Signs of Speculation Emerge in the Home Flipping Market
Flipping Rates Hit Cycle Highs While Speculative Activity Grows
Home flipping activity[i] hit a cycle high in the first quarter of 2022. And the historic rise is recent, reflecting unusual market conditions – namely low inventory and strong price growth – that traditionally support home flippers. However, conditions may have been so good for home flipping that home price speculators may be joining the fray at unprecedented rates.
In this Kukun inaugural report, we take a deep dive into home flipping. Not only do we investigate flipping rates nationally and across U.S. metros, but we also estimate the extent to which flippers are adding value to homes[ii] by tracking the share of flips where the flipper applied for building permits on an individual home. Furthermore, we trend how annualized returns compare to broader home price appreciation. Both measures – percent of flips with permits and annualized flip returns – can help us triangulate the extent to which flippers are adding value or just merely speculating.
First, let’s take a look at the recent national and regional trends in home flipping.
Home Flipping Rates Reach Cycle High Nationally, Led by Southern Metros
The first quarter of 2022 brought the U.S. the highest flip rate this cycle, with the share of home sales comprising of flipped properties reaching 9.5% in February. March and January of 2022, and December 2021, brough the second, third, and fourth highest flip rates in our data series.
While we use the two-year definition of flipping in the remainder of this report, it’s important to also look at how other measures of home flipping have trended over time. As we can see from Figure 1, the recent increase in flipping activity over time has predominantly increased because short-term flippers (buying and reselling within 6 months) have upped their participation rate. This could be for a few reasons: (1) as prices increased at historically high rates at the end of 2021, flippers began to undertake less complicated and less time-consuming flips (2) more speculators entered the game, relying purely on quick market appreciation to drive their returns, or (3) historically low inventory ensured that flippers could dispose of properties at record speed.
Using the two-year definition, we also find that flipping rates vary sharply across the country, tending to be highest and more affordable in the eastern half of the country and lowest in larger, more expensive metros. For example, seven of the top ten metros with the highest flipping rate in the first quarter of 2022 were in less pricey southern metros such as Tampa, FL, Jackson, MS, Jacksonville, FL, Chattanooga, TN, Charleston, SC, and Daytona Beach, FL with the other three being in cheaper Midwest markets such as Madison, WI, Detroit, MI, and Omaha, NE.
At the low-end, we don’t see a particular geographic pattern among metros with the lowest flipping rates. However, several of the largest and most expensive markets in the U.S. appear in the bottom 10 flipping markets. Those metros include San Jose, CA, San Francisco, CA, Honolulu, HI, Washington, DC, and New York, NY. The remainder of the top 10 includes Buffalo, NW, Greensboro, NC, Greenville, SC, Pittsburgh, PA, and Tulsa, OK.
Flipping Returns Aided by Sharp Rise in Home Values
In addition to flipping rates, we also estimate annualized returns to home flipping. What’s the difference between annualized and normal (nominal) returns? Nominal returns are simply the percent difference between what an investor paid for a property and what they sold it for, and an annualized return is the return that controls the length of time that it took to flip a home. By using annualized returns, we can get an apples-to-apples comparison of returns to flipping that is unaffected by the time in which it takes to flip a home and one that is comparable to market-based growth in home prices over the same period. See our endnotes for a clarifying example.[iii]
Nationally, we find that annualized returns to flipping in the U.S. have been on the rise since the first wave of the pandemic passed in the summer of 2020. In the year prior to the pandemic, annualized economic returns fell from around 15 percent at the beginning of 2019 to around 10 percent just before the start of 2020. Since then, annualized returns have nearly doubled to about 20 percent.
Perhaps more interesting is comparing annualized home flipping returns to annualized changes in home values. Comparing the two at any given time provides a sign as to how much flippers are adding value to homes through things like renovations, additions, remodeling, etc versus how much is gained through pure market appreciation. If flippers are indeed adding significant value to homes, we should see their annualized returns outpace pure market appreciation. If flippers are speculating, we’re likely to see their annualized returns approximate pure market appreciation rates.
It turns out that annual home price appreciation roughly approximated annualized flipping returns as of March 2022 at a rate of about 20 percent. This suggests that nearly all the returns to flipping at the national level can be accounted for by increases in home values over the same period and that flippers – whether by design or not – are reaping returns that match what a flipper would have earned by purchasing a home and just sitting on it for a year without doing any work to the home.
