Riding the Investor Wave

Interest rates continue at historic lows. Home prices in many markets are more affordable than ever. Indeed, housing affordability conditions are among the best they have ever been. So why aren’t more people buying homes? One reason is exceptionally tight lending criteria have made it difficult for any buyers to take advantage of such attractive affordability.

For investors with cash, though, the situation is providing them with a golden opportunity. The investor share of home purchases has been creeping up. Investors accounted for 18 percent of home purchase activity in July; the share reached 22 percent in August. (The first-time homebuyer share fell after the homebuyer tax credit expired last year, and investors stepped in to fill much of the gap). Obtaining a mortgage for a non-primary, non-owner-occupied home is even more difficult than obtaining other types of loans. Consequently, a significant share of investors is purchasing properties via all-cash transactions. All-cash purchases represented 30 percent of all home sales transactions across the country and accounted for over half of the sales in hard-hit regions like Las Vegas and Miami.

At the same time, higher rents are also attracting investors to the market. Property management has its own challenges and isn’t for everyone. But for those investors who have the capacity to either hire a property manager or manage a property themselves, the attractive rates of return from rising rental income is a strong lure. Rents rose at a better than 3 percent annualized rate in the third quarter of 2011, according to government data, and private data sources suggest even faster rent growth. Nor is there any reason to believe this rent growth will cool given the favorable demographics of a rising number of young adults over the next 20 years, a high number of “foreclosed” homeowners who cannot buy in the near term, and the very low construction rate of apartment buildings. If annual rent gains remain near 3.5 percent, rents will double in 20 years. If the rents rise 5 percent a year, rents will have doubled in 14 years.

In addition to strong returns on rental property, investors can anticipate solid home price appreciation over the long haul. Using 2000 as a “normal” year in which the market saw neither a bubble nor a bust, the metrics on home prices in relation to consumer prices imply a 14 percent undervaluation. The metrics on home prices in relation to rental rates imply a 20 percent undervaluation. The metrics on home prices in relation to income imply neither an overvaluation nor an undervaluation.

Given that the housing bubble has virtually deflated, the future path for home prices path should follow the future path for rent growth. That means home prices could also double in 14 to 20 years, though it is unclear as to when home prices will begin to catch up with rents. But long-term investors are sure to catch some if not most of the upward ride.

This is an article from Real Estate Insights, a monthly real estate e-newsletter produced by NAR Research.   Click here for more Insights articles.