July 31, 2008Kyle KazanComments 1
If you have been a multi-year reader of mine then you are used to my bearish tone about the real estate market. The wanton disregard for fundamentals by investors, lenders and Wall Street led to the bubble which has now popped. The questions to pose now are; are we at the bottom yet and if not yet, when? As your loyal real estate economist my answers are NO to the first question and to the second I say that it will be when a buyer can achieve a return on investment in real estate that is significantly higher than “risk free investments” (i.e. US Treasuries and FDIC insured bank accounts). The last begets a third question which is how far are we away from a positive investment scenario?
Earlier this month I was asked to speak at a distressed real estate conference in Las Vegas (clearly they were gluttons for my bear talk). As that city’s real estate market was one of the most overheated, I arrived a day early so that I could gauge the market. I visited 6 foreclosed homes to see how far the prices would have to drop for an investor to make a positive cash flow at current rent levels with normal expenses. In past downturns, pricing hit bottom when investors bought up houses and they were able rent them for profit (a return to the basics of real estate which is a property is worth a multiple of its rents). After running the numbers on my sample homes, I found that the prices need to drop at least 33% from the current asking prices. (Note that 2 of the 6 homes didn’t even have a for sale sign on the property indicating that the selling bank isn’t motivated and/or supervising their listing agent.) Should the Las Vegas economy fare worse than it is today, rental occupancies and rent prices will be negatively affected. Lower rents/occupancies coupled with the possibility of higher borrowing costs would push the 33% estimated drop even further.
Tip of the Iceberg
While the underlying bonds securing sub-prime loans along with the firms that underwrote them have seen their value plummet, the actual real estate has not yet reset its value to the market level. The correction thus far is just the beginning. For Las Vegas, Phoenix and Southern California, it is going to take more time for the prices to fall to the point of stabilization as there is excess supply along with far tighter lending standards directly following the years of essentially “no” standards. As in any wild swing of the market pendulum, I would expect that we will be able to purchase properties for less then their replacement value and enjoy strong cash-flows for our willingness to once again be contrarian investors and invest in a punished asset class.
Our property management company Beach Front Property Management, Inc. is beefing up its management team as the business is growing fast due to an increasingly difficult rental market and also sadly because owners who purchased close to the peak are in desperate need of cash-flow. The company is currently assisting two clients through foreclosure and has turned down business from other owners who were deemed to be likely heading to bank repossession. The executive and staff recruitments have been focused on those who have experience in repositioning properties from prior market swings. This will make purchasing larger pools of troubled assets much easier since as investors we make our profits on the purchase price and a focused approach to management.
Sniffing out Opportunities
Because all owners are facing the same issues we’re dealing with, yet may not be in the same strong financial position, I anticipate opportunities in non-performing loans, foreclosed properties, broken condominium deals and repositioning of mismanaged commercial units to begin showing themselves. Recently, I’ve started analyzing deals again as there is a lot of distress yet few buyers, especially for troubled assets.
We have been patient for quite some time and do not mind continuing our stay on the sidelines until the right deal can be sniffed out. I would rather buy as the market begins turning upward than catching a falling knife.