The boom in housing prices has caused many economists, industry professionals, and investors to question whether the next market collapse is looming. Strong appreciation has exceeded pre-recession values, creating concerns that soaring prices and limited inventories could lead to a rapid market decline in the next few years. Are the same market factors present today, and how with they affect the future of real estate investment?
10 Years Later. Is the Bubble About to Burst Again?
The real estate economy has recovered significantly in the last 10 years since the market crash. While some in the industry are anticipating an impending decline due to the rapid expansion of the market and extremely high rates of appreciation in urban markets, it is unlikely that we will face another crash of anywhere near the same magnitude. Many factors contributed to the recession including poor regulatory measures in the mortgage and finance industries, inflated housing values, and overly optimistic speculation regarding continued housing price gains. Opportunistic and unethical conduct by many in the real estate finance industry also led to the excessive price increases and availability of credit.
Today, these factors are not present. Strong regulation as the result of the Dodd-Frank Consumer Protection Act and other related legislation has tempered the growth of the market and limited the availability of credit. Rules that limit the amount that borrowers can finance relative to their incomes restrict loan officers and underwriters from lending to unqualified borrowers. Strict underwriting requirements have stabilized the housing market and significantly decreased the size and viability of the subprime market. The stable growth of industry and labor markets across the country and low unemployment rates are contributing to the strength and resilience of the real estate investment industry.
What Does a Crash Mean for Real Estate Investment?
If another recession does occur in the next few years, you don’t need to be too alarmed as a real estate investor. The real estate investment business is very resilient and often the best opportunities emerge during down cycles in the economy. When the market drops, property owners of all types, including residential, commercial, and business prospects are consistently more willing to sell their properties at a discount. The decline in demand for properties by less savvy retail buyers and investors results in a buyer’s market. As inventories increase, aggressive investors that stick to their investment criteria can make acquisitions that will provide wide margins.
Projects purchased well below retail value provide sufficient margins to allow room to account for excess renovation costs, continuing market declines, and other budgetary issues. Buy and hold strategies are particularly effective during these downturns. If the investor is willing to invest in debt or equity over the long-term, they can reap tremendous profits when the economy recovers. Recessions make fortunes for prepared real estate investors. Many notable investors that started to build their portfolios in the late 2000s were able to expand their holdings from less than 20 doors, to well into the hundreds, despite suffering significant losses during the height of the recession.
The Shift Toward Shared Risk in Real Estate Investment
An incidental result of the recent recession is the robust growth of the online real estate investment model. Real estate investors are now much more conscious of the risk profile of their investments and give more support to crowdfunding platforms that reduce the potential for loss. Crowdfunding allows smaller investments in numerous projects across geographic markets to improve portfolio diversification. When investors pool their experience and resources to capture larger market opportunities, it reduces overall risk for investors that participate in the project and fund. Collaboration in investment is a tremendous benefit that creates teams equipped to better evaluate investment opportunities. It also is able to generate sufficient funds to fully capitalize on projects.
Inadequate funding and inexperienced management contribute significantly to the failure of startup and established projects. Crowdfunding provides an alternative to the mainstay conventional lending institutions that traditionally dominated real estate investment finance. The aversion to risk has not been the only factor that contributed to the expansion of crowdfunding sources. As opposed to independent private lending and investment in projects, pooled funding allows access to projects of much greater scale than present significantly greater long-term returns to investors.
Renewed Tax Advantages of Real Estate Investment
The scale of projects available to investors through crowdsourced investments provide enhanced stability and potential for growth. In addition there are tax benefits due to favorable structures. The Tax Cuts and Jobs Act of 2017 is another factor that promises support for real estate investment in the coming years. Real estate investors can expect reduced tax liability due to increased deduction amounts and favorable tax treatment of real estate gains and business interest. The Act has additionally renewed the 1031 tax-deferred exchange program, with the exception of personal property exchanges.
