Flipping Houses Industry Analysis, Capstone Project Example

Introduction

The aim of the new business venture is to utilize abandoned and foreclosed properties in the state of Detroit, in order to make a profit, provide affordable homes for families, and to improve communities. There is currently a government-funded project and initiative in place that is aiming to end homelessness and create affordable homes in the state. The rapid re-housing project by the Homeless Action Network (2010) is in line with the new company’s goals: “Provide safe, affordable, supportive, and long-term housing solutions for people who are homeless or at risk of becoming homeless” (Homeless Action Network, 2010, p. 4). The founders of the new company would like to buy, renovate, sell abandoned, neglected, and foreclosed properties in Detroit, in order to provide a safe and affordable option for middle-class and disadvantaged families through government funding and collaboration. The housing market is just recovering from the effects of a long-term recession, and the low availability of homes drives prices up. The authors believe that by increasing the pool of affordable, quality homes, the company can create long lasting advantage for potential buyers.

Detroit is considered to be decaying the city of The United States, and there are some alarming trends identified by Follain’s (2011) report on housing. The study determines declining cities’ impact on neighborhoods, communities, and quality of living. During the recent financial crisis millions of individuals lost billion during the foreclosure crisis. More disproportionately was this impact felt in the minority communities, in which was greater compared to their white counterparts. The home prices in Detroit have significantly declined than any major city in the country, and homes are selling at one-third the price when purchased. According to recent reports, on average there are 34 foreclosures per 1,000 households in Detroit, and the homes in foreclosure are worth less than the amount owed in mortgages. (Mueller, 2013) Since filing for bankruptcy, the housing market in Detroit has garnered international spotlight as many Chinese investors are trying to invest and recover the decaying city. Coupled with the population decline, and a string of economic problems it has contributed to the decreasing housing market.  However, with the interest of foreign investors, and a recent uptick in their housing sales, Detroit is soon on its way to becoming a hot market that is attracting many homebuyers and investors.

Industry Review

There is a general trend for buying low-cost homes in the United States, as a consequence of the aftermath of a long lasting recession. According to a recent Detroit News article (Crutsinger, 2014), the sale of pre-occupied homes increased by 4.9 per cent in May, 2014. The low rates on mortgages have made potential homebuyers more adventurous, however, pre-owned homes have a price advantage over new developments. The share of the distressed mortgages (and foreclosed properties), according to a recent publication by the U. S. Department of Housing and Urban Development and the U.S. Department of the Treasury (2013) was higher in Detroit than the national average. The foreclosure rate in Detroit was 0.3 percent, compared to 0.1 percent nationally. In order to stabilize the housing market and increase the availability of affordable homes in the area, the government is committed to re-utilize properties. Based on the aims of the Neighborhood Rehabilitation Program, rehabilitation, reconstruction is likely to be supported by governments, and the aids provided for potential buyers will make the market for renovated homes more viable.

A recent Joint Center for Housing Studies of Harvard University (2013) study states that the U.S. housing stock is ready for renewal. Housing inadequacy is a great problem that needs to be tackled. The average expenditure per unit, according to the study (Joint Center for Housing Studies of Harvard University, 2013) by investors is around $15.600. This means that those properties that are re-developed and renovated by companies that buy, improve, and sell homes for profit are finished to a higher standard than those repaired by owners or banks. The current real estate industry assesses the reasonable business estimation of land property when it is purchased, sold, sold, created, enhanced, safeguarded, debated or exhausted. Around 58.0% of industry income is produced from overhauling the monetary division; the parity originates from adjusting law workplaces, individual managers and purchasers and, to a lesser degree, government and bookkeeping customers. The forecasted look for the industry sees that the real estate income will rely upon on the expansion of the annualized rate of 2.1% to $6.6 billion. According to PR Web (2013), “From 2008 to 2010, the subprime emergency and following subsidence brought about an emotional decrease in property estimations, transaction volumes and improvement action over the private and nonresidential land advertises in the United States. This will bring on interest for evaluation administrations to wane. (PR Web, 2013) In the course of recent years, on the other hand, Ibisworld expects that industry income has recuperated considerably, and appraisals it will develop 6.7% in 2013 as the volume of land transactions expands and property evaluations keep on recovering from recessionary lows.

