Since August of this year, when the sub-prime fallouts caused a ripple of fear felt by most real estate investors, many questions have come to mind. Is the market going to tank? How long will it take to recover? How far will prices or interest rates fall or rise before it makes sense to invest again? What do buyers, sellers and investors do in the meantime?
Real estate markets by their very nature are cyclical. In Southern California in particular, we have benefited greatly from rapidly ascending property values and tidy profits on relatively short-term investments. How long can this last, is the question. As far as home prices go, here is an astounding statistic. The ratio of housing costs to household income in California is 8 to 1, as opposed to 4 to 1 in places such as Seattle. The national average is 2 to 1. This means that a California homeowner is paying eight times his annual salary for his home. One does not have to be a mathematician to conclude that such upside down economics have to change.
I recently had a very nervous client ask my advice about what she should do with the equity coming out of a property she had sold. Poised to do a 1031 exchange to defer taxes on the gain, she was hearing such horror stories from the prognosticators of doom that she was considering paying the capital gains tax and putting her money into stocks, bonds or even CDs. The fear of making a bad investment decision was beginning to outweigh her reluctance to pay the IRS.
In speaking further with the client, I learned that what she was hearing from her well-intentioned friends and associates had more to do with the downturn in the residential market than in commercial. Since she had sold a commercial investment property and would need to replace it with another investment property to satisfy her like-kind exchange, we started looking at her options and trying to decide which ones held the lowest possible risk, if in fact we are heading into a down market.
As real estate cycles are nothing new, it is helpful to look back and see what types of properties have traditionally held their value in good times and bad. Even in the worst of markets, such as that of the early 90’s following the tax law changes and the oil crisis, there are two property types that have weathered the storms with relative ease. They are well-anchored, multi-tenant retail centers and newer, well-located multi-family properties. Here are a few reasons why this is true.
When the economy is in a slump, consumers still need to shop, and do so more frugally. Whereas the higher-end, pricier boutiques and specialty centers may not be able to hold on, a newer regional or neighborhood center anchored by a grocer, a solid discounter such as Wal Mart or Target, and mid-priced soft goods retailers will fare well. As families become more budget conscious, they are more likely to shop at Target, buy clothes at Old Navy or TJ Maxx, and fix up their homes with products from Home Depot. My advice to the client was, if she is considering putting her money into a retail center, look for one such as the one I just described, where the occupancy is stabilized with creditworthy tenants on long-term leases.
Likewise, when the economy slows, many potential new home buyers will be looking at renting instead of buying a home. This is particularly true at this time with the uncertainty in the residential lending markets. Looking for newer, Class A multi-family properties in infill locations where the job market remains strong is a good investment strategy. As more renters come into the market and occupancy levels rise, rents will rise accordingly, creating greater value. Likewise, there will be fewer competing properties built /as credit remains tight. Therefore, well-located apartment properties would be an equally good choice.
I also reminded the client that one important thing to keep in mind is that real estate should not be considered a short-term investment. There are times when investors have been able to flip properties and make tremendous short-term gains, but these times are rare and probably not a safe bet for the future. A savvy real estate investor will consider the long-term benefits of owning exceptionally high quality real estate, such as retail and multi-family, and hold on to it until it reaches maximum appreciation. How long this might be is anyone’s guess, but a good rule of thumb is somewhere between 7-10 years.
Real estate investing is inherently risky, and never more so than in an uncertain market. Wise investors will look at mitigating the risk, however, rather than pulling out and missing opportunities for future profits. Almost anyone can make money in a boom market. It is more challenging to make money in today’s market, but it can be done.
Written By
Jane Hope, CCIM
Vice President - Sales and Marketing
Contact AptBldgTrader Investment Group for further information about Jane Hope and SCI
