Facts, Fiction, and the Fantasy of Real Estate

As the bond market softens, rates have been following suit placing the prepared investor in an advantageous position. There is no doubt this market is, well, new ground so to speak, but that is not to say there is not money to be made, and investors are beginning to lick their lips.

Don’t believe me… then you probably buy stock when you should be selling and vice versa…

Right now interest rates are as low at a low point in the year, housing prices have fallen, and lenders are rolling out programs that are more secure than their past counterparts providing the informed investor with the know-how to leverage themselves into real estate.

Let’s first look at why many people think now is not the time to invest in real estate, at which time we will shift gears and discuss how investors are turning profit despite these protests.

The most obvious rebuttal is home prices are falling. According to the media the housing market is upside down, construction is down, inventory is up, and there are not many signs that suggest recovery any time soon. If you have read any of my past posts particularly “The Biggest Housing Slump in 40 Years” then you know what I am talking about. I am not contradicting myself here. The market is in a interesting place, and many people are going to recognize a loss on their real estate investment; but that fact has nothing to do with what investors are going to accomplish in the future. Because of increased inventory, finding a justifiable (meaning profitable) opportunity is only a question of locating a regional market that is still moving in the right direction. What is the right direction? Population is rising, there is adequate job security, there is a sound rental population (as in a college town) etc… Once a region has been identified, then it is only a matter of finding a home that is priced right, and due to negative media, most homeowners are only thinking short term, and offloading property that has the potential to be very profitable 3, 5, or 10 years down the road.

Moreover, because many of these homeowners got into the market under 100% financing at the peak of the market with adjustible rates need to refinance. For many reasons this may not be possible (if you fit into this catagory I suggest you talk to a lender sooner rather than later so you can prepare yourself for when the time comes). Whether it is credit, value, etc… this will place the burden of sale on the homeowner placing most of the cards in the hand of the investor.

I know what you are thinking. Short sales and foreclosures. Point in fact, buying short sales and foreclosures is much more difficult than you think. It is not as easy as walking in and offering cash under value. This process is more difficult than many give credit to, and although there is money to be made, and many will, unless you have experience in this market I don’t recommend it… moving on… 

The next obvious rebuttal is financing. Rates have risen, various government bodies (namely the FBI) are cracking down on unethical lending practices, and the secondary market (wall street) is tightening, their investing practices leaving warehouse lines backed up. All true, but keep in mind, cracking down on unethical lending practices is a good thing for everyone, and anyone participating in such practice is not helping their client, has ignored their fiduciary responsibility and deserves what is coming to them. As for the secondary market, this is mostly affecting the subprime sector, and will not affect investors that are typically A-paper borrowers – enough said. As for financing. Rates are the lowest they have been year to date, and as we move into the winter months (months typically reserved for buyers), you can be sure that many investors will be taking advantage of the low rates offered. Furthermore, the programs available are more secure. This is due part in fact to the inverted market, meaning, many fixed programs are priced as competitively as adjustible rate mortgages. But that is not the only factor coming into play. Recently fixed option ARMs have sprung up. Banks are starting to offer 40 year fixed with interest only options (in the past it was one or the other) allowing borrowers to lower their payment even further; and there is talk that 50 year programs will have longer fixed terms (typically they are only fixed for 2 years at which time they will be adjust. All this means is there are more options for the saavy investor, allowing them to leverage a postion easier than ever before.

Of course all of this does not mean a lick of difference if the home does not appreciate, and that is the concern most people have in today’s market. For a true investor this is not the primary concern. The primary concern is turning over a positive cashflow on a monthly basis. They view the home as a long term investment, and I challenge you to find a state that has not watched home value appreciate over the last 20 years. 20 years too long, try five years. As long as their is a postiive monthly cashflow on the property and nothing is out of pocket, they understand that they will make money in the long run. Obviously this is a more conservative investment approach rather than the high risk property flipper.

In light of all these facts, it becomes clear how one can make money despite the flattening market. The points made above is the foundation to investing in real estate, and should not be the sole factor guiding someone into a new investment property. There are other considerations to take into account like pyramiding, 1031 exchanges, property management, etc..

If anyone would like more information, or specific advise, I encourage you to comment.

peter@approved-online.com  

This article was sent to me by a colleague in the industry, and is something I feel compelled to share with everyone curious about the potential collapse of the real estate market.

ECONOMY
End of the Boom
 

Dark economic clouds are gathering ahead. After six years of booming home prices, the great American housing bubble has finally popped, and the market is now on the verge of collapse. Tens of millions of families who bought homes at bubble-inflated prices “now face the prospect of seeing their life savings disappear.” This development will have wide-ranging effects on the American economy. “Over the last few years,” writes Princeton economist and New York Times columnist Paul Krugman, “most good U.S. economic news has been the result of soaring home prices.” With this engine of economic growth now broken down, America faces a potential future of “rapidly falling house prices, rising default and bankruptcy rates,” lost jobs, fewer consumption, even a possible recession. The dark clouds ahead may be a perfect storm hitting the U.S. economy. (Read “The End of the Great American Housing Boom,” a new report by American Progress Senior Economist Christian Weller.)

