Slowing returns on renovated foreclosures provide an early retail market barometer.

Buyers purchasing distressed properties at auction pulled back on the price they were willing to pay relative to after-repair value (the estimated value of a property in fully renovated condition) starting in May 2024 and continuing through July 2024. This marked a distinct shift following five consecutive months during which the average price-to-value ratio at auction increased (see Fig. 1).  This shift indicates the local community developers, who are the biggest buyers at the local community developers, who are the biggest buyers at auction according to the 2024 Auction.com Buyers Insights Report, started becoming less confident in future home price appreciation in their local markets in May.  That deteriorating confidence has continued for three consecutive months.  Buyers are in effect hedging their bids at auction to protect their future profits when a renovated property purchased at auction is sold (flipped) or rented back into the retail market – typically about three to six months after the auction.

“The right house on the right street is selling no problem, but also the wrong house on the wrong street is not selling,” said Lee Kearney, CEO at Tampa, Florida-based SPIN Companies, which buys and renovates distressed properties. “In the suburbs, where every house is the same, the inventory is rising there, and people are discounting if they want to be the first one to sell.”

Rising Retail Inventory, Lower Bid-to-value Ratio

Nationwide, the inventory of existing homes for sale increased to a 44-month high of 1.32 million in June, according to data from the National Association of Realtors (NAR). The month’s supply of homes for sale increased to a 49-month high of 4.1 months in June-the highest since May 2020.

Inventory is increasing even faster and rising above pre-pandemic levels in some markets, including Tampa. According to data from Realtor.com, the total inventory of homes for sale in the Tampa-St. Petersburg-Clearwater metro area increased 43% from a year ago in July to 22,913-the highest level since July 2019. The median days on the market in the Tampa metro area was 59 days in July, up from 46 days in July 2023 and on par with an average of 59 days for all of 2019.

The rising inventory and increasing discounts in the retail market are giving local investors in Tampa pause when buying distressed properties at auction. Among properties sold at a foreclosure auction in the Tampa metro area in July, the winning bid was 70.8 % of the property’s estimated “after-repair” value on average, down from 71.4 % in June and down from 82.8% in July 2023, according to proprietary data from Auction.com, which accounts for close to 50% of all foreclosure auctions nationwide (see Fig. 2).

The 70.8% average price-to-value ratio in July was the lowest average price-to-value ratio for the Tampa metro area since May 2015, a more than nine-year low. Although demand from buyers at distressed property auctions in Tampa remains strong-more than 70% of the properties available for auction in July sold to third-party buyers-the price those buyers are willing to pay relative to after-repair value is dropping.

Tampa is not alone in this trend, although the trends there are more pronounced than in many other markets. Nationwide, the average bid-to-value ratio for properties sold at foreclosure auction in July was 56.8%, down from 58.7% in the previous month to an eight-month low. The decrease in July marked the third consecutive month with a decrease after the average price-to-value ratio peaked at a more than two-year high of 60.7% in April 2024.

Strong Demand, Conservative Bidding

As in Tampa, demand is still strong for distressed properties nationwide. Fifty-five percent of properties available for auction in July were sold to third-party buyers, up from the previous month and a year ago. Properties brought to auction in July received an average of 38 saves from prospective buyers on Auction.com. That was down slightly from an average of 39 saves per property in June but up 20% from an average of 32 saves per property in June 2023.

But even with strong demand, bidders at foreclosure auctions are pulling back on pricing at a time of the year when pricing is typically flat or even increasing. In 2023, the average price-to-value ratio at foreclosure auction peaked in June and July at around 60% before gradually declining in the latter part of the year. And in 2019, the average price-to-value ratio held steady at between 60% and 61% from April through the rest of the year, after peaking at 62% in March.

The typical seasonal pricing pattern was also disrupted back in 2022, when mortgage rates ratcheted up rapidly in the second half of the year, sending shockwaves through an arguably overheated retail market. Buyers at foreclosure auction anticipated those shockwaves and started pulling back on pricing starting in March 2022. The average price-to-value ratio at auction peaked for the year in February at nearly 67% and steadily declined from there, ending the year at 51.8%.

Renovated Resales A Retail Market Barometer

To understand why local community developers buying at distressed property auctions pay such close attention to retail market trends and often anticipate retail market trends, it’s helpful to look at data for renovated properties resold (flipped) after being purchased at auction. That renovate-and-resell data demonstrates how emerging weakness in gross profits and time to sell a renovated property allows these local community developers to be among the first to spot-and respond to-emerging weakness in the retail market (see Fig. 3).

More than 400 renovated properties that had previously been purchased at foreclosure auction via Auction.com were resold in June 2024, according to an analysis of public record data matched against Auction.com data. It took local community developers an average of 192 days to renovate and resell those properties after the foreclosure auction, unchanged from May, but up 10 days from 183 days for renovated foreclosures sold in June 2023 and above the long-term average of 188 days.

The average days to renovate and resell properties purchased at foreclosure auction increased in the second quarter of 2024 compared to a year ago in 25 of the 40 top metropolitan statistical areas with the most volume. The biggest increases were in St. Louis, Missouri (up 64 days); Las Vegas, Nevada (up 57 days); Peoria, Illinois (up 52 days); Austin, Texas (up 48 days); and Virginia Beach, Virginia (up 32 days). Tampa had the ninth biggest increase, up 23 days.

Every extra day to renovate and resell equates to higher holding costs, which erode the returns of local community developers. The longer timeline also keeps more investor capital tied up and unavailable for new projects.

Although the data does not include holding and rehab costs, the gross returns-the percent return based on the difference between the purchase price at the auction and the resale price-also demonstrate emerging weakness for renovated foreclosures resold in June 2024. The average gross return was 54.6% in June, down more than 400 basis points from 58.7% in May and 59% in June 2023. Preliminary data from July shows gross renovate-and-resell returns averaging 49.7%, which would be another 500 basis-point drop from June.

The lower returns for the renovated properties being sold now-and purchased about six months ago-means investors have less capital to deploy for their next renovate-and-resell project. It also likely increases their risk aversion, leading to more conservative bidding at the auction.

“I don’t want to catch a falling knife at this point,” said Paul Lizell, a Florida-based real estate investor who also trains other investors to buy properties bank-owned (REO) auctions through REO Auction Academy. “I only want the lowest hanging fruit. I don’t mind doing less deals.”

Tighter Path To Profits

The compressing returns on renovate-and-resell projects are creating an even tighter path to profits for many local community developers who have pivoted away from renovate-and-rent as an investing strategy in recent years because elevated mortgage rates have made it more difficult to achieve desired cash flow and cap rates on rental properties.

“We’ve seen a huge drop in people who are holding properties as rentals,” said Landon Cunningham, owner of Spokane, Washington-based Inland Capital, a private lending company that specializes in lending to investors buying at a foreclosure auction in Washington, Idaho, and Oregon.

Cunningham estimated that half of his investor borrower clients were employing the renovate-and-rent strategy three years ago. He estimates only about 20% are doing so now. He also noted that the buy box for the renovate-and-resell strategy has narrowed in the Pacific Northwest markets he operates in due to a slowing retail market at the higher end.
“Anything that’s below $700,000 is moving pretty quick, but anything that is double the median price point has really slowed down,” he said. “That mid-range is still moving pretty quick.”