The Great American Real Estate Giveaway
As the media reminds us on an almost daily basis many sectors of the real estate market are in the midst of one of worst adjustments since the Great Depression. This is evidenced by the most recent California Association of Realtors CAR publication on existing home sales which reported a price decline in the median selling price of 35.3 from a year earlier. During the worst 12 month period during the Great Depression U.S. housing prices fell by a less dramatic 10.5. For investors with high tolerance for risk it may now be time to embrace the timeless proverb buy low sell high and start sifting through the wreckage for bargains. And while bargains exist they are not available universally across all locations or property types. Investors must know where to look have proper guidance and understand the proper methods for valuation. The sectors with the most opportunity are single family residential properties SFRs in class B or Bminus locations of suburbs outside major metropolitan areas. Properties in many metropolitan markets have adjusted very little while towns in extended metropolitan areas MSAs have deteriorated acutely.
Using the San Francisco MSA as an example CAR statistics released for June 2008 indicate a year over year decline of 4.3 for San Francisco proper. Comparatively the median selling price in Vallejo California a suburb about 30 miles outside of San Francisco has decreased a much more dramatic 37.3 year over year. Vallejo is still accessible to San Francisco via public transportation including frequent commuter bus routes Ferry access casual carpool access and BART access from the Richmond California station. Furthermore the statistics do not fully reflect the willingness of banks and distressed sellers to negotiate on a case by case basis in these markets. As an example one of our investors is currently purchasing a SFR in Vallejo for 104500. In this instance the property is being acquired for a 65 discount relative to the implied valuation on June of 2007 based on comparable sales from First American Title Company. Although this 65 discount is tantalizing it should not be a deciding factor in the decision to purchase the property.
Using a discount to market value approach is a fools approach to valuation at this point in the current environment because it assumes that historical prices were rational. A discount to market value wont pay the mortgage and it doesnt ensure that the home will be affordable to prospective buyers when an investor is ready to sell. Investors should alternatively use an income approach or an affordability approach to valuation.
For example consider the Vallejo property discussed previously. From an income approach assuming a 30 downpayment the cash on cash return is about 11.6 per year and the cap rate is 9.54. From an income standpoint this is an attractive cash yield. It handily exceeds the national average money market rate of 2.99 annual percentage rate and the 2.90 average dividend yield for SP 500 nonzero dividend stocks. This additional return offers substantial compensation for the additional risk and management responsibilities required for this investment.
From an affordability standpoint the medium household income in the zip code is 50030 per year. Most lender underwriting guidelines consider that 2833 of household income is an allowable limit for housing related expenses rent or mortgage plus taxes and insurance. Using this guideline as a benchmark the average household in this zip code can afford 15000 per year 1250 per month toward housing related expenses. The mortgage payment for the Vallejo property will be approximately 550 plus monthly expenses of 200 taxes insurance and repairs/maintenance which is comfortably below the affordability implied limit of 1250 per month. Assuming a 90 loan to purchase price and a 7.0 fixed rate mortgage this property could be purchase by the median household for up to 182000. This represents a 70 premium to the purchase price of 104500. As a cautionary note valuation based on affordability wont guide market values until the mortgage market returns historical underwriting guidelines. Further details of this transaction are posted on our website www.unitedinvestors.com >> education center >> sample property.
About the writer:nbsp;nbsp;Brian Topley CCIM is Chief Investment Officer of United Investors real estate investment advisors based in San Francisco CA. United Investors advises individual and institutional investors in the purchase leasing management and disposition of bank owned/foreclosure properties. He may be reached at www.unitedinvestors.com or 415 2742521.
This information is intended merely to be a general discussion not deemed to be investment or legal advice. Real estate investments are not suitable for all investors and involve significant risks. Individual investors should consult their tax advisor CPA and financial advisors prior to making any investment decisions.
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