Two thousand and ten was full of mixed economic news, glacial growth, and most of all, financial uncertainty. So where are we headed from here? What are the trends that need to be watched? What lessons can we take away from 2010, to improve profitability in 2011?
Unemployment
The unemployment rate, and particularly private-sector jobs, can’t be overstated as the most critical predictor of recovery, both generally and for the real estate sector. Unemployment is what’s fueling the foreclosure spike (and subsequent value drain), it’s what’s causing people to default on their lease agreements (and subsequent vacancy problems), and is generally what’s preventing people from participating in the overall economy. Once job growth is back on track, the foreclosure boom will turn around, and the rental industry will stabilize.
Supply: Shadow Inventory
On the supply side, prices are further driven down by foreclosures, in the form of a massive shadow inventory (properties scheduled for foreclosure or taken back by the lender, but not yet listed for sale, and therefore not included in the normal real estate inventory statistics). Currently, there are 2.1 million residential properties in shadow inventory, or an eight month supply, which has to be tacked onto the normal supply of housing available for sale (which is 4.2 million homes, or a fifteen month supply). Real estate markets nationwide (including lease markets) aren’t going to see substantial value growth until this shadow inventory dissipates, and that will take several years, especially given the current long wait times for foreclosures caused by lender documentation issues. As a final note, it’s worth mentioning that Fitch Ratings currently places the number of vacant residential dwellings in the United States at 14.4 million, and that does not include the shadow inventory described above.
Demand: From Deeds to Leases
Without the artificial boost in real estate demand caused by the tax credit (R.I.P. June, 2010), demand has dropped off, causing real estate sales and prices to languish. But even taking a long-term view, homeownership rates are dropping, for reasons ranging from the high unemployment and foreclosure rates, to household consolidations, to the tightened credit market. The all-time peak for homeownership in America was reached in 2004, at a rate of 69.2%. This number is now down to 66.9% and still dropping, which means tens of millions of Americans who were in owner-occupied dwellings are now signing a lease agreement instead. In a study by Trulia a few months ago, over 27% of Americans report that they have no interest in buying a home in their lifetime, and fewer Americans believe that homeownership has any relation to the American dream (72%, down from 77% only six months earlier). This is actually good news for landlords and real estate investors in a position to buy, as it will create a more stable tenant population, and a survey by Fannie Mae in late 2010 showed that the average predicted change in lease pricing over the next year is a 2.8% increase.
Conclusions
A year ago, there was simultaneously more hope for a healthy recovery, and more fear that we might slip into a double dip recession. It’s now far more likely that neither will occur, and that we’re in for a long, painstakingly slow recovery, which will lurch and splutter along over the next three to five years. Home prices are still dropping in most cities, and while the decline is leveling off, we are still down by over 25% from 2006 prices (comparable to the home value loss in the Great Depression, which was 25.9% from peak to valley). Here are a few take-home points from the trends in 2010, which are expected to continue through 2011:
- Now is a good time to buy real estate investment properties, but only if you can profitably hold the property as a rental unit for several years to come.
- Most real estate markets will continue to be soft through 2011. Exceptions will be cities with job growth.
- Real estate investors should be careful not to over-improve rental properties in lower-income areas, as tightened lending guidelines and diminishing demand for homeownership will prevent investors from being able to “retail” these homes to first-time homebuyers.
- Beware of rising bed bug infestations and litigation, and be pro-active in establishing a bed bugs policy.
- Protect your cash cushion: stay liquid, as lease default rates are up and vacancies are prevalent, and selling properties for quick cash may not be an option.
Stay profitable, stay liquid, and stay in business for another year!
Aside from being our Marketing VP, Brian Davis is a real estate investor and landlord, and tracks nationwide real estate market trends, and has made numerous appearances on news radio shows and websites. Feel free to send an email to him at gbdavis (at) ezlandlordforms.com, ATTN: Brian Davis, with any comments, questions, or interest in a guest blog post or article.