Remember during the Great Real Estate Bubble of 2003-2006 when everyone owned multiple investment properties in bubble markets such as Las Vegas, Phoenix, Miami, etc.? These people called themselves “real estate investors”.
After the real estate bubble burst, we’re not so sure they were investors after all, but more like speculators (or gamblers) hoping prices would rise indefinitely regardless of the underlying market fundamentals.
Now, we’re starting to see investors back – purchasing low priced homes in many (previously bubble) markets across the country. Does the return of real estate investors signal the beginning of another bubble?
Not necessarily.
We have to look more closely at the assets being bought (and the manner in which they’re bought) in order to determine if we have unhealthy bubble-like activity or healthy market clearing activity.
Currently investors are actively purchasing distressed entry-level (lower priced) homes from bank REOs, wholesalers, and trustee sales. Many of these methods require an all cash purchase.
Let’s consider an example. Back in 2005 an investor would put down a small $5000 deposit on a pre-development home in an outlying area of a bubble market for a purchase price of say $400,000. That same home now is probably priced at $150,000 for an all-cash investor.
At the cost basis of $150,000 in the property, today’s investor has the option to rent out the property for a reasonable rate of return (compared to a bank CD at 2%) or fix up and flip the property to a buyer that qualifies for FHA or VA financing. A retail buyer today is often subsidized by government tax credits and seller paid closing costs.
Thus the difference this time with investor real estate purchases is the basis in the property compared to the true economic value of the property.
During the bubble, properties were purchased that had no chance at being cash flow positive when rented out. Now though, residential properties can be purchased that are cash flow positive.
Not only can today’s investors enjoy positive cash flow on properties they hold, they can often sell the properties through the retail channel (MLS) to first time home buyers and generate $15,000 to $100,000 in profit (capital gain).
In conclusion, the mere fact that investors are now purchasing a large quantity of properties does not indicate a bubble. Today’s real estate investor has a much sounder basis in their property because they can rent it for real cash flow or sell it for profit to a real buyer (not another speculator) – unlike during the bubble.
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Elizabeth,
REO means a property that was repossessed by a bank and put back on the market, usually for less than market because it needs work and they just want to get rid of it.
MLS this is the Multiple Listing Services that real estate brokers use. Its a private data base to which most professional real estate brokers subscribe.
In addition to REOs, David might have mentioned short sales which involve houses sold by the owner for less than they owe the bank. This is a slow and uncertain process because it requires the approval of the bank, but it does happen and you can get great deals that way.
There are other ways of getting these low price homes, but most of those involve lots of money or major commitments of time to develop the channels.
Hope that helps.
Very interesting analysis. It would have helped if I understood the acronyms.