Real Estate Investment Growth in Any Market
Stable economic growth, excellent housing demand, healthy labor markets, and significant tax benefits contribute to the viability of investment in real estate through crowdfunding. The number of options available to you with the expansion of the crowdfunding business requires you to ask many questions to determine how each calculates the risk profile of investments, and structures real estate investment opportunities to provide the highest and most stable long-term returns. When you’re ready to move forward in partnering with a crowdfunding platform, choose a firm that has a proven track record of generating returns for investors through carefully selected and vetted projects.
Real estate investing for high-net-worth individuals and couples can be a dense and intricate subject. Getting clear answers to the concerns you’ve been wondering about can be difficult, and sometimes intimidating. This article will answer some of the most common questions posed by new and experienced accredited real estate investors considering investing in real estate through alternative online investment platforms.
What is an accredited investor according to the SEC?
According to the Securities and Exchange Commission Rule 501 of Regulation D, an accredited investor is an individual who has an annual income of at least $200,000 per year, or $300,000 with a spouse. Investors with a net worth of one million or greater, excluding the value of your primary residence, also qualify as accredited investors. Being an accredited investor means you have the financial strength to tolerate the significant risk of getting involved with high-value investments. Even if you’re able achieve accredited investor status, it’s wise to carefully consider the viability, solvency, and transparency of the investment organization you work with, and the projects they sponsor.
What are the best ways to earn stable, low-risk returns as an accredited investor?
Some of the best options for accredited real estate investors include mutual funds, Real Estate Investment Trusts (REITs), and crowdfunding platforms. Each has unique benefits, returns rates, and associated risks. The benefit of these passive investment structures is that they allow you to share risk with other investors, and spread risk over multiple investments, lowering the overall risk profile.
Another advantage is that they lower the barrier to entry by minimizing the amount of funds and experience required to take advantage of the stable appreciation, relatively low risk level of real estate investments, and no requirement to participate in the management of the investments.
3. What is the difference between crowdfunding and private lending?
Participating in crowdfunding as an accredited investor, and investing as a private lender, have the same goal, but with some distinct differences in the way investments are administered, the level of risk, and the potential returns. When you venture out as a private money lender to invest directly in real estate projects, you can earn the highest return on your funds, but you bear the risk directly and will need to be more active in the oversight of the operation to ensure profitability and compliance.
Investing as a private money lender also requires much larger contributions to allow projects to be sufficiently capitalized and implemented within a reasonable timeframe. In the event of default by borrowers, it is your responsibility to seek recovery through judicial and non-judicial foreclosure methods. Partnering with other investors in pooled funding arrangements will allow you to share the risk and minimize management responsibilities.
How can I find viable investment opportunities for accredited investors?
Thanks to the advancement of online real estate investment technology, and the large supply of projects that need financing, it’s not difficult to find profitable, and pre-vetted accredited investment opportunities. Through platforms such as Sharestates and other shared-risk, portfolio diversified platforms, you can efficiently identify and obtain detailed and transparent documentation that supports the strength and validity of potential investments.
When I invest in a crowd funded project, will I be subject to personal liability?
Your personal liability as an accredited investor for civil and legal issues will depend on the degree of forethought by the real estate investment organization that you collaborate with in shared-risk investments. When investments are properly structured, you should be subject to minimal or no risk for litigation arising out of project disputes or claims. In the real estate investment business, for most legal structures that provide liability protection, such as corporations and LLCs (excluding sole proprietorship and general partnership), your risk is minimized by the corporate veil when transparency requirements are met. Otherwise, damages are limited to the equivalent of the investor’s share in the project.
What will happen if borrowers default on payments?
This is another issue that should be a key consideration is selecting an alternative investment solution or an online investing platform. One of the most attractive features of pool funding approaches is that you will not have to make direct collection efforts from defaulting borrowers. The investment organization you select will work to recover delinquent funds on your behalf, without any need for intervention on your part.
