…how's your market?

From time to time I contribute pieces to publications on investing in real estate.  Recently I wrote an article that appeared in the Houston Business Journal on investing opportunities in the Houston market .  Markets are starting to turn south in some areas of the country, but there are three key points that prudent investors can follow that will help turn up opportunities in some sectors:

• Buy cashflow:  positive cashflow is your best hedge against the risk of falling property prices. 
• Understand the risks:  keep it simple, avoid complex mortgage products that you don’t understand. 
• Run the numbers:  don’t get paralyzed by the analysis, but check your assumptions and know what sort of return you can reasonably expect from your investment.

These can feel like truisms, but the key is considering what they mean to you and your particular market.  See the article for more…
 

Today economy.com and cnnfn.com released the most recent data on housing prices, compiled for November of 2006 - it's clear that the slide in values is starting to accelerate.  The chart below shows the one month change in housing prices - for the first time we're seeing negative bars almost across the board. 

Surprises...
Most of these results were as predicted.  Overheated markets like San Diego, San Francisco and Phoenix are starting to backpedal - but there are a couple of things that caught me by surprise.

• Dallas:  Should be a safe haven at these levels, undervalued by more than 20% according to the recent Global Insight study - yet it gives up ground, falling by half a percent in November. 
• Miami:  Continues to tear it up.  Overvalued by more than 60%, Miami is up almost 8% year-on-year and continues to rise, going up half a percent in November. 
• Boston:  Surprises as the biggest loser, down almost 2% in November. 

Investors...Expect a wild ride in coming months, and note that contrarian speculators with nerve can make profitable trades in markets like Miami as owners with jittery nerves hit the exits.  But note that I said "speculators", not "investors" - personally I'm still a fan of undervalued markets where your investing dollars land properties that yield positive cashflow.

In the near future I’ll be working with Jim Kimmons , the real estate business guide for About.com to provide some content on investing in real estate - from the perspective of both the investor and the real estate professional.  Jim is a real estate broker in Taos, New Mexico and an expert on technology and real estate.  Check out Jim’s blog, and look for more investor related content in the near future. 

And when you're done reading about real estate, About.com covers everything from roller-skating to soap operas to politics. 

It’s January 20th and I’m just now rolling out with my New Year’s resolution.  Seems like procrastination, but to me it’s a strategy.  See if I hit the gates with the rest of the masses and proclaim my goals on the first of January then inevitably right about now I end up realizing that my vows to hit the gym more frequently and to get my life more organized are unlikely to pay dividends.  Resolutions (promises) made in the heady first days of the New Year are usually doomed by an excess of optimism – and sometimes by the remorse of a champagne headache. 

So I get around to ticking off some to-do’s for the year towards the end of January, which ends up prompting me to set some boring but do-able goals that take me a few steps closer to where I’d like to be at the end of the year. 

And this year’s goal is to start practicing what I preach in two areas:

• First: Don’t hoard equity in an investment, and
• Second: Don’t  fall in love with a property.

These are good rules to live by, and ones I’ve talked about in the past in my writings.  And they’re also two rules that I’ve violated in one particular investment.  I own a townhouse loft in the Montrose district of Houston.  Towering floor to ceiling windows.  Acres of hardwood floors.  Street lined with majestic live oaks.  And, I happened to live there…and I happened to be living there when I met the woman who would later become my wife.  Fond memories.  So when we moved out I held on to it. 

It hasn’t done badly, all things considered.  Montrose is hopping, builders are building, and prices have started to tick up.  So it’s time to get rid of it, fond though I might be of the property.  Cashflow-wise the property does ok, but that’s because I bought it before the price ran up.  Now it’s time to put that equity to work. 

The graphic shows my plan: take the $130k in equity that’s sitting uselessly in this property and turn it into six multifamily units that will pay me $5,000 per month in rental income (vs. the $2,100 that the loft is generating).  And do it through a 1031 deferred tax exchange that will allow me to avoid paying capital gains tax on the profit. 

