Thursday, November 12, 2009

Should I Buy Real Estate Today?

I was talking with my Dad on the phone last night, and at the end of the conversation he mentioned a friend of his was in the process of purchasing real estate as an investment and he asked me if I thought it was a good idea.

I gave him a brief answer, and while every investment decision has to be made based on a wide variety of factors such as that person's age, income, family, investment goals, etc., I'd like to talk about that answer a little here.

Before I get there, I want to preface by saying that there may be no one on earth who thinks more about the direction of real estate prices than myself. Some of you who read this know me well and others have never met me or know much about me at all.

Based on my extremely pessimistic outlook on the direction of the market, it may seem strange to hear that my life is 100% focused and dedicated to the purchase of real estate.

I spent 40+ hours per week managing a 460 unit apartment community in Charlotte, NC. I spend my days paying rent, paying bills, filing evictions, speaking with vendors, managing a budget, marketing, and learning everything it takes to run a building from top to bottom.

The work is extremely hard, and the pay is horrible.

In my free time I work with a real estate developer who is focused on building a new company. This company is involved with real estate financing projects, consulting with banks on distressed properties, and brokering deals with banks, developers, and builders in the area.

While I'm not working on those projects, I am usually churning through financial statements for commercial property across the country. I run income/expense analysis projectings using software programs to determine how attractive a building is as an investment.

I am also currently studying to receive the Certified Apartment Manager designation.

If you have read more than two articles on this web page you know that I am about as bearish on real estate as anyone in the country. So why on earth would I spend my time doing these things? I'll get to that in a second.

First let me answer the question above. Is real estate a good investment today?

Real estate prices in general are a function of two factors:

1. The wealth of a country. (The median income and percentage employed)
2. The cost to finance real estate. (The cost of credit)

I believe today that both those factors are working together against real estate.

1. The median income in this country has been stagnant for over ten years. This is a scary statistic for a country that has found itself deeply in debt. On top of that unemployment continues to grow month after month. Both of these factors are likely to get worse moving forward.

2. As I have discussed in detail previously, credit/financing for real estate today is almost exclusively being provided by the government and the Fed. The Federal Reserve has become the ultimate buyer for new mortgages issued, and the government has stepped in and provided tax credits to new purchasers.

Let's talk about that for a second, because this is the most important piece to understand the full picture:

If you buy a home today with an FHA loan (government loan), for $200,000 you can receive a 5% interest rate and only need to provide a 3% down payment. With this wonderful loan package many new buyers receive a check from the government for $8,000 for purchasing the new home.

For simplicity sake, let's say that you get an interest only loan.

3% down on a $200,000 home means that you only need $6,000 to close. As I mentioned before the government is chipping in $8,000, so you essentially receive a check for $2,000 for buying the home.

You also lock in on a total monthly payment of only $1,050, estimating taxes at (1%) and insurance at ($50). Going rental rates for your home in this area are $1,200.

To a new buyer deciding to purchase the home appears to be a no brainer. However, lets fast forward two years as this new buyer decides to sell their home and take the profits on their home equity.

In the world I see, for reasons I will focus on in other articles, interest rates are going to be higher. Much higher. Government bonds, corporate bonds, and especially mortgage rates are going to be very different.

The average mortgage rate going back over 100 years is around 10%. I see a world where they could be higher.



The average down payment on a home going back over 100 years is between 20-30% down. I see a world where the down payment could be higher.

How is this possible? Imagine a world where the government did not provide home buyer tax credits, and the Federal Reserve did not purchase all new mortgages. Can you imagine this world? It is the world we lived in only 10 years ago.

If the free market had to price credit/financing for homes then they would charge a higher price. Let's look back at that same scenario in this new world:

The home owner decides to list home their home at $200,000.

Having to put down 20%, a buyer has to come up with $40,000 in cash at closing. If interest rates are at 10%, then the total payment on that $160,000 mortgage is now $1,500, instead of $1,000.

What if the median income in the area has fallen, and what if unemployment stays above 17%? What if incomes fell and unemployment rose?

In order for these buyers to put down 20% and be able to handle a 10% interest rate based on their income, real estate prices would have to collapse.

Is real estate an good investment today? No. I do not believe it is.

That being said, I believe there is an opportunity of a lifetime to purchase real estate in a few years. This future time period is what I prepare for today.

I do not own gold and silver because I think it's a good long term investment. I own them because I believe they will be able to purchase more real estate in the future than any other investment.

I do not spend my days working at an apartment community because I like the job or the pay. I do it because I want to walk into a bank in two years and tell them I have the ability to purchase and manage their asset with absolute certainty.

For those of you that have taken my advice over the past few years and put a portion of your wealth into precious metals I congratulate you on taking that step. You may be wondering what the next location for your money will be once the precious metals have reached their peak.

I assure you that I am focused on that next step today. When the time comes if you are brave once again, I will provide partnership opportunities for distressed real estate assets across the country.

That is some time away, so until then please consider carefully your investment choices today, hope for pull backs in gold and silver, and keep adding to your positions.

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