Risk or Recovery? Article from September 2011 Canadian Real Estate Magazine
by Gord Lemon
Sorting through the Headlines as an Investor
Whether you are in a good economy or a bad one, every real estate investor needs to pay attention for the “signs.” Should you buy now or wait? Should you sell now or wait? If you decide to wait, Woody waiting for to know when it’s time to make a move? Are you watching for specific data or just a “gut feeling”?
Many people jump in or out of a real estate investment often with a serious lack of due diligence. Many of these decisions are based on emotion, the media or the opinion of a friend or relative. How do we know who or what to believe when facing major decisions that not only involve money but can also affect our family, our time and even our livelihoods?
Who Should You Listen To?
Let’s begin by analyzing some common sources most people use as their due diligence to understand the difference between sentiments versus true verifiable statistics. Knowing the source is so important as many are biased realtors positive sentiment among buyers, to want to sell courses, sailors to sell properties in the media needs to sell ads.
We have become a media based culture. Television, magazines, the internet and the newspaper have become our sources of information to which many people base their opinions. It is of vital importance to take a step back and consider these sources and how manipulative they can be and how disconnected the information can end up as it can be “spun” in a certain way to sell more of their product.
When working at NASA, building the international space station, Daryl Hemingway experienced firsthand the distance between the news media and reality. “Turning on the evening news after a day of work at the Johnson Space Center, I would hear reporter talking about shuttle launch or other event. I couldn’t believe how often and how much the media got it wrong. Often the truth bore no resemblance to the story. How could this be?
“Maybe the story was rushed to air, maybe the reporter was not very knowledgeable about the subject matter, or maybe the story was given some ‘spin’. And the lesson I took to real estate, was that the more people there were between me and the raw data, the less reliable the information.”
In real estate, the situation is compounded by the simple contradiction that the news speaks to a national audience, while housing really a local market. You know this yourself if you have ever read city by city statistics in this magazine or elsewhere. While prices are climbing steadily in Vancouver, the Maritimes are suffering an economic and housing setback.
While Las Vegas prices are falling, Boston real estate is climbing again. Real estate is not a national market, so we look beyond national headlines started digging deeper to find information relative to our investments.
As investors, we like to use as many sources as possible as the truth lies somewhere in the middle, but we give higher weight to those that are closest to the raw data. For example, in Arizona, the State University’s W.P. Carey Business School has a real estate research department that collects its own data online for free. (http://wpcarey.asu.edu/realestate/). Such research centers are a good, reliable place to start when analyzing a new city and a great way to double check the validity of others’ information and opinions.
Over the years, we’ve learned to draw our own conclusions based on common sense. Real estate is not rocket science and moves in predictable up and down cycles, driven by everyday events like job creation, population growth, cost of living, climate and infrastructure. There is a wealth of free information that tells the story to anyone patient enough to listen.
Signs of Recovery
What do the signs of market recovery look like? Prices are a result of supply and demand. Decreasing supply is shown by steadily decreasing foreclosure filings and lower numbers of homes for sale. Demand is created by job growth leading to population growth and a drop in inventory. As vacancies drop and rents rise, time to sell decreases and prices rise, then construction begins again in earnest. Leading indicators of recovery include the number of building permits issued. You will notice many of these signs simply by driving around your city and observing advertisements for new homes and then seeing construction progress.
However, we must remember that real estate is local. Whereas job growth and expansion is currently happening in Edmonton as a result of an oil and gas resurgence, it is tough to find a great deal in Calgary as the market remains slower. In Vancouver prices continue to climb thanks to foreign speculators, but there are areas of the lower mainland that have price reductions.
In Toronto, prices are slow but steady as opposed to the faster paced growth of Kitchener Waterloo where job growth has been substantial. We are comparing examples within the same province just a few hours away from each other, so imagine how much market variations happen across the U.S.
When we examine the burning question south of the border, “when will US housing recover?” We run into the same paradox as the Canadian housing bubble question. There is no one US housing market any more than there is one Canadian housing market. Some cities in the U.S. never encountered a real estate boom or bust this time around. Dallas and Houston Texas for example, have seen housing prices hold steady throughout the “U.S. housing crisis”. So, it’s a good, stable market for cash flow investors but based on historically low price appreciation, it is unlikely to provide big capital gains during the recovery.