The advantage of the shared risk investing model is that due to portfolio diversification, diligent project and borrower vetting, strong returns, and the minimal entry requirements, the rare instances when borrowers default will have only a slight impact on the overall performance and risk profile of your portfolio.
What is better for an accredited investor: debt or equity investments? What’s the difference?
Debt and equity real estate investments both have their advantages for accredited investors. Debt investments are secured by notes that receive either a fixed or variable rate of return based on the degree of risk that the venture represents. In an equity investment, the rate of return is based on the amount of profit the project generates. Both forms of investment have their place and can be useful in meeting the financial needs and long-term objectives of the accredited investor.
Equity investments generally carry higher risks, and offer greater returns. Equity interests are less liquid and require a longer-term commitment, whereas debt investments typically have lower rates of return and are more readily transferrable.
What is the minimum amount that I can start investing with?
Every online and traditional investment platform has differing minimum investment requirements. The size of the fund or project, the degree of risk, and the intended market position of the organization influences the investment minimum. As an example, Sharestates has an initial $1k minimum for domestic investors, and $10k for international investors. This is based on the reasonable risk level, and our intention to make the entry into real estate investments less stressful for accredited investors.
When I invest in pooled funding projects, how is my interest secured?
Every platform has its own way of securing your interests. Common methods include debt and equity securities. The type of security issued depends on the risk level of the project and the anticipated term of the investment. Debt is typically secured by notes collateralized by real property, and earn returns at an agreed upon rate and schedule. Equity is most often secured by a contractual share in the property or venture, that earns a share of the income from the operation and resale of the property.
How will my dividends be taxed on shared real estate investments?
Equity and debt investments receive different types of tax treatments. Income generated from equity shares in an investment are typically treated as ordinary income or capital gains, depending on the structure of the investment. Proceeds from debt investments are classified as business interest and are taxed as ordinary income. As a result of the Tax Cuts and Jobs Act of 2017, your potential tax liability from both sources has been reduced.
I have more questions!
We’re here to speak with you to discuss your investment needs and goals. Please contact us by phone, email, or webform, and we’ll be happy to answer all your questions and assist you in achieving your objectives as an accredited real estate investor. As always, be sure to seek the advice of qualified tax and legal professionals before making any real estate investment decision.
Technology is continually knocking down barriers between potential buyers and sellers. From online listings on websites such as Zillow to virtual reality tours of properties, the modern real estate agent has tools to reach buyers that previous generations could not even have imagined. However, this has been a mixed blessing, since agents use these tools to compete with each other as much as to find buyers. Real estate tech has just began to disrupt this industry.
Real Estate Industry Moving Online
One of the most significant changes in real estate has been the transition to online platforms. What began as simple listings of available properties has developed into a sophisticated tool to identify what a buyer is looking for in a home. This has reached the next step with a real estate site Forbes magazine described as the “Pinterest of real estate”.
Compass offers more than a simple list of available properties. It curates the listings based on the data profile of the buyer, then allows additional streamlining that reflects the feedback given to the agent. This tool seeks to replicate some of the personal contact previously attained when potential buyers would visit a property by extending that interaction to an online environment.
The ability to do more than just post pictures online is proving to be the key to successful online real estate marketing. Zillow keeps track of properties viewed by people browsing the site, and sends registered users suggestions based on their interests. This is just the most rudimentary use of such information. More sophisticated programs track how long the viewer spent on each image to gain a sense what is important to them.
Chatbots are the advanced version of tracking buyer interest. These automated systems allow the user to access better information about properties without the expense of an agent providing basic details. When well done chatbots replicate a human conversation and so garner additional information about tastes and preferences.
Real Estate Industry Moving Up
The use of drones in providing aerial photographs and videos is becoming more prevalent in real estate, especially for properties and markets that benefit from this vantage point. Farms and estate properties are particularly well suited to this technology, although even a modest single family home can look better from a unique perspective 35 feet off the ground.
