Will the Real Estate Investor Please Stand Up?

Is it the beginning of the end for the U.S. real estate downturn? Mark Zandi, Chief Economist from Moody’s Economy.com certainly seems to think so (CNN interview aired earlier this week). This discussion comes on the heels of the NAR report stating that existing home sales have actually improved from January to February 2008, but the median price is more than 8% down vs. last year. Methinks that inflection point is happening right now, because prices are finally low enough for people to get back into the market.

Zandi points to this latest increase in sales as the point where homes are starting to stabilize, putting us at the beginning of the end of the downturn, a process he still predicts to be very long. Home sellers are now “capitulating”, lowering listing prices to be in line with the market, and making the deals more attractive for the buyers. Additionally, the mortgage rates are low enough to stimulate homebuying activity. Finally, after decades of home prices outpacing salary growth, homeowners can somewhat afford to get back into the game. According to Zandi, “prices have been declining for two years. I think we’ll see another year worth of declines. We are down 10 to 13 percent from their peak. I think they’ll decline another 5 to 10 percent between now and the spring ‘09 selling season. So it’s not over. We’ve got a ways to go. ”

So here you go. There is one good year left of rock-bottom housing prices, after which they should continue to climb back up. We as investors haven’t had an opportunity like this in several decades, to get into a property at a price low enough to produce positive cash flow. This is an opportunity not to be missed. I would like to re-emphasize from my recent blog post, that this real estate environment is a perfect time to acquire a property that you hold for the long term and rent out, and not designed for a short-term flip.

As so many homeowners are losing their homes to foreclosure, and the real estate market is at the forefront of our economy and politics, investors like us are trying to understand how our worlds are affected.

Because real estate prices have plummeted, quick flips and investing for capital gains are no longer no-brainers of yesteryear. This is due to a confluence of several factors, such as: 1) an oversupply of inventory driving down prices (with new foreclosures predicted to keep flooding the market), 2) tighter lending standards reducing the pool of buyers and 3) general market malaise and impending recession making just about everyone apprehensive about real estate .

Again, the savvy real estate investors know that during difficult times is when wealth is created. Real estate will always be a great investment mechanism, but it’s the exit strategies that will have to change. Hence, investors with experience are focusing their attention on longer term rental investments. Because of plummeting prices, many investors will see positive cash flow from their properties.

As such, it is more important than ever before for real estate investors to understand the relationship between homeownership and rents. I stumbled upon this blogpost from the Curious Cat blog, which I found very interesting and wanted to share. It summarizes the following research paper which focuses on the relationship between rents and home prices between 1960 and 2006. The article focuses on the rent-price ratio as part of real estate returns calculation (the higher the ratio, the more expensive the rents are vs. home ownership). The rent-to-own ratio is basically the “dividend yield”, which must be considered in addition to the capital gains, when calculating the return on the real estate asset. This article is an interesting “rough guide” to the rent-to-own relationship. As the capital appreciation on real estate had increased more rapidly than rents between 1995 and 2006 (the housing bubble), this second part of the “ROI equation” had decreased, which is important to consider. With rents on the rise and housing prices falling, the ratio is likely to get realigned with its historical average.