Michigan and Ohio tell a very different story when you analyze the data. While prices are very low, the areas need job growth to bring population expansion and higher rents for landlords. Rustbelt states hit hard by the economic downturn may take many years to recover, if they ever do. Only by looking beyond price and the underlying fundamentals will you be able to reliably predict the future of your investments.
Florida, Nevada and Arizona however, had big booms and big busts and stand to see substantial appreciation during recovery even if prices return to the cost of construction to allow new home builders to make a profit. But local laws and the job market will have an impact on how fast each recovers.
Florida for example, is a recourse state, meaning that the bank can go after homeowners other assets to pay off the mortgage. This means that those owing more than their homes value are hesitating to walk away and risk their other assets, so the foreclosure recovery will be slower. The data on shadow inventory from Core Logic and the National Association of Realtors reflects this with potential foreclosure property numbers remaining high in Florida.
In a non-recourse state like Nevada, only the home can be claimed by the bank in a foreclosure, but it is struggling with the highest unemployment rate in the country and a net migration out of cities like Las Vegas that will slow recovery there.
One of the main reasons we are focused on Phoenix AZ in 2011 is that it is leading the recovery from the Sunbelt foreclosure crisis. With laws that allow homeowners to walk away from their underwater homes without impact on their other assets and a fast foreclosure legal process compared to many other states, the city is past the peak of foreclosures. We see this in the data showing foreclosure filings continuing to fall, inventory levels down 50% from 2006, vacancies dropping and rents starting to rise. As the city continues to grow at over 100,000 people per year increase the population and a housing shortage is beginning, since builders are not building new homes to meet demand and inadequate supply is the perfect storm. This is a clear sign of recovery.
Timing the market like stock day traders is not the point of recovery analysis. Wealth building is not about getting in and out and making a fast buck. Luckily for investors of real estate, markets do move in predictable cycles, and knowing where local markets are in their own cycles is very valuable knowledge. In real estate, or than any other investment class, a rising tide raises all boats and you can learn to profit from trends in your target areas
We have learned not to be married to a strategy or try to force a deal when the timing is not favourable. Let the market tell you what’s happening. If it is hard to find positive cash flow, as is the case in many Canadian cities today, change your strategy. Within that market, you have the option to inflate your rents above average to create positive cashflow by using lease options and selling the property over time in a high priced market.
You can also look outside your market for more favourable, perhaps less expensive markets where it is easier to find positive cash flow. Investing successfully is hard enough as it is, without trying to swim against the tide in an overpriced market. Why not invest where as many factors are in your favour as possible: jobs, population growth, rent to price ratio, laws for owners, taxes etc.
We use a 1% rule to find good markets where the monthly rent divided by the purchase price is at least 1% to ensure positive cash flow. For example, if we can’t rent a $200,000 home for at least $2000 per month in a city, we look for another city where we can. If you have to justify an investment to yourself with a story, because it is too far off from fundamentals of real estate, that should be a warning sign to look for another deal or a more favourable market.
In our experience of the past two years, we have found that a growing market like Phoenix, where newer $80,000 houses built in the last 5 years rent for $900 or more and generate high cashflow is favourable to both the novice and veteran investor. With our primary objective of the 1% rule in cash flow met, the bonus in these properties is the capital gains potential during the recovery, as new construction of an identical home begins around $150,000. Buying when real estate prices are just beyond the low point and starting recovery is the most profitable stage of the cycle. While it may seem riskier to invest in a recovering market, rather than wait for the headlines to declare the next boom, profits lie being ahead of the crowds. I carefully selecting markets to invest in before they hit the growth phase again, you can benefit from low purchase price, positive cash flow and a nice capital gain through the recovery.
Reliable data tells you what is happening in the market, and allows you to adjust your strategy accordingly. We learned to separate national from local news, factual data from opinion and speculation and to always examine the bias of our sources. By reading between the lines and using common sense, investors can sort through the headlines and make good investing decisions.
Get out in front of the wave of the real estate cycle by knowing where your market is going. Be a leader not a follower, do your own research, form your own opinions and trust your common sense.
If you would like more information on how to get involved in buying US real estate,
email me at info@propertyprohets.ca.
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