So now that I’ve publicly declared my resolution perhaps I’ll feel more compelled to stick to it.  I know a lot of investors have equity squirreled away in properties that have run up in value.  I’d love to have other investors join me in resolving to put that equity by pulling it out and investing it in bigger properties. 

…and , I trust someone will call me out in December and see if I’ve stuck to my goal.  We’ll see…

I'll write a post soon on the ins and outs of the 1031 exchange - the key to making this work. 

I wrote a few days ago about the phantom bounce that some housing statistics may be implying.  The New York Times has followed up with an additional piece on the evolving condominium market, which might flag some opportunities for real estate investors.  

The condominium market is more vulnerable to large fluctuations in price because they disproportionately attract speculative investors, as opposed to single family homes.  Residential homebuyers tend to be less fickle – a property which is purchased as a home as opposed to an investment is less likely to be whipsawed by the market.  

That’s starting to show in some major metropolitan markets where condos used to be selling like hotcakes, but are now slowing down.  Buyers in some cases are forced to sell at a loss – or to rent them out at a rate that turns them into negative cashflow investments.  

This, undoubtedly, will turn out to be a blip in some areas, not a long term trend.  Nervy, contrarian investors can find bargains by jumping onboard when everyone else is headed to the lifeboats – and this current wave of woes was prompted by investors who did exactly the opposite: they broke ground when the market was white hot and development costs were through the roof.  

Check out these stats on the WashingtonDC area.  

Note:  the downturn at the tail end of the "condos sold" graph is in reality likely to be even more severe than the chart indicates, given that cancellations are probably not accounted for. 

Shoot me a note and let me know how your metro area is faring.   

Yesterday’s the Wall Street Journal ran a first page above-the-fold article on tenant/landlord litigation over mold, which reminded me of an experience I had last year. 

I got a call from a tenant who lives in a single family patio home complaining of discoloration on the ceiling of the home’s second bathroom.  I went over to take a look and was fairly surprised at what I found – the ceiling which was bone white when I rented the property to the family a little more than a year ago had turned into a kaleidoscope of dark moldy colors. 

If you’re a Houston landlord then this isn’t something you want to see.  For the uninitiated: mold is big business around these parts.  Houston is basically a big paved over swamp.  Hot summers.  Lots of rain.  A good environment for both mold, mold remediation firms and for personal injury lawyers.  This has been a particularly hot issue in Texas since a jury awarded $32.1 million (later reduced) to a family whose home was infested with mold. 

So I called AMC Engineering & Environmental Services to come and take a look at the place.  The set up some equipment, took some air samples, charged me what seemed at the time to be an annoying amount of money, and eventually produced a clean bill of health for the property; the quantity of airborne particles in the bathroom being “less than the overall quantity of fungal structures identified in the outside ambient air.”
The report went on to state that there is no “absolute criteria” regarding mold and that the recommendations of the report were based on “standard environmental microbiological and industrial hygiene practices.”

Which brings us back to the Wall Street Journal report (note: the WSJ article is available online, but only to subscribers).  The science of mold is a pretty fuzzy one (sorry, couldn’t resist at least one pun) and the references frequently quoted in suits are a maze of conflicts of interest.  One frequently cited paper from the American College of Occupational and Environmental Medicine which was written by a group of experts who paid experts for the defense side in mold litigation. 

The punchline (for me, anyway):  You know this.  And your tenant probably knows too.  My wife is a physician and I’ve learned one interesting fact over the past few years: it’s not the bad doctors who get sued, it’s the obnoxious ones.  I don’t have the data to back it up, but I suspect that the same applies to landlords.  If you tenant brings up a health related issue then look into it.  If need be do an evaluation and show them the all-clear certificate.  It’s a good investment. 

An article ominously titled A Phantom Rebound in the Housing Market, New York Times on Sunday discussed a possible anomaly in the government’s statistical sampling that may have resulted in an over-reporting of new home sales in 2005. 
The methodology does not account for sales cancellations; once a contract is signed then it is assumed that the home is sold.  However, as we know, speculators who signed contracts in booming communities often walked away from their deposit once the market flattened. 