Fortunately, the ease of drone operations has made obtaining these photographs and videos about as easy as any other materials. Drone operators can be found online so there is no need for real estate agents to develop yet another skill set. Some real estate offices have developed this capability in-house and tout it as a competitive advantage to prospective agents and sellers alike.
Helping prospective buyers see the unique value in a particular property is easier when the agent has access to some simple Augmented Reality (AR) tools. These allow the agent to show what an upgraded kitchen would look like, or what new flooring would do for a living room. Improvements like these are often incorporated into the asking price of a house, but seeing what the upgrade will do for the look of the place is another step toward closing the deal.
Helping buyers see what their backyard will look like is the purpose of the “Walk the Property Lines” feature at Homesnap., This startup is a real estate listing site similar to Zillow that is trying to differentiate itself through the use of better technology. The site also promotes real estate agents more prominently than others, a feature that recognizes the value of personal connections in residential real estate.
This recognition goes to the heart of how technology will help, and not replace, the professional real estate agent. Tech savvy professionals will use them to expand their reach and their market presence. Most importantly, these tools will help more people find the house that will become their home.
Real estate professionals are commensurate marketers, able to communicate the valuable features of a property. Creating curb appeal is a large part of successfully selling a property. In fact, an entire subset of professionals work as property stagers to present residences in the most favorable light possible.
The Challenge to Every Real Estate Sale
The challenge is getting the potential buyer to the location to be able to work this magic. This is where mass marketing on websites such as Zillow comes into play. These websites are the logical next step in real estate marketing that began with ads in newspapers. As the Internet has displaced print, real estate professionals have moved online.
This transition has been facilitated by better technology in several ways. At one point in time posting pictures of properties online was a difficult and cumbersome chore. Now with smartphones and wireless Internet access it is almost effortless. Descriptive and engaging copy has been replaced by pictures.
Faster Internet connections have contributed significantly to this new form of marketing. When pictures were difficult to post they were also time-consuming to download. Now bandwidth allows multiple images to be downloaded in a fraction of the time. In addition, drones have allowed the real estate professional to obtain unique and interesting photos that showcase properties.
The Latest Property Marketing Solutions
“Walk-through videos” were the next logical development, providing the potential buyer with a new way to experience any property without leaving the comfort of their current location. However, these required greater care and expertise. Poor production quality meant poor perceptions of value. Quality productions took time and money, reducing the profitability on each transaction.
Now new immersive technology raises the bar on showing properties online. Virtual reality headsets and glasses provide the potential buyer with the perspective of actually being in the house with the ability to move around as they see fit. The amount of data that needs to be transferred to create this impression is remarkable, but not beyond the capacities of most high-speed Internet connections.
The cost benefit equation for immersive technology remains fraught. The cost is higher than simple photographs or videos, and the number of potential buyers who have access to the full experience is still relatively low. At this time sellers are not likely to foot the bill for producing an immersive presentation, so the cost of production comes out of the agent’s profits.
Is Virtual Reality Here to Stay in Real Estate?
The growing popularity of virtual reality viewing devices and the falling cost of production equipment will make this an easier calculation in the future. Agents who offer this service will then have a competitive advantage over those who don’t, driving the market toward greater adaptation. However, the bar is unlikely to remain static.
Virtual reality is malleable, and just because a wall is blue in reality does not mean that it can’t be beige when viewed by the potential buyer. This requires additional computing power, but car companies have been able to provide this service – albeit with a fixed range of colors – for some time now. It may only be a matter of time before potential real estate buyers have the same options available to them.
Creating these augmented experiences carries a risk beyond the cost. Real estate is still a very ‘high touch’ business, and the conversations and connections forged during a walk-through have been shown to be extremely valuable. Virtual presentations do not include this feedback loop and may leave the agent in the dark as to why the prospect was not interested. That limitation may be offset, of course, by the greater number of prospects who can view the property in such detail.
