The tide has turned in real estate. Where buyers were coming into the market with leverage in 2003-2008, today’s market rewards cash and pushes aside buyers using credit.
The National Association of Realtors reported that 31% of all transactions in April were all-cash deals, down from 35% in march but still far higher than the 26% level in March 2010.
The NAR isn’t the only group reporting the surge in all-cash deals. CoreLogic suggests that investors coming into the market are more likely to buy with cash than they are to buy with leverage. In 2010, investors used cash to finance 60% of all purchases, up from 48% in 2009. Levered interest in real estate peaked in 2005, a year when the most second mortgages were written on investment properties.
Why Cash-Only Matters
As part of the NAR’s monthly report was a mention of the abnormally low default rate present in the current market. When investors go in with cash, they simply cannot default. Besides that, all-cash deals (or mostly-cash deals) mean that any capital loss is attributed to the investor first. Lenders who finance only part of a purchase are protected by the owner’s equity.
The effects of cash-only purchasers can be seen in rental real estate. In recent deals, buyers looking at in-land US properties have bid down multi-family real estate (read: apartment buildings) to cap rates of 6% annually. That return is only a few points higher than US Treasuries, suggesting that investors feel safe working into housing at today’s prices. It might also suggest that investors see rising rental rates on the horizon. The National Association of Home Builders is the most bullish on improving rents as it has been during the past 5 years. A recent survey suggested rents could rise by 2-4 percent per year for the next five years.
Current Rental Environment
On Friday, the Financial Times reported that rents are improving in the US. In fact, rents are improving so quickly that they’re throwing macroeconomic indicators out of whack.
According to the Case Shiller Index for US housing, home prices fell at an annualized rate of 4.2% in the first quarter of 2011. But don’t tell the Bureau of Labor Statistics, which reports the critical Consumer Price Index. The BLS uses rents to determine both inflation and the current value of property—if rents rise, then the BLS adjusts home prices upward by the same degree.
Actual and implied rents make up 30% of the CPI, and Goldman Sachs says the rental rebound makes up for 60% of the inflation rise in the last 12 months, according to Financial Times.
Why Housing is Hot
At the end of the day, our job is to determine “why” from “what.” Why is housing on the radar:
- Foreclosures – Every foreclosure means one more family has to find a new place to live. Clearly, they can’t go buy a new home, so they’re moving into apartments to put a roof over their head.
- Low interest rates – Rates are playing into the market differently than they were during the 2003-2008 housing boom. Today, buyers are playing with all cash—they’re looking for better returns on cash, not better returns with leverage.
- Implied returns – Even as home prices dip with each foreclosure, rental units are expected to see 2-4% growth in rental prices for the next five years. Naturally, this bodes well as an anti-inflationary investment, as rental income should grow at a rate equal to (or greater) than implied inflation.
- Investors have plenty of cash – A recent report on money-market funds revealed that retail investors housed $916 billion of cash in money-market funds. Institutional money-markets had $1.7 trillion in money funds. All told, money-market funds are worth $2.7 trillion—and the returns are pitiful.
According to the Case-Schiller Index, home prices are now as inexpensive, or less expensive than they were 10 years ago. Accounting for inflation, rental real estate has never been a better investment.
I’m beginning to wonder how so-called “shadow inventory” is affecting the market. Shadow inventory being all the homes that banks have foreclosed on but have not yet put on the market for sale.
- Buyers are bullish – There seems to be plenty of demand for investment housing. When buyers come on the market with pure cash they’re essentially saying they see limited or zero downside. Additionally, all cash buyers could presumably come into the market with leverage. If you have enough cash to buy an investment property, you probably have the credit to buy five investment properties.
- Shadow rents – With the shadow inventory off the market, rental properties are limited. Each home that lies in wait is unoccupied, which does help to bolster rents.
- Second wave? – The numbers look great. But what happens if rents rise while the supply of homes for rent dwindles? Notice how shadow inventory still leaves housing prices in decline (a constrained supply still fails to keep up prices) but it does the opposite for rental incomes–earnings are rising amid home price declines.
Readers: What’s your best guess for housing? Will prices continue on the downtrend, and will rents continue on an uptrend? Leave your opinion; it won’t cost you anything. 😉
Photo by: LoosePunctuation.