Boom Over, Fundamentals Rule

From the Wall Street Journal:

New Rules for Real Estate

Battle-scarred mom-and-pop investors are still dabbling in real estate. But they are changing the rules of engagement.

During the housing boom, many individual investors went deep into debt to buy investment properties — rental homes and condos — in hopes of selling quickly. The goal: Cash in on soaring prices. They may have had little or no intention of being landlords for the long haul.

Despite the end of the speculative craze, a number of markets in the fragmented real-estate world continue to lure investors willing to adjust their expectations. One key move: As rents take off, buyers increasingly focus on multiunit rental properties instead of the single-family condos and homes that were popular during the housing boom.

Some investors are also shifting money into regions of the country where they expect prices to continue to rise, such as Texas, the Kansas City area and parts of North Carolina.

Developers are also crafting special promotions, such as guaranteed rental income for as long as five years. Deals like these are particularly common in Florida, but they are also appearing in other markets, including Philadelphia and Myrtle Beach, S.C.

Another major shift: Most investors are focusing on the fundamentals that guided the market before the housing boom, especially cash flow — the ability to actually make money from, say, rentals, rather than from quickly selling the property. They are sticking with properties that turn a profit (or at least break even) after factoring in interest payments, taxes and other expenses.

That is a change from the past few years, when speculators were willing to lose money each month in hopes of selling for a big gain.
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Big risks remain for investors in residential property. The National Association of Realtors reported that the median price of an existing home in October was down 3.5% from a year earlier, the largest decline since the group began collecting these data in the late 1960s. And a glut of unsold homes could continue to keep prices in check.

Many investors have fled. The number of borrowers taking out mortgages to buy investment properties was off more than 70% in the third quarter from a year earlier, says First American LoanPerformance, a unit of First American Corp. Meanwhile, investors’ share of home purchases fell to 8.4% in the first nine months of this year from 9.5% a year earlier, says LoanPerformance. Five years ago, that share was less than 6%. (Figures don’t include investors who paid cash or financed their purchases by tapping the equity in their existing home.)

Some of the biggest declines in investor purchases are in once-hot markets where speculators helped drive prices to unsustainable levels. In places such as southern Florida, Phoenix, Las Vegas, San Diego and Washington, D.C., “the numbers just don’t make sense for long-term investors…unless they are able to buy at a strong discount,” says Jack McCabe, a real-estate consultant in Deerfield Beach, Fla.
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The situation is bleaker for those buying homes and condos as an investment, says Mr. Liang. “They should have very limited expectations on appreciation going forward — probably 0% to 3% annually for the next five years,” he says.

Many speculators who bought property during the boom may now be facing a tough choice. They can either lose a moderate amount of money each month while they wait for the market to rebound, or they can sell and take the pain all at once. Refinancing the mortgage could help under certain circumstances, such as when a borrower has an adjustable-rate mortgage that has reset to a higher interest rate. But for those who took out exotic mortgages with low monthly payments, refinancing may bring no relief.