Real Estate Investors - Buy, Sell, or Hold?

Posted in: Real Estate Investment in reinalliance's Blog

Blame Wall Street, the Fed, the greed of investors, the crash in the Nasdaq... blame whatever you want for the housing market correction.

America's homeowners - buyers and sellers - are feeling hopelessly confused. After a dizzying up market of the past few years, sellers are desperate to sell, prices are dropping and buyers have disappeared.

Homeowners don't know what to think about real estate's future anymore. The dizzying rise sure didn't make sense. And the prolonged and painful slump doesn't seem any more logical.

How can investors determine whether the time is right to buy, sell or hold?

Take a deep breath. We can help you through the current standstill between buyers and sellers and come up with a sound strategy to benefit from the current environment.

Housing Prices Tend to Be Mean Reverting Around Rents

Over long periods housing, stocks, bonds, and other investment classes all follow certain historical benchmarks. In periods of over-speculation and busts, the pendulum swings to extremes. But no matter how far prices get unhinged in either direction prices will eventually return to equilibrium.

Over time, prices fall or rise to restore to their normal, long-term relationship with rents. Rents exercise an inevitable gravitational pull on prices. The ratio of prices to rents "behaves much like price/earnings ratios for stocks," says Yale economist Robert Shiller. "Like P/Es, price-to-rent ratios are mean-reverting." In other words, while prices soar from time to time, sending the ratio to exceptional heights, sooner or later the relationship is bound to return to its historical average. - BusinessWeek

All through the 1990s the multiple of prices to rents nationwide remained between 14 and 15. From 2000 to 2007 the nationwide P/R jumped from 15 to 24, an increase of 60%. The figure went from 12 to 21 in Tampa, 11 to 26 in Washington, D.C., and 28 to 51 in California's East Bay, an area that includes Oakland and the area east of the city.

This was a period with higher interest rates than the current environment, so add an extra 2 points for the lower interest rates and we arrive at a multiplier of 16. Offsetting the lower interest rates are higher taxes, we'd subtract a point for higher taxes to arrive at a final multiplier of 16.

Assuming housing markets were fairly priced, you can get a fairly decent idea of the fair value for your proposed or current investment property by using this simple housing to rents multiplier of 16.

Assume your condo rents for $1500 a month, or $18,000 a year. Using the rule of thumb above, and using a 16 multiplier, we arrive at $18,000 * 16 = $288,000.

While not an exact measure, this does provide you with a starting point valuation that you can adjust according to your local market prospects.

The Future Value Of Property

The most reliable of all benchmarks for the current value of an investment property is rents relative to prices, or even better, the return on invested capital.

Future value depends on rent growth, interest rates, employment and population growth. That being the case, we'd expect high employment and population growth markets to outperform markets with declining wages and declining population.

The SubPrime Impact

But that's not the whole story. The adjustment doesn't come exclusively from a fall in prices - rising rents also help close the gap. Because it is well, almost impossible for a young family or a first time homebuyer to qualify for a mortgage, look for the ranks of renters to increase rapidly.

In addition, many investors walking away from investment property will be unable to obtain loans, expect the ranks of renters to increase in this group as well.

Where We Are Today

Florida and Las Vegas developers are routinely offering discounts ranging from 15 to 30%. We're closer to the bottom than we are to the top. Prices on MLS listings that are selling are down roughly 20 to 25%. Again, we'd postulate that we're closer to the bottom. Other boom towns are similarly making their way through excess inventory.

Psychology continues to be a drag on the market as buyers continue to stay on the sidelines. However savvy investors are stepping in when they see opportunities where the numbers make sense.

The overbuilt zone - California, Florida, Arizona, Nevada, Carolinas - is characterized by rapid population growth. It's in these boom towns that the correction will be both fastest and deepest, as we're seeing.

What Should Buyers Do?

This is one of the best buying markets of the past 15 years. Rates are low and heading lower. Inventories are stabilizing. Rents are poised to grow faster than normal over the next few years. If you can find a property that is breakeven cash flow or positive cash flow, for low money down, you will position yourself to benefit handsomely from the coming upturn. This correction has lasted 2.5 years. We've had the sub prime meltdown, the collapse of the jumbo market, the collapse of the real estate market, the war, the weakening dollar, yet prices have remained relatively solid. The worst is behind us and it's a great time to be considering an investment.

Sellers - Will You Be The Biggest Loser?

It's a terrible time to sell. In today's market there are two kinds of sellers.

A. The sellers that need to sell. If you're over leveraged, can't afford the payments, there's really not much to talk about. Creative financing is out. If you can find a buyer willing to work with you, that's your best bet.

B. Sellers that are emotionally exhausted landlords. We're talking about the flippers, the ones that were in it for a quick buck and now that the going is tough, are tired of dealing with the hassles of being a landlord. I believe this group will look back in a couple years, maybe three years, and regret selling today. My suspicion is these are the same people that were selling at the bottom of the Nasdaq only to see the market start a new 5 year and counting bull cycle in 2003.

Investing Isn't Easy, If It Was, We'd All Be Millionaires

Successful investing more than anything else is a battle with your emotions, with yourself. The ability to sell at the top of the market when greed tells you that prices will continue to rise. The ability to buy or hold at the bottom of the market, however painful it may be, and wait it out for the next up cycle.

That's how money is made. Buy low, Sell High. Not Buy High Sell Lower. Investing requires fortitude, and like all good things, financial good fortune requires effort. Sadly most investors today don't want to deal with the pain.

If you've read this far, you're obviously either a seller or a buyer. Call Us or Visit Us on the Web. We'd love to hear from you.

If you're looking for real estate investment opportunities we'd love to hear from you. We are a national real estate investment company with investment opportunities in the Go Zone, Arizona, Las Vegas, Carolina, and Florida

We can be reached via phone at 1-800-859-9815 or email at sales@reinalliance.com