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 IN THE UPDATE: Reading the Tea Leaves.
I’ve wondered lately whether one can best determine the direction of the markets by measuring the tone of major media, rather than reading the stories themselves. In my March 2009 Newsletter, I opined that the stock market had probably hit bottom because rampant paranoia had set in with the media. Front page Wall Street Journal headlines openly wondered if the Dow was headed for 5,000 (it quickly bounced back to 8,000 and then saw one of the best bull runs in history). Recent panicky front page stories (from New York Times and Wall Street Journal) have given me a weird sense of déjà vu.
In “In Striking Shift, Small Investors Flee Stock Market” NYT, 8/21/10, we are shown a scary looking graph illustrating how funds are flowing out of mutual funds at a faster rate than even during the depth of the recession in 2008. We are warned that this time it looks like it could be a permanent trend (cue Jaws music).
In “Plunge in Home Sales Stokes Economy Fears” WSJ, 8/25/10, we are alarmed to read that “Sales of previously owned homes fell 27.2% from June…the lowest level since the industry group started its tally in 1999. Fears of a death spiral abound.” Sounds about as negative as Fox News during an Obama speech. (Oh wait, Rupert Murdoch… nevermind).
My gut feeling is that the preponderance of negative and paranoid news signals that we have now reached the true bottom of the residential real estate market. Here are five reasons why:
1. Even though sales volume dipped this summer, median home prices have actually increased .7% over the same month last year. Whaaaa? This data clearly suggests that the homebuyer tax credit that expired in April simply brought forward all of summer’s buyers into the first four months of 2010. Of course anyone who intended to buy a house did so before the free $8,000 from Uncle Sam expired. Now that the dust has settled and the tax credit is but a distant memory, we’re starting to see activity pick up again. June and July were dead, but the past two weeks have rivaled the mad rush for good deals that we saw in April. Newspaper articles in October and November will likely say that the dip from this year has smoothed out, and the market has again stabilized, this time without any government stimulus.
2. The weak players are already history. In Texas, 2008 and 2009 saw foreclosures galore as the weakest investors lost their ability to stay in the game. In 2009 and 2010, I’ve seen a lot of hardier players (who may actually have been able to withstand the storm if they wanted to) instead throw in the towel via strategic default or short sale. I am confident that by the beginning of 2011, the vast majority of duplex, fourplex, and single family investment properties will be owned either by owner-occupants, or more sophisticated (mostly local) players with rock solid management operations, reasonably priced financing, and strong resulting positive cash flow.
3. Interest rates remain at all time lows. This in and of itself doesn’t mean too much, because good rates that no one qualifies for might as well serve to finance unicorn stables or tooth fairy tiaras. But, what if lenders in search of new business actually make it easier to obtain credit? All of a sudden, millions more Americans have access to capital at good rates, and deal volume starts perking up. Most experts believe this easing of credit will continue.
4. Banks are working through their foreclosed inventory. I’ve recently witnessed how foreclosures in a neighborhood negatively impact the values of the property around it. This is definitely a reality, and the scars of a foreclosure can keep values down for 12-18 months. But once the foreclosure in that area is history, the market tends to forgive and forget, and values return to pre-recession levels. I’ve seen a proportionally large number of duplex foreclosures this year (and some savvy investors are getting smoking deals at the auction and after) – but the rate of foreclosures is now declining. Banks are the most motivated sellers in the market these days, and are discounting REO properties often significantly. Once credit becomes more available and the market realizes that we’ve hit bottom, expect a sharp rebound and the end of “smoking deals”. This will happen sometime in 2011.
5. The “Smart Money” is beginning to stir. Buried on page C6 of the same Wall Street Journal edition about the end of the world is the following article, in small type: “Home Builders Get a Bump as Investors Sense a Bottom“. The article states, “Meritage Homes, Ryland Group, and Lennar rose an average of 2.5% on news of existing home sales’ recent fall to 15 year lows…Investors in the sector are likely expressing optimism the housing market will rebound in August.” As the Almighty Guru Buffett says, “buy when there is blood in the streets”.
I found this article in the Wall Street Journal, a few days ago, to be similarly instructive about where the bargain basement real estate deals are headed. “Bargains on Failed US Banks Are Over” explains that the best of the deals are gone. I sense that will be the case in 6-12 months in residential real estate.
The Name of the Game.
I believe it will be more apparent than ever in coming years that the key to successful real estate investment is reigning in expenses. It will be several years before we can build equity appreciation into our investment models, and that means that the name of the game until then is cash flow, cash flow, and cash flow.
1. Good property management is more important than ever. Good efficient operations are vital to cash flow survival. I believe a good property manager can influence cash flow by as much as 30% over a “bad” property manager. Good property management utilizes best practices that keeps tenants happy, keeps units leased, and keeps maintenance and make ready expenses to a minimum. I’m encouraging new investors to manage their first buildings by themselves to learn the business and eliminate property management fees. This is especially recommended for local investors, who can (and should) keep a regular eye on their investments. Investors who have enough units should hire a dedicated property manager as soon as it is financially feasible to do so. Always remember that no one will watch the shop as well as you.
2. Buy low. I cannot believe how inexpensive some investment properties are these days. I can buy duplexes in decent working class areas for $130k or less (and in solid middle class areas for $170k) that will immediately cash flow $300-$400+ per month. When I am bidding on REO (foreclosure) properties, I sometimes feel like the only guy at the dance, and am stunned at the prices that banks will accept. If I weren’t also a real estate broker, I would never give away the golden goose and tell you that I am basically “stealing” properties from banks right now, with very little competition. If you’re one of the few that will profit from this advice, please use me to sell your property when the time comes – that’s thank you enough.
3. Seek Better Financing. Yes, it’s difficult to finance deals these days unless you have sterling credit, large reserves, a six figure income, and great genes. But it’s getting easier. Always be looking for better terms. They’re out there if you know what you’re doing, and can offer a lender a value proposition that works for all parties.
4. Location, Location, Mmhmm, Yep… A cheap price doesn’t excuse a shitty neighborhood (unless of course it’s REALLY cheap). Focus on areas near the periphery of the action. Working class areas are fine if you’ve got the chops to manage a rougher tenant base, and will definitely cash flow the best. Middle class areas if you’re a working professional that makes your money in other ways – you don’t need the heartache and risk of the lower income areas. Out of state investors – stick with middle class areas. You’ll certainly regret it if you do not.
Note to Owners of Duplex, Fourplex, and Single Family Rental Property.
I have in 2010 repositioned Castle Hill Investments as a seller-only representation firm. It became apparent that we could create the most value by focusing resources on marketing investment property (simultaneously to many people), rather than the far more time consuming task of educating one individual investor at a time. As we’ve narrowed our focus to sellers, I’ve been able to offer superior service and quicker sales, and we’re on track to sell 150 buildings this year worth over $25 million. Our listings are selling faster (45 days vs. 70+ days for the competition) and for more money (98% of list rather than 96%). Our sales represent over 25% of the residential rental property market – no other agent comes close.
Note to Would-be investors
Despite our current focus on rental property owners, buyers seeking representation are still encouraged to reach out via phone, email, or the Contact Us form. The agents that I share these leads with are amongst the most experienced investment agents in the business, and I work with them as necessary to assist investors in identifying prospective property.
Seeking Lender for $3M 2-4 Unit Portfolio Re-Fi
Client who owns 70+ rental units seeking bank, credit union, or insurance/pension fund financing for $3,000,000 re-fi at 6.5% or below. Debt service coverage at 1.5 or better, LTV around 60%. Principals/banks ONLY please email robert@castlehillinvestments.com – no phone calls, please.
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