THE GREAT AMERICAN HOUSING BOOM: Over the past decade, home prices in the U.S. have climbed to never-before-seen heights. Traditionally, home prices tended to rise at the same pace as rental costs (since both reflect the price of a roof over one’s head). In 1975, the home price index was equal to 108 percent of the rent index. By 2000, the ratio of home prices to rents had jumped above 130 percent for the first time. By the beginning of 2006, the ratio of home prices to rents had grown to a whopping 178 percent. Similarly, home prices compared to other prices remained relatively stable until 1999, when the ratio of home prices to other prices surpassed all previous ratios and grew to 208 percent at the beginning of 2006. 

U.S. ECONOMY DEPENDENT ON THE BOOM: “The economic recovery since 2001 has been disappointing in many ways,” Krugman writes, “but it wouldn’t have happened at all” without the housing bubble. The boom spurred the economy directly by surging spending on home construction and renovation, which created jobs and poured cash into the economy. It fueled the economy indirectly by making it “easy for consumers to spend freely by borrowing against their rising home equity.” Homeowners have been borrowing “more than $700 billion a year from the equity in their houses,” and economists estimate that “annual consumption is approximately $250 billion (2 percent of GDP) higher than it would be in the absence of the housing bubble.” This spending spree, bolstered as it was by home equity borrowing, had consequences: For the first time since the Great Depression, savings rates have fallen into negative territory. The average American is spending more than he or she earns.

THE BUBBLE HAS POPPED: Nationwide, house prices are down between 4 percent and 5 percent from their levels at the same point in 2005, adjusted for inflation, and “price declines in some of the most over-valued areas, like Washington, DC, and parts of Florida and California, have been considerably sharper.” The glut of unsold homes “is the highest since 1993 and the year-over-year price decline is the biggest since 1990.” The health of the U.S. economy will be determined by the direction of home prices in the next year.

PREDATORY LENDERS AND THEIR ‘NEUTRON BOMB’: Traditionally, mortgages have been low risk lending. That changed during the recent housing bubble, which was in large part driven by high-risk loans given to “subprime” lenders (people who have “troubled credit records or otherwise have difficulty obtaining a mortgage,” disproportionately black and Hispanic Americans). For instance, option adjustable-rate mortgages (ARMs) “have soared in popularity” particularly among subprime borrowers, jumping from as little as 0.5 percent of all mortgages written in 2003 to at least 12.3 percent through early 2006, estimates show. (In some booming coastal housing markets, they represent up to 40 percent or more of loans.) Today, as these subprime loans come up for renewal and are reset to even higher interest rates, delinquencies and foreclosures are rising. “Most of the pain will be born by ordinary people,” according to BusinessWeek. “And it’s already happening. More than a fifth of option ARM loans in 2004 and 2005 are upside down — meaning borrowers’ homes are worth less than their debt. If home prices fall 10 percent, that number would double.” Roughly $2 trillion in option ARMs come due in the next two years, about one-third of the $6 trillion U.S. mortgage market. The option ARM is “like the neutron bomb,” says George McCarthy, a housing economist at New York’s Ford Foundation. “It’s going to kill all the people but leave the houses standing.” Progressives have long warned against marketing these loans to a vulnerable subprime market. “Subprime lenders are fueling their business by aggressively marketing these risky home loans without considering whether families can truly afford them,” according to the Center for Responsible Lending.

WHAT A CRASH MEANS FOR THE ECONOMY: The downturn following the collapse of the housing bubble is “likely to be far more severe than the downturn from the stock bubble,” says Dean Baker, co-director of the Center for Economic and Policy Research. Housing construction and sales directly account for more than 6 percent of GDP, and housing wealth “is far more evenly distributed than stock wealth.” Declines in residential construction and housing related sectors will have a severe impact on the economy, and will be amplified by a decline in consumer spending. “With home prices falling, millions of homeowners will soon lose the ability to borrow against their homes,” which have lost their value. That means less money spent on cars, travel, appliances, and other goods. “The economic picture over the next couple of years is likely to be one of rapidly falling house prices, rising default and bankruptcy rates, which will be associated with job loss and sharply higher unemployment.” The problems don’t end there. “Other critical sectors are not picking up the slack,” Christian Weller writes. With the government mired in deficits, consumers running out of steam, and trade deficits at new record highs, “business investment must carry the economy forward. This will have to lead to job creation domestically, predominantly in the manufacturing sector, to be successful. This has not happened. Manufacturing employment also fell by a whopping 39,000 jobs in October.” Paul Krugman says “the odds are very good — maybe 2 to 1,” that the U.S. will teeter towards a recession in 2007. Renowned Morgan Stanley economist Steven Roach says the economy is “dangerously close to what we call stall speed. The odds of the U.S. economy tipping into recession are about 40 to 45 per cent.” The Swiss Reinsurance Co., “one of the world’s foremost experts on risk,” puts the chance of recession at 35 percent. And Dean Baker predicts “The Housing Crash Recession of 2007.”
 

www.americanprogress.org