The Internet of Things (IoT) has promised to provide a refrigerator that senses when the milk it stores is running low and adds it to the weekly grocery list automatically downloaded to the delivery service. While convenient, this is nothing compared to a system that has learned the homeowners preference for eggnog during the holidays and stocks up ahead of time. That is the promise of Artificial Intelligence (AI).
Are Your Home Devices Smart or Intelligent?
In an era when 1 out of 5 kids under age 8 has a smartphone, AI can seem like nothing more than a next step. A process that began with electric lights and the light switch just seems to be continuing. In fact, some articles confuse “smart” technology and the IoT with AI. An analogy to a dog can help make the difference clear.
A dog can be trained to do many things. Some of these things are entertaining tricks, and some are useful tasks. This is like smart apps and the interconnection of devices on the Internet. However, a dog can also protect a house against burglars no matter how they try to break into a house. A dog can also tell when its owner is sad or sick. This is AI.
“Smart” garage doors are another example. Currently, sensors in the garage are alerted by the homeowner’s car and open the overhead door in response. The system can also be programmed to turn on the lights in the foyer. But an AI system has learned what time to expect the homeowner to return and will send a text message confirming it is the homeowner if a signal arrives at an unexpected time.
AI Adds Value to Homes
Smart systems need to be taught everything. Worse yet, they have to be communicated with in a way that the system understands. This can mean a keyboard, a touch screen or a voice command, but it must conform to the programming of the system. The problem with this is that a homeowner carrying several bags of groceries into a dark kitchen might not remember to say “Turn on kitchen lights now.”
This interface is the focus of new developments using AI. The goal is to design systems that understand a natural language and are not confused by slight differences in format. The AI system puts a command like “Lights!” into the context of a person entering a dark room and responds by turning on the lights in that room. This makes the system both much more functional and much more valuable to the homeowner.
However, to be able to think in this way the AI system needs to know that (1) a person is entering (2) the room is dark. This requires sensors to know where the homeowner is going and the condition of the room at that time. These types of sensors are another aspect of AI that is currently under development. Obviously, the AI system also has to be hard wired into the electrical wiring of the house if it is going to be able to turn lights on and off.
AI Real Estate Market Value
Understanding the value of AI is absolutely necessary to properly valuing a home that is “wired” for this type of system. Currently, so few homes have these systems in place that they might be considered a small item valued by a select group of buyers, much like a koi pond in the backyard. However, in the future this will probably be one of the items listed on an appraiser’s evaluation, just like “Air Conditioning” or “Burglar Alarm” is now.
There is a commonly held misconception that the real estate market hibernates like a bear. It goes into a deep slumber beginning in December and wakes up hungry in the spring. This fallacy can lead to a sense of complacency on the part of real estate agents, developers and lenders. At worst it engenders a feeling of helplessness that suggests any efforts are doomed to failure.
Those who buy into this perception base their thinking on graphs such as the one to the right. The graph seems to clearly show a strong impact of colder winter weather, or children attending school, or shorter daylight hours, on the housing market. The graph and all these rationales are wrong.
A Historical Trend that is Ending?
The first thing to notice about the graph is that it is the average for each month from 1999 to 2015. While it is certainly fair to average out several years to account for the disruptive impact of an unusually severe winter, averaging over this period of time obscures that fact that the impact demonstrated is fading over the years. It was much more pronounced in the past, which may account for the fact that the perception is so widely held.
The graph to the left shows the monthly sales for the years 2005 through 2015. Sales for 2005 through 2008 certainly confirm the seasonal slump hypothesis, but sales since those years which were marked by unusually high volumes, show a much smaller seasonal differential. Sales for 2011, for example, show only a slight change in January and February, and remained consistent in December.
No Winter, No Winter Slump?
Monthly sales data from the National Association of Realtors for 2016 shows that even a national average hides the differences between regions. Analysis shows that areas of the country such as the West and South show a smaller seasonal dip than the Northeast, where winters are most severe. This is in keeping with the conclusion that all real estate is local.
