As lenders, we have a front-row seat to investing trends—we just listen to our borrowers! Right now, we are hearing from more and more investors who want to make the leap in their investment strategy from fix and flips to new construction.
This 2022 U.S. Home Flipping Report from ATTOM, a leading curator of land, property, and real estate data, helps explain why. The summary reports that “gross profit margins on home flips in 2022 sank to their lowest level since 2008 following the second major drop in two years.”
According to Rob Barber, ATTOM chief executive officer, “Last year, home flippers throughout the U.S. experienced another tough period as returns took yet another hit. For the second straight year, more investors were flipping but found no simple path to quick profits. Indeed, returns are now at the point where they could easily be wiped out by the carrying costs during the renovation and repair process.”
The article credits this change to stalling home prices, rising home mortgage rates, consumer price inflation, and more, changing the ability of homebuyers to buy, and altering demand and investor resale prices. (But it also notes, “profits for home flippers had begun diminishing in 2017 even as the broader housing market was booming. (See chart below.)”
According to Yahoo Finance, Zillow’s Chief Economist, Skylar Olsen also believes that short-term real-estate investing strategies, like house-flipping, are no longer the way to go. In an interview with Business Insider, she blamed this trend on higher mortgage rates and elevated home prices which slowed home purchases. (Olsen recommends a buy-and-hold strategy.)
Some Good News for Fix and Flippers
However, it may not be all bad news for fix and flippers. The National Association of Home Builders (NAHB) Westlake Royal Remodeling Market Index (RMI), which surveys remodelers on market conditions, offers a more optimistic viewpoint of the remodeling industry in general.
In their article published in January 2023 titled: Remodeling Market Sentiment Weakened in Fourth Quarter but Remains Positive, NAHB Chief Economist Robert Dietz stated, “Although the RMI was down sharply year-over-year, it is encouraging that it remains in positive territory. NAHB expects remodeling activity to experience a slowing nominal growth rate, but to outperform new residential construction. Moreover, remodeling should start to pick up buy the end of 2023 as interest rates on home improvement loans begin to trend downward.”
Investors can have a future in either strategy. The main question is, which one makes the most sense for you?
Is Making the Leap from Fix and Flips to New Construction the Right Move for You?
It is a big jump from doing a cosmetic fix and flip to doing a new build, even on just one single-family home. Investors who are considering making the leap from fix and flips to new construction need to consider:
- Individual goals
- Local market conditions (not every market is good for every strategy)
- Available resources (supplies and labor—more on this below)
- Ability to find a reliable general contractor
- Expertise in construction and investing
- Lender criteria
Pros and Cons: Making the Leap from Fix and Flips to New Construction
To help guide you in the right direction, let’s look at some of the pros and cons of each strategy. (These are generalities—specific opportunities may vary.)
Pros: Fix and Flips
- Smaller upfront investment
- Faster return on investment
- Shorter timeline for completion
- Limited team of subcontractors required
- Potential for higher short-term profits
- Funding may be easier to get
Cons: Fix and Flips
- Unexpected costs can kill profits
- Higher renovation costs in older homes
- Competition with other flippers can be stiff
- More difficult to scale quickly
- Shorter loan terms to finish projects
- Flipping older homes in a market where new construction competition is high could reduce profits
Pros: New Construction
- Potentially higher profits
- Ability to customize for market demand and higher resale value
- More control over design, building materials and the finished product
- Ability to offer modern trends, energy-saving/technological advancements
- Possible to scale faster building multiple comparable homes/multifamily
- Ability to offer warranties (reducing the risk for buyers)
- Ability to take advantage of build-to-rent strategy
- Longer loan terms
- Possible tax benefits/incentives
Cons: New Construction
- Potentially larger upfront investment
- Longer timeline to completion
- Risk of overbuilding in an area
- Materials: major shortages and price fluctuations
- More expertise required
- Complexities with site assessments, building regulations, zoning, permitting, environmental planning, infrastructure, setbacks, parking, covenants, conditions, and restrictions (CC&R’s), utilities, curb, gutter and sidewalk issues, stormwater management, ingress and egress, erosion control, energy efficiency requirements, and inspections
- Management of full team of many subcontractors (if not working with a builder)
- Lenders require more experience for loan approval
Labor as a Major Limiting Factor for Both Strategies
Regardless of whether you are doing fix and flips or new construction, a continuing shortage of qualified tradespeople may impact your business.
This 2023 report from The Home Builders Institute (HBI), states: “A lack of skilled construction labor is a key limiting factor to expanding home construction and improving housing inventory and affordability.” It goes on to say, “At least 90 percent of single-family builders reported a shortage of carpenters and 80 to 85 percent reported a shortage of subcontractors in six other trades … The shortages tended to be somewhat more widespread among remodelers … More than 80 percent of remodelers reported a shortage of subcontractors in 11 of the 16 trades.”
(For more on this report, take a look at this Builder Online article: HBI: Labor Shortage is Limiting Factor to Improving Housing Inventory and Affordability.)
How Your Lender Sees It
Lenders like doing new construction loans with qualified borrowers. Financing a property from the ground up gives more control over the quality of the finished product, lenders can be confident in the value of a new build, longer loan terms lower the risk for the builder and the lender, and new construction projects generally have a higher return potential, which works in favor of both the borrower and the lender.
Given the myriad of things that can go wrong with a new build, however, lenders are understandably cautious about lending to the first-time new construction builder.
Your lender is always looking at their exposure, and experienced investment lenders know that, even though an investor may have several fix and flip projects under their belt, new construction requires a different level of expertise.
Experience and Liquidity Count
Says iFC’s CEO, Ryan Herting, “For us, approving a new construction loan comes down to experience and liquidity of the investor. If you are moving from a $75K to $200K heavy renovation fix and flip to a $400 to $500K new construction project, we can use your heavy renovation investment experience to qualify you and get a deal done. However, if you are moving from a $50K cosmetic renovation to a 25-unit townhome development new construction project, you will need a partner who brings that level of execution to get that size deal done.
In other words, lenders (like us) like to see borrowers (like you) take incremental steps in your transition from fix and flips to new construction. This allows you to gain the experience needed to meet the challenges you will (definitely) encounter along the way.
For investors without experience who want to get into new construction, we advise you to consider taking on a partner who has new build or project management experience. This will smooth your way to getting funding and finishing your project.
Look Before You Leap from Fix and Flips to New Construction
Transitioning from fix and flips to new construction can be a profitable venture with the right planning and knowledge.
If you are an investor looking to make this shift, consider all the pros and cons.
Once you have assessed your experience and understand the risks, find a lender that has investing experience and that will have your back throughout the entire building process. This is one of the most important things you can do to ensure that your leap from doing fix and flips to building new construction is ultimately a successful one.