- Here’s An Opinion On:
- Scaffold Newcastle
By Ron Cuttler
What Causes A Perfect Storm?
Well thats the million dollar question, isnt it?
What I deem a perfect storm is a set of circumstances that occur once, maybe twice in a lifetime that offers unparalleled opportunity to purchase undervalued real estate at unnaturally depressed prices. There was one similar opportunity in the late 1980s, early 1990s when the RTC (Resolution Trust Corporation a government-run entity used to liquidate primarily foreclosed commercial assets) had one of the biggest fire-sales of commercial real estate in US history. This was a time that fortunes were made in the acquisition of overly distressed real estate assets.
So whats causing the Perfect Storm Today?
(1)Massive residential property speculation in 2003-2006
(2)Too much credit available to purchase and finance real estate which was overused by lenders and uncreditworthy borrowers at that time
(3)The current overall US market decline/recession that is spreading into a global crisis
(4)Current lack of funds for qualified borrowers
(5)Current oversupply of properties for sale
As you can see, there are 2 stages that follow one after another that lead to the creation of a Perfect Storm and opportunity to purchase real estate at incredible values The Housing Speculation or Run-Up phase and the Market Collapse. We will examine each of these phases so you are more informed on what has led us to this perfect point in time, right now.
But first, we need to examine the most important issue a real estate investor must evaluate when choosing where and when to purchase a real estate investment LOCATION.
Underlying Market Strength
Im sure youve heard the age-old adage, location, location, location. I have a different spin on this saying. Mine goes more like, location, timing, cash-flow. Nevertheless, location is still number one on the list. If the underlying market is not strong with potential for rental and value increases in the future, then whats the point of investing in the first place?
First, lets look at Metropolitan Phoenix as a whole for location. Why the heck would you want to buy property in the middle of the desert?
Even though this market is severely depressed right now, Phoenix has shown remarkable resiliency and long term value appreciation for a number of reasons:
(1)Climate People want to live here because of the warm, sunny weather. It is why snow-birds come in flocks for the winter and to retire. We all know that the baby boomers are reaching retirement age.
(2)Affordability Phoenix is one of the most affordable places to live in the US. This will continue to attract business, labor and retirees to the area for the long term.
(3)Standard of Living very high. Ease of commuting, and a fresh young, vibrant city leads people to want to live here.
After deciding that Phoenix is the right spot to invest in real estate, your next task it to pick a sub-market within the metro region that makes the most investment sense. Some of the most important factors include:
(1)Area of greatest price declines
(2)Proximity to employment
(3)Proximity to amenities
(4)Quality of area
(5)Strength of rental market/values
A qualified real estate professional can assist you in selecting sub-markets to invest in that match these criteria.
The Residential Housing Value Run-up
Phoenix real estate has always appreciated at a steady pace with the exception of a few massive run-ups in value followed by sharp declines. So what has caused the latest mass-speculation and run-up in values between 2003 and 2006?
Well there were a few culprits that acted together to create this latest debacle.
(1)Underlying Market Strength As stated above, Metro Phoenix has inherent underlying market strength. That is what got the ball rolling and led to the mass speculation for 3+ years.
(2)Cheap Credit Interest rates came down to unheard of levels making it easier to buy more assets with less money.
(3)Overabundance of Credit It started in the late 1990s when Bill Clinton passed legislation freeing up credit to allow more people to buy homes the sub-prime mortgage market was created. People that really shouldnt have been buying homes in the first place were not only buying homes, but purchasing larger properties than they could afford. As credit loosened and values started to increase, a run on equity lines of credit and refinancing freed up the equity in peoples homes and allowed them to spend invisible equity in the consumer markets on durable goods and services. This created the economic boom that we all experienced in the early to mid-2000s. The result, even homeowners that bought early in the boom and saw their property values increase 50-100% over a 5-6 year period had little to no equity in their homes by the end of the boom as they leached it all out of their primary asset.
(4)Investor Stupidity As values went up and loans became easier to attain, investors started buying property with no money down and buying as many properties as they could get loans on (see next point below). It became an exercise in buy high and hope to sell higher.
It got the point that, in 2005, there were actually busloads of investors that were driving around in town stopping in new housing subdivisions and lining up to buy new homes. Why did they concentrate on new homes? Because they could purchase a home to be built, put little money down to secure it and watch the value of their property increase for 6-12 months without even owning it yet!
Builders were turning away buyers, holding lotteries and using other methods to hold back the swarm because they couldnt build homes fast enough, even as they continued to raise prices on a monthly sometimes even weekly basis! As a result, new homes were overbuilt in 2004, 2005 and 2006 by a wide margin by fake demand since many of the buyers were investors with no intention of ever living in the home!
(5)Lender & Investor Fraud As the run-up in values was occurring, lenders and investors started to get greedy. Lenders began offering programs that made little or no sense for some homebuyers to get them into a home. Many times, a home larger than they knew their client could afford with programs that their clients did not fully understand.
