Real Estate Investors: Go Away, For Your Own Sake

Assuming you didn’t take my advice based solely on the headline, here’s the line of thought for today inspired by an e-mail I sent one of my investors on Monday:

In this market, with inventory as thin as it is, about the only way to secure a home is to overpay for it. There are no bargains out there right now.

Everything – everything – new to the market is going to be a multiple offer, highest and best scenario where the highest cash offer will win. And the ones on the market longer, such as this one, are going to be overpriced and most likely by more than a couple of thousand. The gamble is whether values will come up between now and when you want to refinance. Some might, some might not. Hard to say.
The only way to avoid the multiple offers and get to where you can finance is with new builds, but there aren’t new builds open to investors for less than around $130,000 or so.
Just the state of the market right now. When we finally get some more inventory – assuming the wave some predict finally shows after four years – there will be some more opportunity.

Now, a couple of qualifiers. The above applies primarily to those looking for homes in the sub-$100k range (something we in the biz call “bargains”) though it safely can be said of homes running up into the mid-100s just as easily. This also applied to someone who, quite logically, would prefer to finance and leverage their cash versus having to come in with cash on every single property – something that isn’t working these days below around $125k or so.

It’s all simple supply and demand – we’re at 8,310 detached homes across Maricopa County, a net drop of 230 homes from Sunday – that’s a 3 percent net drop in the inventory in about 48 hours time. Homes that come to the market are like a drop of water on a hot skillet, bubbling with a sizzling sound and then disappearing.

Of those 8,310 homes, only 665 are priced under $100,000; investors chasing these homes reminds me much of a pack of hyenas all attacking the same carcass. Or, for those who prefer their metaphors more Disneyesque, like kids (and spouse) digging into a plate of cheese fries at Disneyland’s ESPN Zone. In either case, there isn’t nearly enough meet on the bone (or fries on the plate) to sate everybody’s desire.

As it stands now (subject to change if conditions change), the waiting game isn’t a viable option; part of the reason there are so few homes in the sub-$100k price range is the scarcity of resale housing is pushing prices higher and higher by the day. So if you happen to be waiting for that alleged tsunami of homes to hit, know in advance that those homes are going to be priced at a higher level than they might have been had they hit the market six months ago. Or three months ago, for that matter.

None of this is to say real estate investment in Phoenix is impossible. It is to say if you happen to be trying to invest in the sub-$100k market, you’re better off in about 1,000 locales other than the Phoenix real estate market. That window of opportunity has all but closed after being open for the better part of three to four years. The lone exception may be in the trustee’s sales, assuming you’re comfortable with the risk attendant in purchasing a home sight unseen and thoroughly uninspected  with absolutely zero contingencies – a workable scenario if you’ve got a crew who can do any work needed on the cheap, more daunting if you don’t.

Where the opportunities currently exist are in the new build world. Base models in Buckeye start around the $100k mark and $150k will get you into spec homes in areas such a Surprise or Glendale. Note: it also helps to know which communities and builders allow investors – information I happen to have handy.

Depending on the areas, the rents are not going to be earth-shattering. But much like a sports franchise, where there’s as likely a chance as any of either operating losses or simply breaking even, the value isn’t necessarily in the cash flow as much as the potential. No, my friends, real estate does not always go up (as the diehard Realtor haters will say we always say). At the moment, however, there’s better potential in the appreciation than in the rent.

This may not make the Phoenix market the most attractive out there (he says, in a blatant paean to real estate guru Jeff Brown). In general, though, I’d still be inclined to bet my long-term money on the Valley of the Sun as there’s more long-term potential in this market, which already has been beaten down and is starting to come back ever so slightly, than elsewhere.

We’ve got some really smart real estate investment types who read this site, Mr. Brown included. The defense rests here and I turn things over to them in the comments.

