mortgage interest rates, impact affordability everywhere, which reduces demand. The flood of foreclosures from 2008 to 2011 occurred as the result of regional events, such as defaults of thousands of homeowners who had risky mortgages. These foreclosures released in a state or metro lowered values on a large scale.

Homes.com’s valuation tool is a good way to monitor local and hyper-local price trends. The valuation calculator can finger current values down to zip code and street by street levels. The data are updated every 30 days.  By checking values at monthly intervals, you can track price trends anywhere in the nation.

Focus On the Acquisition Price

Whether an investor plans to flip a property or hold it for years and rent it out, the price paid to purchase an investment property will determine its profitability. Investors who buy properties to rent them out generally make more money the longer they hold onto their investments. They make money two ways: from rents paid by tenants and the appreciation of a property over time. When values are rising steadily, and demand for housing is strong as it has been during the real estate recovery, these landlords do well, often better than they can by investing in stocks.

The key to both strategies is buying investment properties at the lowest possible price, but a low acquisition price is more important to flippers. When prices change slowly over time, property acquisition costs are high. Investors who buy in these markets, even if they are paying market value for a property are more successful because strong demand and rising rents will help rental income prosper.

Flippers will do well if they can acquire a property at a favorable price before prices appreciate will do well. By fixing up these properties and waiting for prices to improve, they can sell at a handsome profit.

Flipping Was Down in 2018

Cooling home prices in 2016 helped to slow down both the number of flips and the average return on investments. The Q3 2018 U.S. Home Flipping Report from ATTOM Data found that a total of 45,901 U.S. single-family homes and condos were flipped in the third quarter of 2018, down 12 percent from a year ago to the lowest level since Q1 2015 — a 3.5-year low. Total flips during the quarter fell to 5 percent of total sales, down from 5.1 percent in Q3 2017.

Home improvement project in progress.

Homes flipped in Q3 2018 sold for an average of $63,000 more than what the home flipper purchased them for, down from an all-time high average gross flipping profit of $68,000 in the first quarter and down from an average gross flipping profit of $65,000 a year ago to the lowest level since Q2 2016.

“Home flipping acts as a canary in the coal mine for a cooling housing market because the high velocity of transactions provides home flippers with some of the best and most real-time data on how the market is trending,” said Daren Blomquist, senior vice president at ATTOM Data Solutions. “We’ve now seen three consecutive quarters with year-over-year decreases in home flips. The last time that happened was in 2014 following the mortgage rate jump in the second half of 2013, but it’s still far from the 11 consecutive quarters with year-over-year decreases in home flips extending from Q2 2006 through Q4 2008 and leading up to the last housing crash.”

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About The Author
Steve Cook
Steve Cook is editor and co-publisher of Real Estate Economy Watch. He is a member of the board of the National Association of Real Estate Editors and writes for several leading Web sites, including Inman News. From 1999 to 2007 he was vice president for public affairs at the National Association of Realtors.