Even those areas which have some of the winter lulls are not as severely impacted as commonly believed. The graph at the start of this article appears to show a significant increase in activity during the summer months, but the scale skews perception. It begins at 5% and tops out at 11%, emphasizing the difference in each month’s sales volume.
According to housingwire.com, the source of the data, the four slowest months of the year account for 27% of the year’s total sales. But those months are a full 1/3 of the year, and so should account for no more than 33% of the annual total. This mean they lag the summer months by only 6%, which can hardly be considered a market in hibernation.
A Self-Fulfilling Prophecy?
To a certain extent, the existence or non-existence of a seasonal slump is irrelevant to the success of a real estate developer or agent, regardless of the market they are in. A seasonal slump can be nothing more than an excuse to be less diligent because “it’s winter”. Real estate always has some barrier that has to be overcome. High interest rates, low consumer confidence, a lack of marketable properties; the list is endless.
And, unfortunately, many times even the most diligent, seasoned professional can fall prey to a bad news story and respond with less effort instead of more to overcome market conditions. It has been said that the first budgetary casualty of a drop in business revenue is marketing. This is a mistake. A drop in business means that more marketing is necessary. A slump in the real estate market for any reason is a clarion call for more activity.
At the minimum, stepping up marketing and other efforts in the winter months can be thought of as planting seeds that can yield greater activity for the rest of the year. Farmers do not sow and harvest in the same month, and real estate professionals can remember this simple fact to go against “common knowledge” and stay busy all year long.
Commercial real estate is under siege by sustained low interest rates that have driven down cap rates and forced companies and individuals to both work harder and take more risk in order to achieve their investment return goals. With the unknown impact of unwinding QE on the financial horizon, commercial real estate firms need to be proactive in restructuring in order to prepare for any eventuality.
Technology Advances In Commercial Real Estate
The commercial real estate industry is often slow to change. A recent study by Deloitte found that many companies are still using simple electronic spreadsheets to track all the details surrounding their commercial real estate holdings, including lease dates. This limits the capabilities to use new analytical tools to evaluate both the holdings and their performance.
The same holds true for the properties themselves. New technologies can help commercial tenants identify far more than the volume of pedestrian traffic in front of their location. Important demographic information can be gleaned by high tech sensors, and the data can be harvested by Artificial Intelligence (AI) on a real-time basis to suggest ways to turn the foot traffic into customers.
The fintech industry is also going through technological upheavals with Crowdfunding and cryptocurrencies displacing traditional banking relationships. Commercial real estate firms need to have at least a foot in this world in order not only to be prepared but to take advantage of lower costs of capital and more flexible lending terms.
Changes In Real Estate Workplace Demographics
An aging workforce and the impending retirement of many Baby Boomers is stressing many commercial real estate firms, but can actually be a blessing in disguise. Replacing talented employees is always a challenge, but by understanding the needs of the new generation of skilled workers commercial real estate companies can significantly expand their in-house capabilities.
These needs include a higher degree of flexibility than required by previous generations. Hiring part time, “gig” employees and project specialists can provide commercial real estate firms with a workforce that has highly specialized skills. These workers are often available on a short-term basis and can augment an existing, salaried workforce.
Somewhat paradoxically, these new workers sometimes have a stronger entrepreneurial attitude toward the success of the project they are engaged to work on. Management can cultivate and harness this attitude with incentive pay structures that mimic phantom stock plans traditionally reserved for long-term employees. Carefully tailored agreements that tie bonuses to results are very attractive in the “gig economy”, and commercial real estate firms that offer them have a competitive advantage.
Combining the best of technological advances and employment practices is a tricky combination, but it has the potential to pay-off for commercial real estate firms in the coming year and beyond. These advances have the potential to improve the cost of doing business in addition to identifying new efficiency opportunities. While their many facets that are unknown, and currently unknowable, make them uncomfortable for early adopters, they may also prove to be critical to success.