Statistically this problem shows up in two ways.  First, as noted, the level of sales is overstated.  A second order problem is that the inventory is understated by a like amount as these houses are not added back to the count of houses on the market.  Estimates of the discrepancy vary widely from 100,000 to 200,000 sales that did not occur.  So whatever shift that occurs in the inventory numbers in early 2007 will be amplified by this adjustment.  

The real estate industry slowly but surely continues it’s march towards a new, yet-to-be-defined future state – driven by technology, new players, new business models, and ever changing customer expectations.  Against this backdrop the National Association of REALTORS® continues it’s quest to block the freight train of progress, this time lauding H.R. 111, the deceptively titled Community Choice in Real Estate Act which was introduced Thursday by Congressmen Paul Kanjorski (D-PA) and Ken Calvert (R-CA).

In a statement released today, Pat Vredevoogd Combs, the NAR Presidents, states:

• Realtors® provide extensive personal attention to consumers during the lengthy process of buying a home.  It would be difficult for banks to provide that type of counsel because of conflicts with their other business objectives.

Wow, where to start?  First, banks already offer advice on a vast array of services, and they do this well because of the brutal competition between them.  Sure, it’s probable that some banks will do a shabby job of representing real estate customers – and these are the banks who won’t manage to make any money doing it.  The phrase “extensive personal attention” is buzzword filler.  The consumer will determine the standard, and whatever market player meets this standard will capture the business.  This is the very definition of competition.

More importantly, the banks will jump in if and when it's profitable to do so -  which means using synergies to pull cost out of the system and using this to compete with customers based on price (lower fees).  Beware an industry group who seeks legislation to keep a class of competitors out of the market in the name of… drum roll…competition. 

But perhaps I’m not being completely fair here.  It’s hard to knock the NAR for backing their friends Kanjorski and Calvert – after all this legislation is unambiguously a threat to Realtors®.  In corporate America “synergies” is a code word for “redundancies”.  This isn’t corporate America we’re talking about here, but the concept remains the same. 

The real problem, though, is that all of the arrows in the NAR’s quiver look kinda similar.  Storm clouds on the economic horizon?  Just send David Lereah out to tell everyone that everything looks rosy! .  Sales are down?  Proclaim that now is the perfect time to buy and sell a house!  .  New technology players offering new options?  Use your leverage to muscle ‘em out. 

Facing an evolving market with a brave face and a vision isn’t an easy thing, but 1.3 million Realtors® out there are waiting for some direction.  Bad idea.  Some regional associations are taking matters in their own hands, but there’s trouble on the horizon for the rest. 

The fuzzy sciences get a bad rap.  Everyone likes to knock economists, and their faith in efficient markets has been canonized in marginally funny jokes  (I'm thinking of leaving my husband, complained the economist's wife.  All he ever does is stand at the end of the bed and tell me how good things are going to be.) 

We also love to bash the popular press (infotainment hacks) and automated forecasts (love ‘em or hate ‘em you cant get away from Zillow conversations in the real estate blog world).

So what am I going to talk about today?  A CNN piece compiling economic data from Moody’s that makes some predictions about future home prices .  Why?  ‘Cause I love this stuff.  Just like Zillow gives you a potentially useful data point (not a certified appraisal upon which you’re going to write a contract) economic studies can give us a glimpse into how the factors that drive prices are lining up.  Plus – there’s an element of a self-fulfilling prophecy that comes from a forecast that is shotgunned out to huge swaths of the consuming public. 

So what’s next for real estate in ’07.  Well according to this study check out these markets:

1)  McAllen, TX
2) El Paso, TX
3) Albuquerque, NM
4) Salt Lake City, UT
5) Syracuse, NY
6) San Antonio, TX

The numbers aren’t too sexy, in terms of property appreciation – the best markets in the country are expected to rise at 7% to 9% in ’07.  But consider the fact that you’re leverage goes a long way in an undervalued market – which most of these are.  A zero down investment that appreciates at 7%...I’ll take that.