US Real Estate: Has the Opportunity Passed?
By Ryan Hittel
For the past 24 to 30 months, certain regions of the battered US housing market have been terrific places to invest. Phoenix, in particular, has offered investors a welcome escape from the squeeze between brutally low-interest bond issues and increasingly volatile and underperforming equities. Phoenix has been a standout because housing prices were hammered down 40 to 50% in a region with a very strong long-term economic outlook.
As expected, the Phoenix area is now leading the turnaround in the US housing market, with an average 25% price appreciation in the past 12 months. So the question that confronts us now is whether the big opportunity for US real estate investment is a thing of the past.
Real estate markets, whether in Canada or the US, are driven by regional dynamics. Smart investment dollars analyze and pursue opportunities on a regional basis. We must be careful not to get caught up in the “simplistic” media hype relating to the “US Housing Market.” Every region has its own unique challenges and opportunities. To be sure, certain advantages may be common across the entire market — but the crucial drivers of opportunity are regional. The US subprime mortgage crisis hurt the entire country and drove the global economy into recession in 2009. But housing prices in some areas of the United States were far less affected than those in the Sunbelt, where millions of home buyers overextended themselves with the active encouragement of lenders offering “Easy Money” with subprime, adjustable-rate mortgages. But, not all real estate markets are created equal. Or, put another way, the three keys of real estate investment are location, location, location.
While the causes of the US housing market implosion were national in scope, impacts were very unevenly distributed. In an expanding US economy, subprime, adjustable-rate mortgages took over 20% of the US market between 2004 and 2006. As those loans rolled over, or reset, into higher interest rates and ballooning monthly payments, one in every seven mortgages in the US went into default. Foreclosures reached 2.8 million by 2009 and, as housing prices plummeted, more than half of all homes in Phoenix and some other parts of the Sunbelt sank to values that were far less than mortgages owing. This compared with 23% of all US homes that were said to be similarly “underwater.” Banks that suddenly found themselves owning thousands of repossessed homes invariably worth less than their mortgages, rapidly pulled back from further mortgage financing, virtually killing the housing market. In the broader economy investment banks teetered, Lehman Brothers failed and US stock markets lost 40% of their value — or some $8 trillion dollars.
With US Sunbelt home prices suddenly cut in half, Canadians rushed in to take advantage of this situation, this trend was strengthened by the Loonie trading above parity with theasset whose value, unlike stocks and bonds, never goes to zero and because, during downturns, it generates rental income that essentially pays you to wait until there’s a recovery. Furthermore, because shelter is a basic human need, rental rates are more resistant to downward pressure.
That said — all real estate does not provide the same opportunity at the same time.
In 2009, our firm Capstone Real Estate selected Phoenix as the home to the first of two successive US real estate investment funds for a number of reasons. Housing prices were cut in half yet the rental market remained healthy. From a monthly payment standpoint, it was cheaper to buy a home than to rent one. It was an investment paradox that we believed would be short-lived in an area that had undergone several years of population growth at three times the national average and that we believed was likely to return to strong growth in the years ahead. We believed Phoenix would retain its Sunbelt appeal and continue to be a magnet — not just for retirees but for a wide range of industries that are not location dependent and that prefer settings that make it easy to attract top talent.
Since early 2010, we’ve acquired over 190 single family revenue homes directly from the banks with cash for an average all in price below $105,000. The average monthly rent of our homes is $1,050, or 1% of the purchase price. It is this type of price/rent ratio that has made Phoenix so appealing to investors.
Today, Phoenix is growing again and leading the nation in the real estate recovery. More than 28,000 jobs have been created in the past 12 months and the jobless rate is 7.5%, versus a national rate of 8.2%. Phoenix now ranks 4th in large city job growth, compared to a dismal 49th only two years ago. Median housing prices have risen 33% to stand at $155,000. And the inventory of homes for sale has declined 44% over 12 months, creating an environment in which many listings attract competing offers and bidding wars. Since November 2007, inventory has declined 70 per cent, from 48,340 homes to 14,547 units in July, 2012, which is less than three months’ supply at the current pace of sales.
The Phoenix single family market housing market is expected to continue to improve based on sound economic drivers. And Canadian investors who are already in the market are likely to see solid returns as Phoenix continues to outperform other regional housing markets. For the last 2 years, purchasing single family revenue homes in the Phoenix area was the opportunity of a lifetime. Other markets may still offer opportunities similar to what Phoenix provided in 2010-12. After all, median prices across the entire US are up by only 2.93% in the past 12 months, compared with 33% in the greater Phoenix area. But other regional opportunities will need to be carefully assessed on their merits, with careful analysis of regional economic drivers and real estate supply/demand balances.
It is important to be opportunistic, not only when identifying a specific region, but opportunistic when identifying different types of real estate opportunities within the real estate cycle. A buy, renovate, rent model is a sound investment strategy when housing prices have reached a bottom in the real estate cycle and rental demand is strong. This is our experience in Phoenix over the past 3 years. But now market conditions are changing. A drastic downturn in prices is normally followed by an increase in prices when combined with historically low supply. The key to successful real estate investing is to identify these cycles and adjust your strategy accordingly. No one investment strategy is perfectly suited to every market cycle.
We believe that very favorably priced properties with significant upside still exist, but the “buy, renovate, rent” model may not be best suited to take full advantage of this evolving market cycle. The “buy, renovate, sell” or better yet the “buy, renovate, finance” model may provide the best opportunities. There is significant demand from quality buyers who are still unable to obtain traditional financing due to tightened lending criteria. Many families made a business decision to return their home to the banks via foreclosure rather than continue to pay an underwater mortgage. With the low housing supply and new demand pushing up home prices, previous home owners don’t want to miss out. And they are willing to pay a premium to ensure they are able to re-enter the market at these rock bottom prices.
Today the Dow Jones Industrial Average has almost fully recovered the losses it experienced, providing an 85% increase from its market lows of February 2009. The Phoenix housing market has seen a significant increase in the average price per square foot, from a low of $79 to a current price of $99. This though is a far cry from the market high of $192 per square foot seen in June 2006, so a great deal of upside still exists.
The US housing market, specifically the Sunbelt region, has, and will continue, to provide significant opportunities to the astute investor.