Is now the time to invest in real estate? Have the glory days of the residential real estate investor passed? Low prices, rock-bottom interest rates and stable rental markets had created buying opportunities. Now, regionally, locally and nationally we are seeing the “long term” real estate investors (known to many as vultures because they swoop in and buy distressed properties cheap) are no longer making as big a splash. Does that mean that the opportunities for real estate investment have passed?
It would have been great if you had realized that the buying opportunity was 2-4 years ago. But it was hard to convince sophisticated investors how strong the local markets would be, much less neophyte investors. But in my eyes, the economic strength of job creation and lack of new product in high demand neighborhoods bodes well for local investors.
Continued distressed markets such as Las Vegas, Phoenix, Atlanta and Orlando and others continue to be popular even though the 70+% discount of the past few years is no longer available. Are we seeing this in Austin, San Antonio, Houston and our Texas metros? No, not as much. Why? Unlike other markets such as above, we never saw the run up of values (appreciation) like other markets did. Therefore it makes it hard to profit on “flipping”/speculating on the housing market in Austin. Are we seeing the vulture groups? Again, not really. We saw a little in DFW, but not the other Texas metro markets. What we are seeing are true real estate investors who are looking long term. Once, they analyzed their decisions based on home-price appreciation, which is very speculative. Now they consider potential rental profits, which is far more stable. But how they’re investing has changed. In the boom years, they would buy a property and flip it for quick cash out. Today, they are holding and renting for steady incomes. The new economy dictates that you have to have a long term view.
To underline the small appreciation on an annual basis in the Austin local market, below is a chart showing residential appreciation over the last 5 years.
What should you look for? For example, do not even factor in home price appreciation for at least a year. After that, calculate only a 3% annual increase or less — a return that won’t turn heads of investors who only want to buy low and sell high. Look for cash flow. Know that you will have to put 20% to 30% down on the investor loans. At today’s low interest rates, they’ll get a near 5+% loan, 20% down. Figure another 10% of the price for property management (unless you like getting calls in the middle of the night to unstop toilets, etc.), 10% for maintenance, an 8% vacancy rate, plus taxes, insurance and other home ownership expenses.
What are you looking for? Cash flow vs. appreciation.
Generally properties that cash flow immediately come from “blue collar”, low income, lower priced areas. Many realtors would call them the ‘entry level’ buyer. Nationally as well as locally this buyer is not as able to purchase with current lending guidelines. Historically these areas appreciate, but not as fast as higher income areas.
Properties that appreciate more quickly are generally in higher income areas (desirable) and generally don’t cash flow immediately. But, you should look to increase rents to cover your mortgage payments within a minimum of 12 to 24 months. Both are good opportunities, but do it now while affordability costs (rates, values, rents) are low.
As we have stated before, there is a limited number of developable lots. There is limited funding (bank loans, etc.) for development. Those that are currently being built will take a while to get to the market. Why is this important? If more product is not coming on the market to compete, rents should stay high…economics 101 – less supply, therefore values increase. Although conditions are very favorable, investors have to be adaptable because the market is evolving rapidly. It’s the income from rentals that’s paramount right now. The beauty of cash flow, of course, is that even if the prices decline another 10% or 20%, the investors should be able to live with that. Investing in rental properties is a long term investment strategy. You need to look at a minimum of 5 years to hold. As always, you need to visit with your CPA, financial consultant, mortgage professional, and real estate professional before you dive in. Now is the time to buy investment property!
Why rates should increase and the housing market will improve
Milton Friedman once observed that low interest rates are an excellent indicator that inflation is low, so consumers wonder why economists keep predicting that inflation will rise. Short term, after this week’s Federal Reserve meeting, rates will remain low for a short while longer, hoping to encourage small and large business to expand and hire.
However let’s look at historical economic facts: low inflation does indeed lead to low interest rates, and vice versa, but the two don’t necessarily move in lock step. Often it takes a period of high interest rates (the result of Fed tightening) before inflation moves down and interest rates eventually follow. The early 1980s would be a great example of this. Similarly, it often takes a period of low interest rates (the result of Fed ease) before inflation pressures rise and interest rates eventually follow. The 1970s were a good example of how low interest rates can lead to higher inflation and higher rates. I think we’ve been in the latter kind of period for some time now. Milton also observed that the lags between monetary policy changes can be long and variable.
The consumer looks at today’s rates that are very low, adds in Milton’s observation about low rates and low inflation, and infers that inflation may actually be at risk of being so low as to threaten deflation. There’s a decent chance the market may not be reading things correctly and may be failing to learn the lessons of the past.
Historically, it is also the case that low interest rates can be a sign of a chronically weak economy, as Japan has suffered for decades. When investment opportunities are scarce, it doesn’t take much of an interest rate incentive to balance savings flows with investment demands for cash. This could be the reason why mortgage rates are so low and why so many continue to worry housing prices have not yet hit bottom: low mortgage rates could be signaling that there is a shortage of mortgage borrowers relative to the number of investors willing to buy MBS—thus, the demand for housing could fail to absorb all the housing supply that is due to hit the market over the next year or so as foreclosures allegedly pick up.
One needs to keep in mind, however, that there is no indication that the housing market is not improving or will soon fail to improve nationally (by improving I mean that sellers are able to find buyers at some price). According to the NAR, the monthly supply of unsold homes in the U.S. has fallen from a recession high of just over 11 months to now just under 9 months. Sales volume is up in many markets, particularly in California and Florida, and the Case-Shiller index of home prices in 20 major markets shows that prices have been flat to slightly up since early last year. Texas and Austin continue to lead the market.
The housing market is improving, and has been improving for over a year. Between declining mortgage rates and declining housing prices and a recovering economy, the market has found a price that equates buyers and sellers. The ongoing decline in mortgage rates is obviating the need for lower home prices. Think of it this way: the bond market, thanks to its conviction that the economy is going to be very weak for the foreseeable future, has been acting as a great shock absorber for the housing market by bringing mortgage rates down to all-time historic lows. In this view, low mortgage rates could be signaling simply that the market is very pessimistic about the economy, not that there is a shortage of homebuyers. Higher rates wouldn’t jeopardize the economy or the housing market, since they would signal rising confidence, stronger growth expectations, and the prospect of rising incomes and rising home prices. Higher rates would also be a sign of rising inflation expectations, and that would only add fuel to housing demand.
So we don’t see any reason to think that the recovery is fragile or that the housing market is on the verge of another collapse. Instead, we see lots of signs that consumers are concerned about the future of the economy. Those consumers with focus on their bottom line are out buying and financing at rates we won’t see again for a long time.