As the housing market transitions, here’s what real estate investors can expect—and how they can adjust.

Real estate investing can be profitable in any market, but successful investing strategies often vary widely depending on broader market conditions. As the housing market transitions quickly from frenzy to flatline, here’s what real estate investors can expect and how they can adjust accordingly.

“When there are speed bumps, there are typically opportunities for investors who are ready to act,” said Andy Heller, a veteran real estate investor and founder of the Regular Riches training program for real estate investors. “A potentially generational opportunity for investors to buy property below market. Those opportunities typically last one to four years.”

According to Heller, investors preparing to take advantage of that opportunity should do three things in advance of the downturn:

• Identify one or two acquisition strategies to focus on.

• Identify funding sources.

• Identify both preferred and backup exit strategies.

“Right now, they should be identifying an acquisition method such as REOs or short sales or buying on the courthouse steps,” said Heller, whose preferred acquisition source during downturns is real estate owned by the bank (REO). “Identify a source and get good at it. … Don’t be a jack of all trades, be a master of one or two.”

Where’s the Inventory?

With housing demand dwindling in the face of surging mortgage rates, the inventory of homes available for sale is gradually rising and will likely increase further in early 2023 as a growing number of would-be sellers will no longer be able to put off listing their homes for sale.

Data from the National Association of Realtors (NAR) shows how this dynamic is playing out. Weakening demand is evident in slowing home sales, which were down 24% year-over-year in September on an annualized basis—the ninth consecutive month with a year-over-year decrease and the fourth consecutive month with a double-digit decrease.

As demand weakens, inventory of homes for sale is gradually rising and home price appreciation is quickly slowing. The NAR data shows a 3.2-month supply of inventory in September, unchanged from the previous two months but up from a 2.4-month supply in September 2021. Median home prices were up 8.4% from a year ago in September, but that pace of appreciation is nearly half of the 16.2% pace just six months ago, in March 2022, and it is one-third of the 25.2% pace at the peak of the pandemic market in May 2021.

A more dramatic rise in housing inventory is showing up in the new homes market. There were 462,000 new homes for sale in September 2022, up 23% from a year earlier, according to data from the Census Bureau. September was the 16th consecutive month with an increase.

Meanwhile, the inventory of distressed properties, which represent prime value-add acquisition opportunities for investors, has been gradually increasing in 2022 and is poised to increase even further in 2022.

The volume of properties brought to foreclosure auction in second-quarter 2022 increased to a new pandemic high, up 55% from foreclosure moratorium-suppressed volumes a year earlier, according to proprietary data from the Auction.com platform. Even with the increase, second-quarter foreclosure volumes were still 50% below the pre-pandemic levels of 2019.

Foreclosure auction volume plateaued in the third quarter, but foreclosure start data indicates more increases are coming in 2023 and beyond. More than 67,000 properties started the foreclosure process in third-quarter 2022, up 167% from a year ago, according to ATTOM Data Solutions. The third quarter marked the third consecutive quarter in which foreclosure starts were up by triple-digit percentages from a year ago.

An Auction.com historical regression analysis of the relationship between foreclosure starts and completed foreclosure auctions indicates the foreclosure starts in the first three quarters of 2022 should produce about 137,000 completed foreclosure auctions in the first three quarters of 2023. That would be more than double the volume in the first three quarters of 2022, although it’s likely the actual increase will be lower, given continued aggressive foreclosure prevention efforts.

Deeper Discounts

More distressed inventory will likely translate into more discounted acquisition opportunities and deeper discounts, especially in an environment where home prices are falling. In that environment, distressed property sellers—and other sellers—will need to adjust their pricing expectations lower to avoid the danger of catching a falling knife by holding out for the higher, but outdated, price point.

One California-based real estate investor said many distressed property sellers have yet to adjust pricing to match with the market, but he expects more to do so by early 2023.

“In 90 days or so, it could be a lot better if banks come to their senses on pricing,” he said, adding that he was still “buying heavy” in late 2022 thanks to enough distressed property sellers who have already adjusted pricing to align with the downshifting market. “It’s harder to find the properties. You just have to search more. But there is a lot of money to be made.”

Proprietary data from Auction.com shows many distressed property buyers are pursuing deeper discounts as the market turns. In the third quarter, buyers at foreclosure auction purchased for an average discount of 23% below estimated “as-is” property value, up from an average discount of 15% in the previous quarter and more than double the pandemic low of a 9% discount in the first quarter of 2021.

These distressed property buyers are, in effect, hedging against a possible home price correction in many markets.

“I think Boise will get whalloped. I think Maricopa County will get whalloped. I think Florida will get whalloped,” said Tomasi. “Central and South Florida are just overpriced.”

Atlanta-based investor Jared Garfield doesn’t think the middle-America markets where he buys are as likely to experience a home price correction because they didn’t experience a massive run-up in home prices during the pandemic. Those are markets like South Bend, Indiana; Montgomery Alabama; and the Quad Cities in Iowa and Illinois.

“Some of the markets that have gone up 25% a year for five years—of course, there’s room for a correction,” said Garfield, who also helps run Housefolios, a real estate investing software designed to help investors identify good deals. “(But) the news for Salt Lake City for real estate is not the same as for Davenport, Iowa.”

Garfield said an increasing number of his deals are coming from other investors who are skittish about the possibility of a home price correction or crash.

“I’m finding a lot of investors that are selling properties right now because they are anticipating a crash and they want to be liquid,” he said, providing as an example a duplex he recently purchased in the Quad Cities for $64,000, 26% below its original listing price of $99,000. “They’ll still sell it at decent discounts because they have had so much appreciation. … They might give up 10, 15, or 20% of their equity on a deal.”

“I’m increasing my purchases. We’ve done 35 deals in the last two months that we have bought to renovate,” said Garfield, who primarily renovates and resells turnkey rentals to other investors. “We’re buying every deal that makes sense.”

Mitigating Risk

Tampa, Florida-based investor Lee Kearney is employing a more cautious strategy given both his market, which is at more risk for a price correction, and his primary investing strategy—selling renovated homes to owner-occupant buyers.

“We’re just trying to move inventory quickly,” said Kearney, who has invested during multiple down cycles in the housing market. “If it’s not moving, change the pricing so it does move. These are market-based decisions.”

“We try to buy properties at a price where it doesn’t matter what the market does,” Kearney added. “I don’t see any rise in prices in the next couple of years. I see prices continuing to decline with this current environment.”

Kearney’s strategy reflects both sides of the double-edged sword that is real estate investing during a market downturn, according to Heller.

“Clearly, if the economy is softening, there will be plenty of opportunities to acquire properties below market,” he said. “The problem is on the back end, what you’re going to do with the property after you buy it. Many investors don’t think about that, and that is greatly impacted in a downturn.”

Heller’s exit strategy of choice during a downturn is leasing properties with an option to purchase. That allows him to receive rental income from the property in the short-term and realize a greater equity gain by selling down the road in three to five years after the market has started to rebound.

“You’re not going to have to sell the property at a severe discount as you would have to if you sold the property quickly in a severely depressed market,” he said. “If you’re buying in a down cycle and you’re not utilizing a lease purchase, then you’re leaving money on the table.”