Investing in real estate in 2008
Real estate investment? Isn’t that an oxymoron, or at least a contradiction in terms? It may seem so in the context of the current housing market’s price and sales weakness, especially in those hard hit areas of the country where this is gallows humor under a dark cloud. It is accepted that home prices as a whole will be down in 2008. According to the government Office of Federal Housing Enterprise Oversight (OFHEO), which tracks price changes of conforming loans, home prices have already declined over 4.6% from their April 2007 peaks through April 2008 (the most recent month reported) and have some more to fall before stabilizing. Reports from the broader S&P/Case-Shiller indicies of 20 big metro market home prices are even more gloomy. In times like these we need to look back a bit and see where we have come. Over the last five years, despite the recent dip, the average single family American home has appreciated over 38%, according to the OFHEO. And even in the states that are suffering the most from price declines, California, Nevada, Florida and Arizona, prices were up 56%, 63%, 67% and 72%, respectively (see page 4 for one- and five-year price changes for all states) over five years through the 1st quarter.
The message that we want to deliver is an old, but important one: real estate is a reliable source for steady, unspectacular appreciation (that 38% national increase is a compounded annual rate of just over 6.6%) which, over time, has created substantial wealth for many Americans. For some it has come as home equity, for others, equity in a portfolio of investment properties. But it can have swings just like other investments. When prices get too far above long-term trends, they will inevitably return to more sustainable levels, as they are doing now. The re-tracement of prices is being aggravated by the unwinding of some of the very things that drove prices too high in the first place: lax lending policies, lofty purchaser expectations for appreciation and speculation.
Eventually we will return to a more normal and lasting real estate climate, one where real estate appreciates by about 1 to 2 percent above the rate of inflation. Those days may seem far away now, but they will return, and, thankfully, are closer now than when we started.
Two measures that got out of lines during the peak of the market are returning to historical norms.
First, the ratio of home prices to annual incomes had dropped and is now nearing more usually territory, though trepidation about a weak economy (and shaky incomes) may require us to overshoot before a turnaround. Second, the ratio of home prices vs. rents is coming down, but is only about halfway to pre-boom figures. However, with fewer opting to or, because of tougher mortgage rules, being able to buy and, thus, having to turn to rentals, rents could climb. Remember when we used to say it was cheaper to buy than to rent? Those days may be here again before too long.
What do both of these measures have in common? They are connected to affordability, which, with mortgage rates that are still low, is starting to turn some heads. So, while many are fearing to tread in the current market, some buyers, both investors and those looking to find a new home, are starting to cast their nets in hopes of catching a bargain. Foreclosures or REOs (real estate owned by the banks) are out there (more on them later) and, along with short sales and fha/va hud homes, can present great opportunities, but good properties being offered by individual owners can be the best choice for most homebuyers. Many owners who had listed at unrealistic prices in hopes of snaring a buyer blinded by the fabulousness of their house have now come to their senses and withdrawn from the market. The stubborn ones who have not withdrawn will stick out in their unwillingness to accept the verdict of the market.
No sense in bothering with them. What is left these days are those who are committed to sell for economic reasons, job relocation or because they have or expect to find a bargain themselves. So you will find they have priced their property accordingly. “Priced below appraisal” is what we are seeing from determined sellers. Although these are words we still approach with caution, homebuyers can appreciate the psychology behind it.
So much for homebuyers, what is out there for investors? A lot.
A key to owing investment property is to be able to apply enough leverage (ratio of dollars invested to dollars borrowed) to make your assets work effectively for you, while not saddling you with large negative cash flows. You want the rents to offset your mortgage payment or to leave you with an affordable monthly negative.
Getting a house for a good price is essential for getting a real estate investment property off to a good start.
You can no longer count on rapid appreciation to immediately put you in the black. With 90% financing deals harder to construct than in the past (see page 4), the market is making it easier for you to opt for smaller negatives and a better cash flow by reducing your ability to craft a highly leveraged purchase. For many investors, that may even be in their long-term interest, if a short-term irritant. Some of the best deals for investors are with REO’s (bank-owned properties). Once a bank has foreclosed on a property, they have no cash flow on that home and are saddled with a large negative on their balance sheet. Many banks are willing to sell these properties (they want to get income on the properties as soon as possible), even to an investor, with financing at below-market rates. Here, the relatively few owner-occupancy buyers will always get preference over investor deals. So, too, will an investor contract with outside financing that gets rid of a non-performing property entirely. Yippee!
Another possibility for investors is the pre-foreclosure sale. Banks will do anything reasonable to avoid having to foreclose. If the Investor is willing to make up the back payments and take the loan over at the original terms, banks are very open to negotiation. They not only avoid the costs of a foreclosure but also guarantee the cash flows under the original terms. The original owner also gets a benefit, since they avoid a foreclosure on their credit.
Before we close, we want to address the notion that every homeowner is an investor. The standard line in real estate is that, for most people, owning a home is the best single investment they make in their lives. We think this is true, but there have been dissenters. Some may have an argument if they want to disagree about the short-term results, but a glance at the five-year appreciation numbers in the table on page 4 suggests to us that real estate usually appreciates over the period that most people keep a home (seven years). Some would say that you shouldn’t view your home as an investment and warn about the cost of upkeep, refinancings and improvements that don’t pay back their full cost. But if you live somewhere and don’t own, then you are renting from an investor.
If you own, you become the investor and are essentially paying rent to yourself (what economists call “imputed rental value”). Investment aspects aside, the control (ability to improve or modify your home according to your changing needs or desires) and security (you can’t be kicked out unless you fail to pay your mortgage or face rent increases unless you refinance or you have an adjustable rate mortgage) are benefits of ownership that are critical, but not easily quantified.
© 2007, Real Estate Information Services, Capitol Assets, Choice Real Estate, Inc. & Choice Finance®
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