While compelling, the data point is not conclusive since home price indices don’t avail themselves of appreciation due to renovation. In other words, we can’t conclusively determine whether changes in home values account for all the returns in flipping, or whether returns in flipping account for increases in home values. However, we can use other data points – such as Kukun’s proprietary data on building permits – to determine whether flippers have applied for more, less, or the same rate of permits on properties they are flipping and use that as a proxy for speculative activity. We take a look at this in the following section.
Flippers Applying for the Lowest Rate of Building Permits Since 2013
Flippers in the U.S. applied for building permits at near the lowest rate on record in the first quarter of 2022. Using Kukun’s proprietary database on permit applications in over 2,000 permitting jurisdictions in the U.S., we find that as of March 2022 just 19.9 percent of flippers applied for permits on the homes they flipped, which is the second-lowest rate in our data series (the lowest being 19.5 percent in November 2021). Prior to the most recent escalation of home price appreciation to the highest rate on record at the end of 2021, flippers were applying for building permits at the highest rate on record at about 29% of all flips in December 2019.
However, we see a significant regional variation in the rate at which flippers have applied for permits on the properties they flip. On the high end, flippers in the San Francisco Bay Area apply for permits at the highest rate – 63% – of all metros in our sample, followed by Washington, D.C., Cape Coral, FL, New Orleans, LA, and Los Angeles, CA with flipping rates of 53.3%, 48.2%, 45.5%, and 41.7%, respectively.
On the lowest end, Detroit, MI has the lowest rate of permit applications on flipped homes at just 2.3% of all flips, followed by San Diego, CA, Las Vegas, NV, Cincinnati, OH, and Miami, FL with permit rates of 2.9%, 3.8%, 4.5%, and 10.3%, respectively.
Why are flippers in some markets applying for permits at a higher rate than others? We don’t have definitive answers, but we do find a moderate negative correlation (-0.44) between the rate of flipping and the rate that flippers are applying for permits across markets. In other words, markets with more flipping activity tend to have fewer flips with permits. While suggestive, it does not prove causality since it also may be easier for flippers to operate in markets with less restrictive requirements for building permits. Flippers may be more active in markets that have looser building code requirements or looser building code enforcement.
The Flipping Takeaways
Does this mean that home flippers are definitively speculating? Not so much. While we find that home price appreciation explains most of the returns that flippers reaped over the past year, the problem with popular measures of home price changes is that they don’t weed out appreciation induced by home renovations. Furthermore, it’s possible that some flippers entered the market with the intent to renovate but were stymied by a shortage of contractors and/or materials and simply had to settle for more cosmetic renovations or other smaller value-add projects that don’t require permits.
Still, the evidence does show signs of speculation: rising flipping rates, shorter flip duration, little to no flip returns above general home price appreciation, a drop from the highest permit rate on flips to the lowest in less than two years, and the fact that the lowest rates of flips tend to be in markets with the highest flipping rates. While not definitive, we believe these are some of the first signs of speculation in the U.S. housing market since the Great Recession.
[i] We define flipping as the purchase of a property with the intent to sell within a two-year period for profit. We use the 24-month definition as that is the Internal Revenue Service’s threshold for when real estate holdings could be considered owner-occupied and thus eligible for capital gains exemptions. We also diverge from previous work on flipping that uses a 12-month definition. We do so because 12-month flips only capture flips that are subject to short-term capital gains tax, whereas properties flipped but held for 12-24 months are considered investments but subject to long-term capital gains tax. Since long-term capital gains tax rates tend to be lower than short-term capital gains tax rates, using the 24-month definition thus allows for a much broader analysis of investment in, and returns to, home flipping activity since some flippers may choose to hold properties longer than 12 months so that they may pay the lower long-term capital gains tax rate.
[ii] We consider a flip a non-speculative “value-add” flip if the flipper applied for any type of building permit during the period in which the property was flipped. While there remains a wide range of value-adding work that requires a permit, from water heater replacement to a foundation-up renovation, trending the share of flips that had a permit application over time gives us an unprecedented indication of flippers’ intent. Our assumption in this work is that an increase in the share of flips without permits is an indication of an increase in speculative activity more than a decrease in “value-add” improvements.
[iii] Consider this example: An investor purchases a property for $100,000 and sells it a year later for $200,000. In this case, they earned a 100 percent return over one year. A similar investor could have bought the same house and sold it for $150,000 just six months later. In this case, the return was 50 percent of six months, but when annualized it equates to a 100 percent return.