The practice of buying and quickly reselling real estate is well established. It generally goes by the name of “flipping.”
There are different business models under the broad umbrella of flipping, with different risk and return profiles. At one end of the spectrum Wholesalers try to buy super cheap by finding private deals. At the other end of the spectrum Renovators focus on adding value to a property through construction. Despite the easy profits shown on TV, flipping is a competitive and challenging business.
Large, well capitalized companies have gotten into the game by proposing to flip on a national scale. They’re generally referred to as iBuyers. Multiple companies have their services up and running in test markets.
They are struggling to make the activity profitable. This is unsurprising given that small scale flipping is hard work, and iBuyers are doing basically the same thing.
How iBuying Works
The iBuyer acquisition process involves estimating the market value of a property and then offering to buy it at a discount. Next the iBuyer makes minimal repairs and/or improvements to the home and lists it publicly for sale.
Their approach is more like a Wholesaler than a Renovator. They try to get to the owner first and offer a discount, like a Wholesaler. They justify the discount by making the sale very easy for the owner. iBuyers are not looking to do significant construction, like a Renovator would, but they do set a modest improvement budget to make the home presentable once they own it.
Getting In and Getting Out
Consistently “buying right” will be difficult for an iBuyer because they begin with a “market value” from their valuation algorithm and/or a real estate agent. There is an attempt to play fair with the owner and then justify a discount to arrive at the acquisition price. Early reports are that few property owners accept an iBuyer’s bid because it is much lower than what the owners believe they can get by selling through an agent. There is a limit to the discount that iBuyers can demand.
When the iBuyer prepares to exit their investments, they will find that the public isn’t going to pay more for a home just because it is advertised by an iBuyer. The buying public will compare the condition and quality of iBuyer inventory against the other homes available in the local markets. Home buyers are sometimes inclined to bid more aggressively for properties owned by a faceless corporation than a property owned by real people. Holding time is money, as every flipper (and bidder) is well aware.
A floor in the potential acquisition price, combined with the ceiling in the eventual sale price, creates a relatively narrow financial window in which the iBuyer has to purchase, carry, improve, market, and sell their homes … while still leaving room for a profit.
Costs of Ownership
Once they own a property, iBuyers need to decide what gets repaired, replaced, painted, and maybe even staged. That work has to be overseen by a local project manager, just like a traditional flip. Someone needs to be on the ground to make property-by-property decisions and ensure that they are properly implemented.
Small scale flippers consider their labor to have no cost. As a sole businessperson there is no need to differentiate between their labor and profit. Both end up as cash in the flipper’s pocket after the property is sold.
An iBuyer does need to differentiate between project manager labor and profit. If their goal is to do minimal work on each home, then perhaps the project manager can handle more properties than a typical flipper reducing the per-property cost of the project manager’s labor in the overhead expenses.
Operationally, iBuyers should be able to standardize their processes and cut out some expenses. For example, replacing the listing agent with employees when they market their portfolio properties could save them a meaningful amount of money (as long as their sales volume is consistent and the employees don’t turn into extra overhead).
Or if they flip enough homes in a region then perhaps they can negotiate discounts on services and materials they regularly use. Despite some potential operational opportunities, there are other expenses that will be very difficult to manage away.
The biggest uncertainty in the iBuyer model is the “market value” on which they base their original bid. Once they buy a property they assume the risk of advertising it to find the actual value the market places on the property.
Relocation companies periodically take on this value risk by buying the homes of their customers. We’ve seen them absorb some brutal losses from incorrectly assessing the likely market value of a property during their acquisition process.
Finally, owning a home means dealing with its problems. If the HVAC system fails, then the property owner will have to either replace it prior to closing or reduce their asking price enough to induce a buyer to take on the expense.
Unlike a normal flipper, iBuyers have executives and the expenses that come with them.
They have also spent quite a bit more money establishing and marketing their brand/service, building their transaction platform, and setting up their business processes.
Again, they may hope to minimize these expenses on a per-property basis by allocating them over the scale of a national operation, but they are still an extra expense that needs to be overcome to reach profitability.
The iBuyer’s Challenge
The iBuyer business model is constrained in its ability to buy low and to sell high. It requires much of the same labor, and incurs most of the same expenses, as traditional flippers. When factoring in corporate overhead that regular flippers don’t have, iBuying appears to be a business with structurally limited profit potential that is quite modest compared to the amount of capital invested to acquire each property.
Profits on individual properties will depend not only on the iBuyer’s decisions and execution, but also on the macro economy and the regional real estate markets. Borrowing costs to purchase and carry the homes is critical. Real Estate price appreciation in local markets can cover for execution errors.
The current environment in which existing iBuyers are rolling out their services appear to have favorable conditions for their services. The housing stock is relatively uniform, making their automated valuation algorithms more accurate. Interest rates are near historical lows, minimizing their borrowing costs. Home prices are rising, mitigating the cost of inventory languishing unsold.
Most of the companies rolling out iBuyer services are private, hiding their financial results. Reporting that I’ve seen is that they are losing money on each property, despite the favorable environment, and that a very small percentage of owners who request a bid end up accepting because the offers are so low.