Sales Slow as Owners Dig In
With rents increasing at such a rapid clip, investors are storming back into the market, right? Well, not quite…
After getting off to a quick start in 2011, the market has stabilized. It appears the year will finish with a relatively low transaction total similar to that of last year (but not as bad as the two years prior).
My personal feeling is that quickly-rising gas prices have played an outsize role in the slowdown. Most media focus on how gas prices negatively influence home prices in the suburbs (as fewer families are willing to trade larger homes for higher gas bills). But I also see gas prices impacting investor behavior. Investors also have to fill up their own gas tanks, and there’s a subconscious fear that I get at the pump that maybe the economic recovery is more fragile than I’d prefer.
There are other more easily provable factors, of course:
1.Sellers are not motivated. With little vacancy and rents rising, the number one incentive owners usually have to sell (cash flow problems) simply is less of a problem. Weak sellers have already exited the market either by choice (selling) or by force (foreclosure, short sale). Most of the market today is represented by hardier souls that have good cash flow and operations due to substantial experience managing property, or long-time owners that have so much equity, operational cash flow isn’t of paramount importance (how nice!) I believe most owners are satisfied with their investments and have no current designs on selling. The Wall Street Journal recently wrote a great article on this.
2.Investors have a long memory. The scars of the bubble popping run deep, and amateur real estate investing has far from regained its faddish status. Thus, there remains less of a demand for “mom and pop” investing – probably the lowest demand in 15 years. Of course, history will probably do a double take ten years from now when the masses wade back in, and realize how inexpensively some portfolios were assembled during the downturn. Or will it be twenty years? Or five?
3.Financing is still a bear. 20% down-payments along with excellent credit are required for most duplex purchases, and 25% down required for fourplexes. The more money you have to put down on the investment (ie the less leverage), the lower the price has to be in order for the investment to provide the same return. Given #1 above, sellers aren’t motivated, so prices aren’t falling. Long story short – real estate brokers need to either sell that Mercedes, or consider a bartending gig to supplement income. Feast or famine, indeed.
A trend that may surprise us all… It appears that the commodity market bubble may be coming to an end. A lot of money that once went into real estate has gone into gold and other commodities. Will those funds flow back into real estate?
By the Numbers
Unfortunately, the previous five quarters sales numbers graph is not particularly helpful. Why? Because the Federal Homebuyer tax credit of $8,000 was in place through April of last year, and it dramatically skewed the numbers forward. Buyers in the market chose to buy then, rather than wait. It was a nice bump for Realtors and sellers early last year, but has resulted in quite the hangover since. Here are a few other considerations from this data worth mentioning:
· You can see the bump from last minute tax credit buyers in the duplex sale total from Q2 last year (fourplexes are rarely purchased by owner-occupants, and therefore saw no gain as a result of the tax credit).
· The significant drop-off in median duplex sale prices that began in Q3 and continues through today is related to the fact that higher-paying owner-occupant buyers got their fill of purchases during the Q2-expiring tax credit. Investors tend to hold out for better bargains, and thus the investor-driven duplex sale market shows lower final sold prices.
· The increased quantity of fourplex sales beginning in Q3 last year was due to a large increase in post-foreclosure REO sales. Fourplexes had been the last shoes to drop in terms of market-clearing foreclosures. As of this writing, there are few if any fourplex foreclosures remaining. Given the relatively low supply of fourplexes (compared to duplexes), it was enjoyable to witness what was fairly obviously the bottom of their market cycle, and equally exciting to watch their values steadily increase back to reasonable levels today.
Neighborhood Metrics – Real Estate is “Hyper-Local”
Ever wondered what would have happened with a typical investment, made in $150,000? See below for exactly what would have happened, broken down by neighborhood and property type.
As you can see from the graph, real estate is not only a local business, but a “hyper-local” business, often valued neighborhood by neighborhood. In this particularly volatile five year period from 2005 – 2010, fourplexes citywide lost a combined 24% of their value, while duplexes in 78704 gained 22% – an astounding 46% difference. An investor who purchased a $150,000 fourplex in 2005 has an average value of $114,000 for that fourplex today. That same investor who instead purchased a $150,000 duplex in 78704 is now worth $169,000. Wow.
However, just like in the stock market – past performance is NO INDICATION of future performance. In fact, heavily hit sectors like fourplexes have a lot of room for value growth, which is why I believe fourplexes will see a moderate rise in value in the near future.
In future updates, I’ll go more into detail regarding the economic factors that influenced these changes. Some are obvious (Round Rock is a suburb with values crippled by $4 gasoline, while South Austin and the 78704 areas benefitted hugely from a return to the city core and equalizing previously undervalued real estate). Other neighborhood value changes are head-scratchers that I did not anticipate.
A Look Ahead
In my first attempt to quantify the factors that influence cash flow, I present to you the “Spring 2011 Cash Flow Index”. I’ve attempted to quantify the four most significant factors in the cash flow consideration of an investment, and graph their presence over the past five years.
The Real Estate Center at the Texas A&M University writes crazy-good Texas-related real estate articles that combine rigorous academic research with interesting narrative and detail. I, like most Texas real estate practitioners, look forward to every issue. Two particularly good articles this quarter:
Housing’s New Reality – Excellent academic piece on the potentially long slog ahead of residential real estate.
Extend and Pretend – Game-changing explanation of what’s been going on in with Commercial real estate over the past five years; particularly banks’ efforts to “kick the can” down the road, and the mixed success they’re experienced with this strategy.
Money Magazine scared my silly when I read this article back in 2007, that suggested that like stocks are valued based upon their PE (price to earnings) ratios, real estate prices were based on their price to rent values. In other words, residential real estate was worth roughly what you could get in rent for the same property.
This was anathema at the time primarily because values had gone nowhere but straight up for five years in a row. More frightening though if true, US real estate values were bound for anywhere from a 20% to 60% fall, depending on what city you were talking about. Money Magazine nailed it, and credit where credit is due. On a similar note, Inman News recently informed us that in 2011 it is cheaper to BUY than RENT in 78% of Major US Cities(!) All I can say as an investor and a broker.. what a long strange trip it’s been..
I don’t spend a lot of time on blogs, because frankly, most of them stink. But I do know there are a handful of good Austin real estate blogs. Two of them are Steve and Sylvia Crossland’s blog and the Austin Contrarian. They both write clear-eyed, intelligently, and with a unique insight into Austin-specific real estate and cultural issues. I’m looking for additional blog recommendations, so please send any good ones my way for future publication.
Each quarter, we’ll highlight a handful of our current listings that best represent the goals of the majority of our investors (usually the best combination of price, rents, location, and condition). This is just a partial sampling of our overall listing inventory. To see the entire list, please click here.
$157,900, Technology Corridor Duplex, 3 bedroom, 2 bathroom on each side. $1685/mo Rent.
$172,900, South Austin duplex, $1625/mo rent.
By the way, did you know El Paso, Texas is closer to San Diego, CA than it is to Houston? Really!