Residential real estate on Long Island continues to strengthen, with signs that only the lack of available properties will cause the market to find a top. The overall market showed positive gains over the first part of 2017, and each individual segment of the Long Island residential market posted positive numbers. Real estate investors would be hard pressed to find a more robust real estate market.
Overall Look at Long Island Home Sales
By any measure the residential real estate sales on Long Island is booming. This is not a surprise to even casual observers since it has been a hot market for several years already. The average sales price of a single family residence rose by 3.55% Year-to-Date over the second quarter. The number of days on the market fell a remarkable 15.5% to only 87 days.
As would be expected, sellers were able to command their price, giving up only 3.4% in the second quarter of their listing price in order to close the sale. However, when the top 10% of sales – defined as the luxury market- are excluded from this calculation the listing discount fell to only 1.1%. This is remarkable given that the Long Island residential real estate market has posted annual increases in the median price of homes every quarter for over 4 years at this point.
Sector Analysis of The Luxury Real Estate Market
The robust performance is not hindered by softness in any particular market. Condos, single family homes and luxury homes all posted increases in both average and median sales prices through the second quarter of the year. All posted a drop in the second quarter in the number of days on the market, although the luxury market had an insignificant Year-To-Date increase of 4 days over the second quarter of 2016.
It is no surprise that the threshold for luxury sales increased as prices in the market increased. The top 10% of sales had a cut-off of $825,000 in the second quarter, an increase of 4.4%. The listing inventory for luxury homes fell to the lowest level for the second quarter in the past 9 years, strongly indicating that the robust demand will continue to drive price increases for this sector of the market.
Area Analysis of Residential Real Estate Sales
Just as with the different market sectors, all the geographic areas of Long Island saw increases in the key indicators of the real estate market. Both Nassau and Suffolk posted increases in average and median sales prices. Both areas had price trend indicators that foretell higher prices in the future, such as a fall in the Listing Discount and the Number of Days on the Market.
However, none of the areas can compare to the performance of the residential real estate market on the Suffolk North Shore. Both average and median prices rose by 11.7% year-To-Date over the second quarter of 2016. A decline in both listing inventory and marketing time strongly suggest that prices will continue to continue this strong upward trend. As if to emphasize this potential, the absorption rate – the number of months it would take to sell the existing market inventory fell to only 2.6 months.
Real estate investors can take some good news home from the performance of the market for multi-family housing through the first part of 2017, and rest comfortably based on expectations that little will change for the market in 2018. In addition, the variety of classifications in this massive sector may allow the diligent investor to still maximize their profits through rents and not need to sit out any unexpected price softening in order to pocket a healthy return.
Real Estate Market 2017 vs. 2016
Overall, the volume of home transactions in the multi-family sector fell in the first half of 2017, particularly in comparison to the robust market that was 2016. The first quarter of 2017 was slower than the second, but taken together were still down a remarkable 22.3% YTD from 2016. Total transactions reached 4,600 last year, but barely crossed the 1,500 mark over the first half of 2017. Analysts are confident that the lack of activity is due to a lack of availability, rather than a lack of demand.
The slowing market is also not uniform across all sectors. High rise multi-family transactions caused most of the slowdown in the multifamily market. These fell by almost 60% over the first half of 2017 in comparison to last year. Because of the larger size of each transaction relative to the rest of the multi-family market, this decline can be attributed to a drop in attractively priced offerings and new construction.
Forces Driving Multi-Family Home Sales
High prices on multi-family real estate properties are being driven by two main factors. The first of these is foreign investment. Christine Espenshade, Managing Director of Multi-family for the US at JLL, says that investors from Canada and Germany in particular are showing robust interest in the US market, due to similar rent structures in those countries. This investment is focused on the larger cities including New York and Chicago.