Credit was so loose and readily available during this time that many investors and homebuyers were fraudulently misreporting their income too high on stated income, no-doc loans and lenders were turning the other cheek and underwriting the loans with no clear proof of the borrowers ability to repay.
The Market Collapse
So why did the proverbial %#$ hit the fan? Greed and loose credit were the culprits and it culminated when investors and homebuyers ran out of money to purchase and overall economy began to slow down as people started running out of capital and credit.
From there, the first phase of the market collapse occurred. Overpriced properties for sale with no buyers. Property owners unrealistically priced their homes too high to sell and buyers began to pull off to the sidelines as they were unwilling to pay the exorbitant prices for homes. Listings began to pile up and very few sales were occurring. Some owners started to realize what was happening and dropped the price of their home to help it sell. As the market leveled off and began to slowly correct, phase two began..
Investors that were counting on property appreciation soon realized that the end had occurred. They began putting property up for sale en mass further straining the supply side of the market. Because all these investors were buying property based solely on appreciation and NOT cash flow, they soon realized that they would be unable to hang onto their property if they didnt sell them. Some tried to rent, but because they had paid so much for the homes, the properties were unable to cover the expenses. Some investors and homeowners hung on for longer than others, but almost all of them eventually succumbed to the realities of declining property values.
This was further compounded by the variety of flexible mortgages that were available to homebuyers and investors including shorter term, loans at lower interest rates. Investors planned on short hold times so naturally obtained lower interest loans with shorter terms as they planned to sell within 1-2 years. As the market declined and those property owners could not sell, these loans became due and because property values were declining, they could not get new loans to cover the value of the old loans. Many more property owners walked away for this reason and it continues today.
The market was soon flooded with distressed properties of all kinds. This forced home values down further and faster as distressed properties are typically aggressively priced at least 5-10% less than current market value. This cycle has continued to force values down for months to the point where most submarkets in Metro Phoenix have fallen 25-50% in the past 2 years. Some properties have fallen over 60% from their highs 2 years ago.
When Will The Housing Market Hit Bottom?
Good question. Heres the answer..
I have no clue. In fact, no-one does. But thats not the most important thing. There is no way to know for certain when the absolute bottom is reached. As you can do is invest wisely NEAR the bottom. Purchase properties that give off positive cash flow (will be explained later), and wait to ride the wave back up.
Why Now?
There are several critical elements in evaluating the state of the residential real estate market. Many of these criteria are now pointing to real estate values bottoming out. Here are some of the statistics I have been watching carefully that lead me to believe we are finding resistance that is creating a market bottom.
(1)Housing affordability has shot through the roof see statistical data below
(2)Residential Resales are on the rise see statistical data below
(3)Homebuilding is at a 25 year low
(4)Applications for new mortgages are on the rise
Affordable Housing Is Back!
One of the best indicators on how attractive a specific real estate market is for homeownership is the affordability index. This is a measure of how affordable homes in a particular area are relative to wages and incomes. In the speculation frenzy in the mid-2000s, that affordability plummeted to numbers never seen before. As prices have fallen, the affordability coming back to the point where now, we are above our historical average.
Residential Resales are Picking up Steam!
Sales activity is on the rise, although over 40% of the sales are currently lender-owned properties. This shows that we are starting to hit a resistance at the bottom as people are starting to grab the deals at the bottom of the market. If this trend continues, it could signal the slow-down in price declines and near-term stabilization of our home values.
So why not wait until things start turning around? Well, you certainly can, but there are 2 reasons why now is the ideal time to get involved.
(1)Abundance of properties (supply) with so many distressed properties out there of all kinds, you now have your pick of what to purchase and can be more aggressive on price. As the market shifts more towards demand with more buyers chasing good deals, the number of opportunities will certainly diminish, it will be more difficult to find really good ones and there will be more competition to buy them.
(2)Positive Cash flow prices are so low right now, that it is relatively easy to find residential properties that will produce a positive cash flow.
Why Residential Property?
Normally, I dont recommend purchasing individual single family homes because they are harder to manage effectively and usually dont cash flow. The major benefits that they have over other forms of real estate you could invest in are:
(1)Liquidity Simply stated, there are more buyers for this form of real estate than any other. It is therefore easier to sell when needed for the greatest value.
(2)Appreciation Potential for the smaller investor, it gives you the greatest potential for appreciation if purchased at the right time because there is such a broad market of buyers for housing
(3)Lower mortgage rates than commercial property investments, typically
(4)Values may have fallen 30-60%, but rents have not really fallen much at all.
For more information on how to evaluate properties to purchase for investment, read an additional article, “Buying residential property as an investment”.
About the Author: Ron Cuttler is a Buyer’s Agent in Metro Phoenix with Prudential Arizona Properties and specializes in assisting Canadians purchase real estate in Arizona.
CanadiansBuyArizona.com
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