In spite of the fact that the business now utilizes an expected 86,997 individuals contrasted with 82,154 in 2008, at the start of the subprime emergency, numerous executives shed workers ahead of schedule in the five-year period. Workforce decreases were only one methodology industry administrators used to cut expenses and keep up net earnings in the course of recent years. Other expense cutting activities included lessening commissions, mien of unrewarding stakes and a lull in merger and procurement movement. These measures and enhanced financial conditions are relied upon to prompt an enlarging of overall revenues, which tumbled from around 16.0% in 2008 to 13.5% in 2013. (PR Web, 2013)  Notwithstanding an expected expand in edges over the current year, industry benefit succumbed to three of the previous five years. In the five years to 2018, Ibisworld ventures that the Real Estate Appraisal industry will develop. Industry execution will be backed by recuperation in the downstream land markets and builds being developed, and venture exercises. In spite of the fact that industry income is relied upon to climb, benefits development will probably be obstructed by the utilization of unified property databases (processing projects that can do the employment of an appraiser). Additionally the developing notoriety of evaluation administration firms, which frequently oblige appraisers to work for lower charges.

Looking at the overall real estate industry, there are five central organizations that represent short of what 15.0% of industry income with the biggest having a piece of the pie of only 6.2%. The bigger members in the business are for the most part subdivisions of huge multinational property, financier, and worldwide land administration firms. The dominant part of organizations working in the business are little, autonomous firms with few representatives or single-manager administrators. As indicated by the US Census and Ibisworld gauges, 75.3% of stations are nonemployees. From 2008 to 2010, the aggregate number of organizations in the business was declining. The amount of nonemployee foundations was diminishing at a quicker rate than management firms. This pattern, notwithstanding, has turned around as of late. As shown by Jose, the aggregate number of endeavors started expanding in 2010, and the amount of nonemployee firms is anticipated to develop at faster rate than executive firms throughout the following five years. This movement will probably come about because of mergers and acquisitions and additionally a pattern of evaluation experts leaving firms to wind up autonomous foremen as interest for their administrations is progressively separated through examination administration organizations.

Related Research

According to related research on the overall industry of house flipping, 3.7 percent of all US single family home transactions were flips. Where the house is acquired and along these lines sold again inside the first half of 2014, in which was down in the last quarter of 2013 4.1 percent.

According to RealityTrac, “Slowing home price appreciation early this year in many of the most-popular flipping markets put some investors in danger of flying too close to the sun.” Financial specialists seem to have recalibrated their flipping procedure, representing the slower home value thankfulness regardless of the possibility that that implies fewer flips. This is an alternate decent sign that this home lodging recuperation is acting considerably more sanely than the last housing blast, which was based on an unwarranted theory instead of reality based counts.

Housing flips ended in the first quarter took an average of 101 days to finish, up from a normal of 92 days in the past quarter and up from a normal of 79 days for flips finished in the first quarter of 2013. Among metro regions with a populace of no less than one million, saw more than 25 homes flipped in the first half of 2014. With major cities such as Las Vegas (6.7 percent), New York (10.2 percent), San Diego (7.1 percent), Miami (5.9 percent), and Jacksonville, Florida (10.0 percent) flipped in the first quarter of 2014.  (RealityTrac, 2014) In looking at metro areas with greater population they was a greater return on investment on single family homes that were flipped mostly saw close to 50% or more in Detroit (48 percent), Memphis (51 percent), Philadelphia (56 percent), Seattle (48 percent), and Pittsburgh (89 percent). More industry analysis recognized that the greatest expansion in the house flipping market was growth in Austin up 35 percent, Oklahoma City up 33 percent, Providence up 33 percent, San Antonio up 52 percent, and Indianapolis up 47 percent. (RealityTrac, 2014) Analysis shows that home flipping transactions have increased in the last year as more and more money is being invested in home flipping renovations across the housing market. As indicated in the chart supplied by Reality Trac (2014), the markets of major cities has increased:

The best markets for house flipping include Detroit in which a 48% percent ROI is expected, with an average purchase price of $67,960, average flipped price of $100,734, and flip profit an average $32,773. (Hill, 2014) Ranked the fourth best market for real estate flipping, the company will do well in this industry.

Regulation and Legal Concerns

The Michigan Article 25 of Public Act 299 of 1980 regulates real estate agents and sales intermediaries. Real estate pre-licensing courses need to be taken in order to start operating in the industry. The 2005 hearing document of the Ninth Congress (2005) indicates that the government is trying to make the real estate market more liberal, embracing competition among companies in order to benefit customers. The Department for Licensing and Regulatory Affairs (n.d.) website confirms that a maintenance and alteration contractor (M&A) needs to be licensed in order to perform trades and business activities. There is a 60 hours course that all contractors need to complete, related to safety, marketing, liability, and risk management. Further, the website also states that contractors detailed above need to be registered as salespersons. The Joint Center for Housing Studies of Harvard University report (2013) confirms high vacancy rates in Detroit. A comparison table (p. 43) confirms that in the second quarter of 2010 there were 91.892 vacant properties in the area, significantly higher than the rest of the counties. Vacancy rates increased by 12.4 percent between 2008 and 2010 in Wayne County (p. 45).

