Thursday, May 22, 2008

Should I Buy Investment Properties Now?

I am a strong advocate that now is the time to buy investments properties in the markets where Prime Properties manages homes. I am putting my money where my mouth is, I am actively seeking buying opportunities right now and have recently closed on two purchases. Two purchases might not seem like a big deal, but I work with what I have and it takes more cash to close on investment homes at this time.

The reason I feel an urgency is because now is a lull in the market and when the market picks up again there will be many things changing so you will see a completely different landscape. To qualify this, you need to understand that I look for buying opportunities which I will hold for 10-15 years, I do not look for "buy and flip" situations in our markets. Here are points to consider....

1) It is much better to be a landlord when vacancy rates are low. Vacancy rates are below 5% in all of our markets, a rate which we consider full occupancy. This low vacancy is driving up rents and causing people to adapt their behaviour by being better tenants. Because there are fewer units available tenants are less demanding regarding aesthetic repairs and are more likely to be a better partner in taking care of the house they are renting.

The reasons for the low vacancy rate is tied to these factors:

  • Buyers are sitting on the fence. They see no need to jump into a market to protect their future because they believe the house the see available today will be available in the future at near the same price.
  • People are less sure about their future, so they are more likely to rent to insure flexibility to move to a new job.
  • The entry requirement to home ownership is higher, both higher down payments and more stringent credit requirements are making hard work for potential buyers
  • There has been a huge decrease in new construction of single family residences. New construction has had more margin available to attract/entice renters. Now that the new home builders have slowed to a standstill, so has their marketing arms which lured renters away from where they should be. Remember, some people should be renters - home ownership is not right for everybody.

2) Investors need to put 20% down right now. There is money available, but lenders want to see better credit and they want you to have some skin in the game. This money requirement is blocking out amateur investors who shouldn't be in the market now and making sellers more pliable. If you have money to put down you should be using it now!

3) Interest rates are at an attractive level. Rates are not at all time lows, but my last two mortgages were at 6%, a very reasonable cost of money - especially since these interest payments are deductible! The federal reserve has lowered short term rates, but my money people are telling me that mortgages are not expected to drop significantly lower and may actually rise. This is an important consideration since one of the important benefits of buying real estate investments is the opportunity for leverage, so higher interest rates would diminish the benefit of this leverage. I always buy on 30 year, fixed rate mortgages, and since I plan to hold my rental properties 10-20 years the short term benefits of short term ARM's does not compensate for the risk of higher mortgage costs in the future (for me).

4) The markets where Prime Properties operates are markets of continued population growth. This is an important consideration because incoming people will need homes! Over the next 30 years the biggest threat to success in our markets is something strange like a "bird flu" which would wipe out 50% of the population. Barring a catastrophic event like bird flu you should see continued migration of jobs and people into areas of the country that have a lower cost of living.

  • High oil prices should accelerate migration to places like Dallas, Austin and Oklahoma City. As transportation costs rise and consume a greater part of someones budget, people will not be able to afford to pay $3,000/month for the same house they would pay $1,000/month in Dallas. This is true whether they are renters or buyers.
  • There will be a bottom in the markets on the coasts which should still leave our central sunbelt states a significant cost advantage for businesses
  • Business will continue to make changes to allow profitability, meaning they should do again what they did in the last great recession of the 1970's - move to central sunbelt states that provide the most efficient costs
  • The world is flat! An information based economy can put their employees where they cost less. This does not always mean sending a job to India, it may mean sending a job to Austin! As India and China grow their costs advantages diminish, but there is still a significant cost savings by moving a job from New York or San Francisco to Austin.

5) Future costs for new construction should be much higher! The current downturn will not last forever. When the economy picks up again the entry point for new homes will be much higher. The increases in home values on the nation's coasts were primarily because of increases in land values, the next increase in home value will be because of the increase in the value of the actual product. This works well for the sunbelt states since most of what you are paying for is the cost of the structure, not the cost of the land.

  • Higher oil costs will drive up the costs of all the materials for new construction. If the economy picks up again in 3 years the materials cost of a starter home should be 10%-20% higher then they are right now, even though the builder will not be making any more money. The costs to process, manufacture and transport raw building materials will be impacted by the cost of energy as well as worldwide competition for these materials.
  • Labor costs should increase as well. People will need to make more just to get to work, and with the tightening of our borders as demanded by national security you should expect the building trades to be exponentially affected. This may add another 10%-20% to the cost of new construction.
  • All these factors make it even more likely that people will migrate to areas where they can create affordable housing, but the new house that may be available for $140,000 today will cost $180,000 in 2011 just because of the costs of labor and materials.

6) What new construction is occurring? If you follow current "new home construction" reports you may have heard that new home construction was up last quarter and that we may be at the end of the cycle. If you dig deeper you will find out that the reason for the uptick is because these reports consider apartment construction as "new home construction".

  • There was a significant increase in apartments because the people with the access (money) to perform the in-depth research have realized that more and more people will be renting.
  • In April of 2008 the US Commerce department report that apartment building jumped by 40.5 percent, to a seasonally adjusted annual rate of 326,000 units. The larger single-family sector dropped by 1.7 percent, to an annual rate of 692,000 units.

7) Where else are you going to put your money?

  • Do you really feel our stock market will perform at a high level over the next ten years or do you feel unsure about the ability of Corporate America to respond to changing worldwide economic issues and deliver consistent profits?
  • Do you put your money in CD's (now earning 1%-4%).
  • Do you put your money in high earning AAA bonds earning 7%-10% (remember that the sub prime real estate loans were rolled into investment vehicles rated as A, AA and AAA).

8) This is a business for people with money and time! These are my personal opinions and there are others who say you can do this with nothing down, but if you are not bringing anything to the table why do you expect to get anything in return.

  • It does not take a lot of money, but you should not be doing this with the only money you have and you should not be borrowing to use for a down payment.
  • If you can put 20% down you should be able to find a home where your your costs are covered and you do not have to reinvest additional funds as your costs over the first five years should be covered by rental incomes
  • Anyone with over $500,000 in assets should have 20%-50% of this invested in real estate
  • Take $100,000 and invest it in three homes worth $450,000 total. You will have $360,000 of loans on real estate worth $450,000. After ten years the initial $100,000 investment should be worth $300,000 based on growth in the homes values at 3%/year and the benefit of your tenants paying down your loans. You will now have $300,00 worth of loans on real estate worth over $600,00. This scenario turns $100,000 into $300,000 in ten years.
  • You should not expect to touch you investments for 10 years. If you need the money to live off now, then do not go to real estate. However, if you have just retired at 65 and know what you need for the next ten years and still have money left, then this is a good conservative plan for having extra money at age 75. Many people are living longer than expected, so this is a way to cover your bets so you can have money available for those unexpected extra years!

9) No - we are no longer in the "turn and burn" glory years where you buy a house in Phoenix or a condo in Miami with $5,000 down and sell it for a $50,000 profit the same day you close. If you want that type of fun, go buy gold futures on leverage. For investors with a 10-15 year view - you should be looking at residential real estate!

Thanks for taking the time to read my notes. I look forward to feedback or comments from all of our clients or those who may want to be clients.

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