Future investor sales will limit appreciation
In a normal and healthy real estate market, sales are dominated by owner occupants. These owners accumulate equity through paying down a mortgage and price appreciation, and they execute move-up trades seven to ten years after they buy their starter homes. Unfortunately, that isn’t the market we have today.
For the last several years owner occupant sales have been stuck in a holding pattern at 1990s levels. Orange County home resale volume very weak by historic norms, and the only increase in sales volumes over the last couple of years has come entirely from investors. Unlike owner occupants, investors don’t accumulate equity for a move-up purchase. Most hold the property for a while, collect some rent, and sell when they feel they need the money for something else.
Ordinarily, investor purchases are a small fraction of the total market, and they are dispersed over time. Over the last few years, investor sales are a high fraction of total sales, and they are concentrated in time. Most of the investors who purchased over the last few years are very different from the over-leveraged speculators who bought during the housing bubble. Many paid cash for their investments, and the remainder put at least 20% down. Most will be cashflow positive and feel little or no pressure to sell in the future. However, many of them have a planned exit strategy, and particularly with the hedge funds, many will sell these investments in five to ten years.
A concentration of sales overhanging the market will limit future appreciation. As with cloud inventory of distressed sellers, most investors are withholding their properties from the market until prices reach some higher value, and they will hold out until prices get there before they sell. For the market to push prices higher, many new buyers will need to step up to absorb the cloud inventory of distressed sellers and the investor inventory waiting in the wings.
by Jann Swanson — May 21 2013, 12:10PM
Recognizing that real estate investors have played a key role in the state’s housing market recovery, the California Association of realtors® (C.A.r.) recently surveyed its members about their interactions with investor customers and have developed a profile of investors and their behavior.
Two-third of investors are following a long term strategy in investing, buying and holding property although three-quarters of intend to hold the property for less than six years. About one-quarter (26 percent) of inventors buy property in order to flip it.
The first statement about long term investing is not congruent with the statistics on selling quickly. Six years is not a long-term hold on real estate. If 75% of investors plan to sell that quickly, a great many homes will come to market at higher prices in the later years of this decade.
Most investors, about 75 percent, are what C.A.r. termed small mom-and-pop type, owning between one and ten investment properties. Fifteen percent own one property, 46 percent own two to five, and 14 percent own six to 10. Owners manage more than two-thirds of the properties rather than hire a professional manager.
Single-family homes represent 78 percent of the investor purchases, 14 percent were multi-family properties and 7 percent were other investor types. Bulk-sold properties made up only 1 percent of sales.
Investors spent a median of $272,000 on their properties and 67 percent of transactions were all cash.
Wow! That’s a lot of all-cash buyers. Some people have speculated that investors will panic and sell in a stampede that causes prices to crash. While that was true for over-leveraged speculators, that’s not what all-cash buyers will do. Most will wait patiently for prices to rise before they sell. They form a ceiling, not an anchor.
Eight out of ten buyers made repairs to the property at a median cost of $10,000 or 4 percent of the median sales price. The more expensive the property the less the investor spent on repairs with an average of 4.2 percent of the median price spent on properties priced below $250,000 compared to 3.4 percent where the properties cost more than $500,000.
Among the reasons investors cited for buying or selling include profit potential (cited by 34 percent), good price (26 percent), low interest rates (10 percent), personal (6 percent), and location (4 percent). The median rate of return on investment was 14 percent.
The median rate of return on investment will not be 14%. Orange County houses are lucky to provide a 4% cap rate, and even with appreciation factored in, getting to 10% annual returns over the course of the next six years is a stretch. Perhaps those with a minimum 20% down payment might see cash-on-cash returns that high, but most won’t. The 14% return reflects their fantasies more than any concrete reality.
Fifty-nine percent of investors found their property on a multiple listing service and 27 percent were foreign investors. China, India, and Mexico were the most common countries of origin for foreign investors.
The rumors of foreign buyers make for great anecdotes, but their impact on the market is not as large as most believe. If investor sales are 30% of the market — which is double the historic norm — and if 27% of those are foreign, that means about 8% of market sales are foreign investors. Conversely, 92% of market sales are American citizens.
Prices are still rising rapidly today, but house prices nearing affordability limits in many markets, and many distressed borrowers are lingering in cloud inventory. Add to that supply the exits of large number of investors, and the ceiling on future house price appreciation comes clearly into view.