The home flipping industry is also set up that companies will need to know the rules and regulations in which the Federal Housing Administration (FHA) has implemented an anti-flipping regulations where, companies and individual investors in Detroit and surrounding states need hold onto the house for at least three months. This is due to the non-eligibility for mortgage insurance, and need for independent appraisal to justify the sale of houses sold over 90 days of purchase.  Although they have suspended the practice through December 2014, it is working in the best interest of the real estate investors. (Seim, 2013) Rules also extend to the IRS in which taxes the income made on flipping houses at around 15% of the gain. The rules and regulations to the real estate industry are normally the same, and in Detroit more attention needs to be paid to having enough money to cover mortgages, renovations, and security. When working in the Detroit market, the company needs to have a real estate lawyer who is close to the Detroit real estate market, to know how to approach purchasing homes, the correct lines of communication with the banks, and also knowing the right regulations in the zoning areas. This includes opening and closing costs, money to cover insurance, prepayment penalties, determining the building permits, and knowing the correct timing.

Location and Business Environment

It is important to consider the real estate market’s local characteristics, as well as the business environment for investing into residential homes. A market update by Real Estate One (2014, p. 4) confirms that within the next year, the availability of low priced properties is going to decline in Michigan by 49 percent. The trends determined by the research show that there will be a general decline in the number of available homes while the median asking price is going to increase over time. This means that there is likely to be a difference between supply and demand. Given that about 2 percent of the homes in the area are vacant and foreclosure rates are above national average (U.S Department of Housing and Urban Development & U.S. Department of the Treasury, 2013). The supply of homes available for sale can be increased through renovation and sales of foreclosed, long term vacant, and under-utilized properties.

The newly founded company would be able to fill a gap in the market and serve buyers who are interested in good value for money and would not like to go with homes offered by the government. Many buyers would decide to buy from a trusted and experienced property developer, instead of participating in government revitalization schemes. A recent article by Macdonald (2014), Detroit city officials have a bad reputation for flipping homes in the area. The article confirms that the renovation projects resulted in a financial loss for the local government. Therefore, the asking price of these properties was affected by the lack of cost-effective project management. Detroit city spent over eight million dollars to bring in two million, according to Macdonald (2014).  Another important aspect of the business environment is that Detroit is considered to be a declining city. The local government has existing initiatives to create jobs, improve the quality of living, strengthen communities, and bring back the city from the brink of decay.

The Joint Center for Housing Studies of Harvard University study (2013) states that there are new opportunities for remodelers in the current U.S. housing market environment. The document states “the growing supply of homes that have been through the protracted foreclosure process represents a major opportunity for remodeling firms. In 2011 alone, renovations of just over a million distressed properties generated about $10 billion in spending. With nearly three million additional homes currently in or at risk of foreclosure, many more billions will be necessary to upgrade these properties for return to the market” (Joint Center for Housing Studies of Harvard University, 2013, p. 10). Real estate markets in declining cities, based on Follain’s study (2010), have specific characteristics. Home values start reduced, due to the lack of employment opportunities, infrastructure, and the low quality of living.

Due to the high number of foreclosed and vacant homes, neighborhoods become distressed, communities break down. However, the city of Detroit have begun their turnaround began in 2011, as their values of the homes declined to 52 percent. The median home value also increased for most homes, with over 70 percent of homes in the Detroit market alone selling for a gain. The home market are also expected to increase another 4.3 percent over the year. The housing market however shows that 30 percent of Detroit’s business environment is also vacant, with homes on the market for $500 to $5000. The city of Detroit has also placed a large amount of homes on their auction site selling for $1 to $500 in order to get a lot of vacant homes off the market. Many foreign investors are also entering the Detroit market, where they are starting to buy up many low costs homes, hoping to rejuvenate the housing market in Detroit. Fannie Mae and Freddie Mac have implemented a new program that is controlled by the government in order to place the current homes through loan modification, in order to matched distressed homes with non-profit organization in order to assist with building demolitions and resale. The city plans to sell an additional 400 homes throughout the year with this program.

Zoning Issues

According to the Detroit Zoning Ordinance (2012), the geographical area of Detroit has several residential zoning districts: R1 for single families, R2 for two-family homes, and there are districts created for low, high, medium, and thoroughfare density housing areas. This issue is likely to affect the developing company: major extensions and expansions are not likely to be approved by regulators. However, homes located in planned development districts will need to be renovated according to the initiatives of the local government. The City of Detroit Neighborhood Clusters document (n.d.) needs to be studied before initiating development and investment projects. Zoning is required in order to control the growth of housing development and must be followed in order to be within the confinements of the law.