About Jonathan

Jonathan Dalton is a 30-plus-year resident of the Valley and has been helping folks buy and sell homes since 2004. He can be reached at 602-502-9693 or info at allphoenixrealestate.com.

  • Hey Jon — Of all the markets on which I keep tabs, Phoenix is maybe the most troublesome, even mystifying. It’s not just the current micro goings on, re: supply/demand, but the upcoming(?) foreclosure increase. It’s what appears to be a trend in AZ’s macro analysis. Sadly, the political climate, which for good/bad/ugly directly affects real estate, and business in general, has been showing empirical signs of hangin’ a left. 

    However, as you’re painfully aware, AZ, at least lately, has been a split personality, politically. On one hand state gov’t touts values and principles for which they’ve been known for generations — we’ll call that personality the Goldwater side. Then there’s the Janet Napolitano side. Though people can surely agree to disagree on economic principles, the economies themselves cannot. It’s that part of AZ that keeps me at arm’s length, as my experience with CA has left me more than a bit gun-shy. Once a state buys into the high tax, high regulatory, statist approach, it’s pretty much a matter of time before their economy begins to mimic CA. As you’re well aware, that ain’t a good thing. 

    I love AZ, but as far as investing their, I’m in a long term holding pattern.

  • Another Investor

    My problem with the Phoenix market is twofold.

    First, it is a dramatically cyclical market.  Because it is close to the breathtakingly expensive California market, money pours in when prices are comparatively low.   When the Phoenix economy is strong, there is a lot of demand for housing from owner-occupants as well as renters.  There is net inward migration, particularly from California, for lower housing costs and improved lifestyle.   Investors see better rent to price ratios and dive in for actual cash flow as well as appreciation. 

    In the 15 or 16 years since the end of the last housing bust, Phoenix’s economy has grown substantially and it has diversified.  It’s not all call centers and warehouses now.  However, when the larger economy softens, Phoenix falls faster and harder.  Although the economy is diversified, many of the business functions housed in Phoenix are back room, non-core functions that get cut severely in a downturn.  In addition, construction and other real estate employment are large contibutors to total employment.  When economic growth deteriorates, these jobs are the first to go. Employment is more volatile than in corporate centers.  Because employment and housing are so closely tied, the housing cycle is more pronounced in the Phoenix market.

    The second and more important problem is the realized cash flow.  The last time rents went up by a very large percentage was 1994-95.  When I bought my first house in Dobson Ranch 16 years ago (1996), market rent was around $1,100.  The same house would rent for $1,350 today.  Calculate that annualized rate of growth.  The reason for this is the supply and pricing of housing available for purchase.  If rents go up, good tenants become buyers.  With plenty of available buildable land, “drive until you can buy” becomes the renter’s mantra.  The investor is left with a less attractive tenant pool.  If the economy then weakens, rents will actually decline.

    Flat rents are bad, but increasing operating expenses and capital improvement costs are the killers.  A roof that cost $3,000 in 1997 costs $10,000 today.  A/C units cost $2,000 to $2,500 then, and $4,500 to $7,000 today.  $10-$12 per hour marginally skilled labor is $25 per hour or more.  Property taxes have more than doubled in some places.  Part of the problem is business owners and workers moving in from California and bringing California price expectations with them.  A bigger part of the price increases is the cost of commodities and the cost of government regulation that are factored into prices.

    My guess is the rent increases we have seen lately are not sustainable.  As the short sellers and the foreclosed find their way back into the market, demand for rentals will drop and rents will flatten or decline.  As long as buying is affordable and government policy favors getting these folks back into home ownership, they will choose to exit the rental market.  Economic growth will bring migration, but the benefit to the rental market will be temporary.

    As long as interest rates stay low and the Phoenix economy strengthens, I believe we will see strong appreciation in prices.  I do not think we will see the same in rents.  More important, I see no reason to expect an end to the increases in operating expenses or the cost of capital improvements.  Investors at today’s and future prices need to think carefully about their goals before they jump in blindly.