Going "All In"

Renting rather than owning. Has the time come to be a landlord? An article in the Wall Street Journal on Saturday described a June 2009 survey by the National Foundation for Credit Counseling that discovered a deep pessimism about home ownership. 33% of all respondents do not believe they will ever own a home. 42% of those who once purchased a home, but don’t own one now, believe they will never own one again. While 66% of all families in the USA own their own home, that percentage is declining and is highly correlated with culture and race. Minority home ownership at the peak of the housing market in 2006 was less than 50% for blacks and Latinos and those percentages do not look to increase in the near future. Minority home buyers in 2006 assumed sub-prime mortgages at twice the rate of white buyers and similar statistics exist for foreclosure rates. So where are these families to live? Even if renting isn’t as fashionable as home ownership, it may be the only alternative for many. Also remember that a short sale impacts the sellers’ credit (and thus their ability to qualify for a loan to purchase a home) for a minimum of two years. A deed-in-lieu of foreclosure process impacts the mortgagors’ credit for seven years same as a bankruptcy.
Thus a significant set of families may have no other alternative but to rent. Many investors see this already; that is why there are so many “all cash” offers on bank-owned properties in our area. The prices are so right that most of these properties can return a positive cash flow that only gets better the more you invest.
For example: assume a $400,000 purchase price for a nice 4 bedroom, 2.5 bath home that is in good physical shape needing paint, carpets and similar “wearables”. Assume that the typical rent for such a property would be $2350 per month.
Case #1 – 25% down payment
Down payment =$100,000 Loan = $300,000 30 year fixed rate loan @ 6%
Principal and interest = $1800/mo Taxes = $415/mo Insurance = $75/mo
Total expenses = $2290/mo
Income = $2350 / mo Gross Profit = $60/mo before taxes etc ROI= $720/100000 = 0.72%
Case #2 All Cash Purchase
Expenses = $490/mo
Income = $2350 /mo Gross Profit = $1860 /mo
ROI = 12* $1860 / $400000 = 5.58% before taxes
The only way a Case #1 scenario would prove more lucrative is when you consider the appreciation on the properties and assume that you spread a $400,000 investment over 4 properties rather than one. But what average rate of appreciation would you need to get to make the two cases returns equal?
Assume a 5 year window. Case #1 (assuming 4 properties) earns a total of 3.6% return ($14,400) over the period while case #2 (the single investment) earns 27.9% over the period ($111,600). The four properties need to recoup $97,200 more in appreciation over 5 years than the single property. In other words, assuming all properties appreciate the same, the properties must appreciate at a rate of: $32,400 each over the period or $6,480 each per year. That’s 1.62% average. Certainly an achievable return in most real estate markets of the past.
However, this does consider selling costs. When selling costs (primarily real estate broker fees) are included, the required average appreciation rate for the four property scenario rises to 2.82% annually.
And there is your conundrum, Mr. or Ms. Investor! If you believe the real estate market will hold prices relatively flat for the next five years, a single large investment could pay off better and return significant cash each year along the way. If you think that home prices will accelerate in the next decade, spreading your available cash among several properties will create a better return but only if your realizable appreciation exceeds about 3% per year on average. From this, you can see why many investors today are going “all in”.

High-End Homes- Disaster or Opportunity?

Yesterday's Wall Street Journal included an article that echoed what I have been saying about the market for $1M and above homes. Higher mortgage rates (6.35% vs 5.25% yesterday), higher down-payment requirements (25% to 30% or more vs 3.5% for FHA) and no "buyer incentives" (ex. First-time buyer tax credit, New Home tax credit, etc) all have contributed to a dead high-end real estate market. Nationwide there is a glut of these homes on the market and experts predict more to come as unemployment increases. Nationally there is 21 months of inventory at prices above $1M compared to 16 montsh a year ago. In the $500K - $750K price range there is 11 months on properties available today versus 13 months a year ago. And at the entry level, there is 8 months inventory nationally versus 11 months a year ago says the National Association of Realtors.
Locally we are seeing the same situation: the >$1M price range has 14 months inventory as of July 15th; the $500-750K range has less than 3 months and homes below $400K have 18 DAYS of inventory!
We are seeing prices for upper level properties retreat to pre- 2002 levels. For example, a beautiful 18 year old home with 4000 sf and 4 BR and 3.5 baths plus office and game room, on 2.5 acres is priced at just over $1M today down from selling in 2005 for $1.5M. There are so many properties on the market and so few active buyers that "Feature Compression" is running wild again. This is when a small increase in price offers much more in the way of land or amenities. As prices fall at the upper tiers and sales pick up in the lower and middle tiers, huge compression occurs in the market above $800K or 900K. Buyers are not valuing "extra" land (ex. 5 acres when all they need is 2 acres) and so properties on larger parcels are suffering even more. Many sellers see this as a disaster. Many are renting in an attempt to keep their homes from foreclosure rather than selling at what they perceive as an unacceptable loss. Buyers should look at this as an opportunity to obtain homes with the quality and acreage they may have thought unobtainable in our area at prices they thought would never return.

A Home Again

I’m hosting an Open House at a home I listed a couple of years ago. Not sure exactly what happened since, but the owners went through bankruptcy and now the home is back on the market as a short-sale after being rented for awhile. It's vacant now. Yet it's still a magnificent home. Only nine years new with all the bells and whistles, and the most awesome views of the valley I have seen in a long, long time. It’s bitter-sweet however, as while it's still gorgeous in so many ways, it’s a bit dingy, unkempt and unwanted. The grass is browning and some of the flowers look tired and thirsty. Sad really.
I’m sure there were some fantastically happy times in this home. Maybe a few unhappy ones as well. I know at one time there was love here. I could feel it when I worked for the owners. You can see it in the murals on the kids old bedrooms, the Pooh lamp and fan in one bedroom and the care in selecting the colors, wall treatments and landscaping. Now it’s kinda like a stray puppy at the pound. Looking for a new start, a new family, some care and some appreciation.
And so today, at this Open House, I discovered another reason I like real estate. Not only do I get the opportunity to help people find a new home, start a new life, or make the transition to a new part of their lives; sometimes I get to help rescue a wonderful house and help it become a home once again.
I hope I get a lot of traffic this weekend. I hope we (the home and me) can find it a buyer. If I work hard perhaps I will earn a sale. But the home deserves a good family no matter what. It‘s ready to be a home once again.