Business Licensing

Business licenses are issued by the City of Detroit. Business locations are inspected by officials, and permissions are subject to training and fees. Applicants must obtain a business license with the all the correct paper work, and file annually in order to keep their documents current. By choosing to incorporate the business as a Limited Liability Corporation, the company must register with the State of Michigan, get a sales tax number, obtain a federal tax ID number, and then apply for the Detroit Business License. As per the requirements by the city of Detroit. The business licensing also includes filing the correct business entity type which will be a Limited Liability Corporation that will ensure that each member will be able to make business decisions on behalf of the company, and abide by the rules and laws that other business entities do not.

Research Documents

The newly founded company will need to obtain information from the Detroit Planning & Development office, in order to gain insight into current projects, initiatives, and housing preferences. Trends analysis, statistics, and forecasts are likely to be supplied by the government agency, and details of the Neighborhood Stabilization Program are available to download from the Detroit government website. Further, funding is available for creating neighborhood regeneration projects in line with the government’s initiatives. According to the Detroit website (n.d.), $21.922.710 was recently allocated for the purpose of planning and redevelopment. Other research documents that need to be obtained include housing market information supported by Reality Trac, and other major housing data analysis in order to know the correct times to enter the market, as well as which houses are more likely to sell after renovation.

Business Entity Type

The newly funded business is going to apply for a business license as a Limited Liability Corporation. More importantly it will be officially filed as a limited liability corporation in which, will be a hybrid of a corporation that will offer the flexibilities of a partnership and offer tax efficiencies. LLC profits are passed through each member of the business, and each member can make decisions for the business. Each member’s assets are shielded from the liabilities of the small business corporation. The steps to forming the business includes choosing the name, EcoFlip, filing the Articles of Organization, creating the Operating Agreement, obtaining the correct permits and licenses, hiring employees, and announcing the business. First of all; in order to attract investors, the company would like to create stocks. In order to create market confidence, the organization needs to accept certain liabilities that come with the corporation status. As many regular corporations are subject to double taxation, and it is likely that the new firm will have limited partners, the small business corporation option seems to be the most viable solution. This way, the business can maintain a healthy cash flow by avoiding double taxation.

Current Regulations

Local government regulations are in place to support redevelopment of housing in Detroit. The Detroit city website (n.d.) has two important grant programs in place, in line with the Housing and Economic Recovery Act (2008) and the American Reinvestment and Recovery Act.  The FHA has also suspended their anti-flipping regulation through the end of 2014 to ensure that investors are able to sale the vacant homes in the housing market, as well give a chance to revitalize the housing market in Detroit.

Pending Regulations

According to a Detroit Free Press article (2013), it is likely that a new Michigan bill is going to be introduced to speed up the sale of foreclosed properties. The current six month time frame given to owners is likely to be reduced to sixty days. For the new business venture, this would mean that more properties will be available for sale at a low price, and the effectiveness of the business operation can be increased.

Competitive Analysis

The Detroit housing market is a hot bargain at this moment, as many low-end homes are being placed on the market for as low as $1, and this has created increased demand for foreign and domestic investors. As more bargain homes are being placed on the market, the houses are bought and sold for increased rental proprieties, with foreign investors from Australia, China, UK, Dubai, Iraq, Brazil, Russia, Morocco, and just about everywhere. There is an increased interest from abroad, and this has driven up the competitive market for Detroit. (Sands, 2014) The home prices in the Detroit metropolitan rose half a percent, and the much of the inventory is recovering from foreclosure and homes that are priced right are more likely to sell in the competitive market. There are more and more cash offers for homes than ever before, and this has resulted in a strong bidding war between foreign and domestic investors. Also benefiting from this strong competition, is the home builders that will see a surge in services for the flipping industry. Many homes that are being brought for rehabilitation is also on the rise for the Detroit markets. Companies that rehabilitate as well as purchase and flip houses, will be able to profit from the competitive resale market.

Competitive Landscape

The main competitors of the newly founded company are likely to be government-backed construction companies, new home developers, and other companies that engage in renovating and selling pre-owned homes. Further, real estate agents, offering low cost-owner renovated homes will pose a threat to market share. Land banks, featured by Sage Computing (2009) are also creating competition for the new service. These agencies acquire homes that have been foreclosed and promoted the redevelopment of the properties. These agencies, based on their existing working relationship with government offices would be able to acquire permissions, tax exemption licenses, and maintain properties assuming ownership. Further, these land banks act as property managers for tax foreclosed homes. Even though land banks create a large competition on the marketplace in Michigan, Detroit, they can also be viewed as potential partners for development projects. Land banks do not buy, maintain, manage, and sell bank foreclosed homes, only deal with tax foreclosures. The real estate market in Detroit is seeing a turnaround as the mortgage rates are at near-record lows, and 46 percent drop in short sales and foreclosures. The competitive landscape is filled with new and established investors and brokers looking to make a profit in this resurging housing market.

