Monday, February 6, 2012

2012 Real Estate Outlook: Supply - Local Market

2012 Real Estate Outlook: Introduction
2012 Real Estate Outlook: The Rise (1980 - 2006)
2012 Real Estate Outlook: The Fall (2006 - 2011)
2012 Real Estate Outlook: Where We Are Today
2012 Real Estate Outlook: Where We Are Going
2012 Real Estate Outlook: Demand - Willingness
2012 Real Estate Outlook: Demand - Ability
2012 Real Estate Outlook: Supply - Local Market
2012 Real Estate Outlook: Supply - Shadow Inventory
2012 Real Estate Outlook: Conclusion
2012 Real Estate Outlook: Commercial Real Estate

The numbers reviewed on this site are based on national information. Many of my readers are from outside the United States or they are looking for information about the US housing market as a whole to make macro-economic decisions on the economy and impact of price direction.

For this section, I want to speak to a person reviewing this information that is specifically trying to decide on whether or not to purchase or sell a home vs. renting.

It is important to understand that the motto "all real estate is local" is true.

I wanted to discuss the financing of real estate first because financing a home in today’s landscape will be the same for someone looking in Detroit and someone looking in Washington DC. It should not be this way, but due to our government run mortgage business, it is the world we live in.

This means if you agree with my previous analysis, no matter what city or town you live in, the ability to finance loans over the next few years is going to be a net negative on your investment.

However, when discussing supply, this is not always the case. There are portions of America that experienced far greater bubble-like symptoms during the run up and the enormous supply created still needs to be worked through. In addition to the number of homes for sale in your area, you must also weigh the cost of a monthly mortgage payment against the cost of a monthly rental rate.

When looking at the cost to rent, you must also factor in the future cost to rent when the coming shadow inventory will hit the real estate market (discussed in the next section).  To help explain why, let's go back to our original example:

Let’s say you live on an island with 100 people, 70 of which want to live in a home while the remaining 30 are content to live in an apartment community. 35 of those 70 that are willing to live in a home cannot qualify for financing, so they would like to rent. There are currently only five homes for rent, which has driven the cost to rent very high.

However, there are an additional 20 homes in foreclosure, but have not yet hit the market for sale. The island bank is holding them off the market because they do not want to take the write down and have to close their business. The question is, what will happen to the cost to rent a home when these 20 properties hit the market? It will be reduced greatly.

This is why apartments have had a temporary surge in both valuations and rent (a topic I will discuss further in the commercial portion of this forecast). They have the combined advantage of both foreclosed homeowners moving out and the shadow homes being held off the market constricting supply.

Let me give you a real life example of why understanding shadow inventory is important in your rent vs. buying decision:

I live in uptown Charlotte, where rents have surged due to a limited supply of inventory and high demand for rental property. Down the street, there is an enormous condo building sitting almost completely empty.  If an investor were to purchase this building and turn the condos into rentals, the supply available in the city would surge.  Rents would fall across the board, which would change the outcome of a rent vs. buying decision for someone who did not know this shadow inventory existed.

For reasons I will expand on in the next section on shadow inventory, a large portion of the foreclosed real estate in our country has not yet hit the market for sale, but for this discussion we are looking only at the homes you can see for sale through the multiple listing service (MLS), which can be accessed through any local real estate agent.  Once you have your data set you can begin to analyze price direction.

When making a decision to purchase, you must look at the available supply on the market (MLS inventory), the current economic strength of your community, and the future economic strength of your community (when you will be selling).

For example, the housing market in Washington DC is roaring right now. The main source of jobs in DC is the federal government, which as most know has seen a spending surge since the financial crisis hit. Residents of that area have not felt the recession in terms of unemployment. I tell my friends when I visit there that it feels like Miami in 2006.

As a potential homeowner in DC, this may seem like an excellent opportunity to purchase, but you must also factor in what federal spending will look like in 3-4 years when you are looking to sell. If the federal government were forced to cut spending, it would simultaneously reduce the income levels in the DC area. An income reduction would simultaneously reduce the price level which the pool of willing buyers in the area could pay for a home (think of the island). If you believe federal spending will be higher in 4 years and the annual salaries will be larger then it changes your investment outlook.

The same goes for any jobs category. Purchasing in Detroit and counting on jobs related to manufacturing was a losing bet in 2008. However, in small towns in North Dakota right now, real estate is booming due to new jobs related to oil fracking. An investor looking to buy in a market must project out the job growth and income growth in the area years ahead to when they plan to sell.

Once you have a strong understanding of the ability and willingness of the potential buying pool (demand), you must factor that against the current inventory of available homes (supply) in your market, which you can gain access to through the MLS and the services of a local realtor.  By looking at how quickly homes are selling per month, you can acess data on how quickly the inventory will be gone in your city. Lower inventory (supply) means higher prices everything else staying equal.

With this understanding, you are ready to look at the final piece to the puzzle: the second half of the supply equation which is unseen to the untrained eye.

Next: 2012 Real Estate Outlook: Supply - Shadow Inventory

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