The second factor keeping prices high in spite of low sales volume is low interest rates globally. There are a variety of economic reasons why rates have stayed at or near historic lows for so long, but the net impact has been to support higher real estate values. Debt service is more manageable at lower rates, and this has brought eager buyers into the market.
How Low Cap Rates Are Affecting Home Sales
Higher prices mean lower cap rates, and this is demonstrated across the nation as well as across most sectors of the multi-family market. Most major markets saw cap rates in the range of 4% to 5%, with a small sampling of slightly higher rates in Ohio and a few other scattered cities. This is expected to continue into 2018 as real estate continues to provide an attractive risk-reward alternative to other asset classes.
However, higher cap rates can be found in areas and for smaller buildings that are not on the radar screen for larger or institutional buyers. These can be found in the suburban areas surrounding major cities, in places with older housing stock that needs refurbishment, and in buildings that appeal to Millennials who continue to prefer to rent rather than buy a primary residence.
That demographic trend may prove to be more powerful than current analysts expect. It has already driven up occupancy rates, but it may drive them even further as more Millennials start families and move out of their parents’ homes. Keep in mind that renting is a practical choice for Millennials rent because of the mobility it provides to respond to changes in the job market.
If this trend continues it could drive up rents and the resulting cap rates. This would provide current buyers a real cash flow bonus. Absent significant changes in the interest rate environment those increased cash flows can be expected to push cap rates back down through higher prices, creating an even healthier return for the long-term investor getting into the market today.
Fix and flip investing in real estate continues to pay big profits. In addition to being driven by high investment returns, this approach continues to see increases in activity. Furthermore, this market continues to be dominated by small investors. Small flippers – defined as those who closed only one flip transaction in the last quarter – accounted for 69% of flip transactions in the first quarter of 2017.
Defining the Top Real Estate Markets
A fix and flip transaction can be identified by the short time frame between the purchase and the sale. Minimizing the time it takes to flip a property not only reduces interest expenses but also enables the investor to complete more transactions in a given year. Public records that will identify top real estate markets will show a significant percentage of purchases and sales in the same 12 month period yield meaningful information about the effectiveness of this investment strategy.
Of course, public records only provide the purchase price and the sale price, leaving out the amount spent by the investor to get the house ready for returning to the market. However, dividing the difference between the sale and the purchase prices by the purchase price gives a sense of the profitability of each transaction. Based on this methodology, Pittsburgh, Pennsylvania was the place to fix and flip a single family residence. Transactions there averaged a return of 146.6 % in the second quarter of 2017.
Pennsylvania Shows Strong Fix And Flip Activity
Pennsylvania was a strong leader in the market overall, too. Philadelphia and Harrisburg also recorded triple digit returns of 114% and 103% respectively. Even giving a generous allotment for remodeling costs suggests these locations produced a remarkable profit for real estate investors. Interestingly, none of these areas saw a significant increase in fix and flips as a percentage of total real estate transactions. That may change as homes currently owned by flippers come back on the market.
This is a potential development in any market, but the flip times in these communities makes this more likely. The average flip times were 184, 190 and 194 days for Pittsburgh, Philadelphia and Harrisburg respectively, falling into the small flipper average of 194 days. This suggests that the market in these communities is dominated by small, perhaps local, flippers. That, in turn, leads to the possibility that more opportunities can still be found in these markets.
Other Top Fix And Flip Locations
The same dynamic may be taking place in Baton Rouge, Louisiana with an average return of 120.3% and Cleveland, Ohio at 101.8%. The average flip times for these markets was and 172 days and 184 days respectively. Neither market has yet seen a significant increase in the percent of sales that meet the definition of flips.
Those markets that did see an increase in the percentage of flips still showed solid investment returns. Baton Rouge, Louisiana was up 72%, but still returned 120.3% with an average flip time of 172 days. Rochester, New York was up 39% with a return of 72.4% with an average flip time of 183 days. All these returns suggest that there is still plenty of money to be made by fixing and flipping residential real estate.