Key Competitors’ Names

Eco Flip will strive to offer quality family accommodations, in which will be the key to gaining competitive edge over competitors. Competitors such as, Higbie Maxon Agency, Inc. operating in Detroit, Lucido Real Estate, and Real Estate Dreams are the main players in the pre-owned property market. Individual real estate agents also will play a large role in the competitive market, as many are seasoned with knowing the areas that will be the most profitable, as well as how to navigate through the Detroit housing market.

Competitor’s Strengths and Weaknesses

Most of the companies are realtors and sales agents in one. The agencies offer bank owned, privately owned, to be developed, and neglected properties. The main strength of the existing real estate companies and chains is the existing reputation, expertise, licenses, and the large pool of existing, past customers. They also have dozens of properties featured on their website. They also are aware of the neighborhoods that will sell the most, or attract the most buyers. Knowing the rules of the Detroit streets, as well as the official rules will be a strength to already established real estate agents. The process of buying a new home, however, can be lengthy, using a realtor, as many homes would be available only when the owners find an alternative property. The weaknesses of the companies, therefore, can be concluded as a slow process, legal procedures, and a variety of homes available, of which it is hard to choose from. Land banks, however, have an important advantage over the newly created company: legislation, the fact that the banks are backed by the local government, and experience in property maintenance, legal issues, such as clearing titles, applying for tax exemptions, dealing with creditors and transfers. One of the main disadvantages of land banks is the slow process and low availability of funding for new projects. They are unable to materialize the return on investment in a reasonable time frame.

Competitive Market Share

While market share data is not readily available, a premise of the competitors can be obtained from the local government’s Planning & Development department. The three prime competitors are seen in the pie chart.

It is likely that two or three real estate agents complete more than half of the residential home sales in the area. Further, government owned and renovated properties might account for around ten percent of the exchanges. There are also will be a surge of non-profit organizations that will be supported by the government-backed program supplied by Fannie Mae and Freddie Mac, which will purchase and resale several vacant homes, as well as demolish depilated structures in Detroit. Other competition that will have share in the market is independent investors that will come from abroad or in other states in the United States looking to make a profit.

Capturing Market Share

In order to capture market share in the Detroit area, it is important that the new company effectively communicates the benefits of buying a home that has been renovated to the highest standards over buying a new property. The price advantage is evident, however, customers need to understand that they will not need to wait long months until the house is available to move in. Further, focusing on customers who are looking for value for money, the company will offer lower prices per square feet, guarantee on repairs completed, and a speedy procedure. As houses will be marketed directly to customers, the legal and professional costs can be reduced. Finally, building upon the price advantage, the company will also offer fast moving packages.

Competitors’ Reaction

Competitors are likely to engage in an aggressive marketing behavior. They might seek extra funding for speeding up the process of buying, renovating, and selling properties. They are likely to increase market activity; advertise, and recruit staff for locating available homes that have the potential of a large profit margin and a quick sale. In order to ensure that the market share gained by the new company will remain stable, a response needs to be created to prevent other companies from being the first to bid on properties. The strategy will also include hiring established real estate lawyers, as well as getting feedback from people that know the areas the best, how to get through the red tape, and work to be a profitable business. The strategy must also include using local resources who know how to navigate through the economy, the reputation of most crime-riddled neighborhoods, as well as enforcing security on purchased homes. The corporate strategy needs to include a cash flow management project that will ensure that the firm can buy homes immediately after they are available for purchase.

SWOT Analysis

In order to break into an existing and already served marketplace, it is important that a SWOT analysis is completed. This will help the management eliminate weaknesses and threats, build upon the strengths, and make the most out of the opportunities offered by the market segment.

In looking at the overall industry analysis, there are several factors that must be taken into consideration, this includes the growing housing market that is being supported by the government backed programs. As well as placing homes at prices as low as $1. Much competition will come from foreign investors, and new companies that will begin to spring up to law claim in the new rebounding market. In order to stay ahead, the company must offer quality, and information about the Detroit market that will differentiate from other agencies in the market. The recommendation is to pair with knowledgeable individuals that already know the ins and outs of the Detroit market, and help guide the company to be successful.

References

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