Value-add real estate investing opportunities have been harder to come by — although still quite profitable — during the pandemic, but the expiration of the nationwide foreclosure and eviction moratoriums in late 2021 should help bring a modicum of balance back to the housing market and provide more acquisition opportunities for real estate investors in 2022.

Lack of sufficient housing inventory to meet buyer demand became a common theme in the broader housing market during the pandemic. Although that theme is validated in the double-digit home price appreciation that has become commonplace during the pandemic, there has still been enough inventory to fuel a 22 percent increase in the annual pace of existing home sales in 2021 compared to pre-pandemic levels.

Data from the National Association of Realtors shows the annual pace of existing home sales averaging 6.1 million through the first nine months of 2021, compared to 5.3 million through the first nine months of 2019.

Dearth of Distress

The supply-demand imbalance is much more severe in the distressed market, where many real estate investors turn to find the best value-add deals that don’t require rapid home price appreciation to generate a healthy return.

Data from the Auction.com marketplace — which has accounted for close to 50 percent of all U.S. foreclosure auction sales during the pandemic — shows the number of properties brought to foreclosure auction in the third quarter of 2021 was 68 percent below the pre-pandemic level in Q3 2019. That 68 percent drop in foreclosure auction inventory is coming off an already low level. Total foreclosure auction volume in 2019 was at its lowest level since 2006 according to public record data from ATTOM Data Solutions.

The more severe supply-demand imbalance in the distressed market is also evident in an average foreclosure sales price that is rising at an even faster pace than the overall market. Properties purchased at foreclosure auction in the third quarter of 2021 sold for an average price of $167,503, up 15 percent from the previous quarter and up 42 percent from a year ago, according to the Auction.com data.

Rising Tide of Distress

The good news for real estate investors struggling to find value-add inventory: the foreclosure auction tide is slowly starting to rise. Although still well below pre-pandemic levels, the volume of foreclosure auctions on the Auction.com platform in Q3 2021 increased 16 percent from the previous quarter and was up 89 percent from the third quarter of 2020 to the highest quarterly level since the onset of the pandemic.

The tide is rising more quickly in some markets than others. States with third quarter foreclosure volume rising closest to pre-pandemic levels included Oklahoma (3 percent below pre-pandemic levels), Indiana (22 percent below), Kansas (37 percent below), Michigan (40 percent below), and Mississippi (54 percent below).

Buying Low

Despite skyrocketing home sales prices, foreclosure auction buyers are still purchasing well below “after-repair” market value, allowing them to earn rental or resale returns through value-add renovations. Properties sold at foreclosure auction were purchased at 32 percent below the estimated after-repair market value in the third quarter, according to the Auction.com data.

That means real estate investors who have been able to find distressed property deals during the pandemic are still capable of realizing healthy profits that are grounded in value added through substantial renovation rather being heavily reliant on unpredictable home price appreciation.

“I’m still getting my 20 percent gross margin,” said Rick Starnes of a distressed property he purchased during the pandemic for $280,000. Starnes said he has spent $170,000 on renovating the property. “It was in a lot of need for some love. It needed $170,000 worth of love.”

The significant time and cost spent on renovations allows Starnes to resell renovated foreclosures at close to full market value. That helps him helps to achieve his target returns and also helps to improve home values in the surrounding neighborhoods where he buys. In the second quarter of 2021, renovated foreclosures resold for 104 percent of estimated after-repair market value – an average 37 percentage point lift in value from the distressed purchase price, according to an analysis of Auction.com data and public record data from ATTOM Data Solutions.

Well-renovated homes also attract owner-occupant buyers: 71 percent of renovated homes purchased at foreclosure auction in 2019 and 2020 were resold to owner-occupants, according to the analysis.

By contrast, homes that did not sell to local buyers like Starnes at the foreclosure auction, but instead reverted to the foreclosing lender as real estate owned (REO), were subsequently resold in Q2 2021 on the traditional retail market (Multiple Listing Service) for 87 percent of estimated after-repair market value. Only 49 percent of all traditional REO sales between 2019 and 2020 went to owner-occupant buyers.

Distressed Deals

Since he started investing in 2018, Starnes has purchased five distressed properties, four of them on Auction.com and three of them during the pandemic. All the homes are within driving distance of Starnes’ Chesterfield, Virginia, home, and all thus far have produced the gross margin goal he has set for himself.

An analysis of properties renovated and resold after being purchased on the Auction.com platform shows that Starnes’ gross margin goal is neither unrealistic nor uncommon. The analysis, which looked at more than 65,000 resales of previously distressed homes between 2018 and the second quarter of 2021, shows average returns for renovated foreclosures rising — even during the pandemic.

The rising returns for distressed property renovators is counter to the trend in the larger retail market, where the average gross flipping profit decreased to a 10-year low in the second quarter of 2021, according to ATTOM Data Solutions. The retail market data includes properties resold by iBuyers such as Opendoor, Offerpad and Zillow, the latter of which exited the home flipping business in November due to the “unpredictability of forecasting home prices.”

Renovation Required

Most Auction.com buyers budget at least 20 percent of the acquisition costs for rehab and holding costs, according to a 2021 buyer survey. Many, like Starnes, spend much more on renovations.

“You’re wasting your time if you’re not doing a good job and expecting to get top dollar for the house,” Starnes said, noting that his contractors tell him other investors don’t spend as much as he does on rehabbing homes. “The last two I’ve completely gutted the houses. … When I walk away from them, I want them to think they are buying a new house. I’m an engineer and I don’t want to do it halfway.”