Housing as an Investment Class

| August 23, 2012 More

By Nam Ngo, All Property Management

Changing Investment Model

The phrase “housing is the biggest investment most people will ever make” is a commonplace in our society. Investments in the 2000 housing boom were primarily defined by individual home owners who lived in the homes they purchased. This individual perspective of investment differs from the view of financiers. Finance likes to see investment assets churn out streams of income while simultaneously appreciating in value. An occupant-owner home does not fit this model, but rather offers a method for the owner to save and accumulate wealth in the long run.

The 2008 financial crisis and economic recession caused a paradigm shift in residential housing investments. The most notable housing investment trend of the last several years has been a shift of ownership from occupants to investors. The financial model of an owner-occupant homeowner resembles savings. The investment model of an investor-owned residential home is different than occupancy ownership. From an investment standpoint, it is very appealing to purchase rental residential housing as an asset which produces a stream of income (rent) on top of price appreciation. The rents collected from residential rentals average a 10% capitalization rate, meaning the asset will churn out 10% of what you bought it for over the first year. The typical value of an investor owned rental home is $100k, so the cash it would produce in a year is $10k. In the markets with rental demand high, the cap rate grows up to 13%. These high capitalization rates are not uncommon since the rental homes are bought at a discount rate of 30% (and even 40% in some cases) from distressed markets.

Return Estimates

Morgan Stanley views the growing family home rental market in the United States presents an attractive opportunity for investors, distinct in its model than financial securities in the equity market. Analysts estimate net annual returns to be 8.1% with a volatility index 1/5 of the stock market. In a current environment where stable investments are short, rental properties provide a safe haven for its predictability of modest returns and disassociation with the stock market.

What is “Real” Estate?

The “real” in real estate investments is best understood when compared to financial assets that are intangible in nature. Unlike financial securities, real estate occupies physical space and is subject to deterioration and depreciation. As such, it is crucially important for homeowners to maintain the physical aspects of their home to save them potentially expensive costs in the long run. The maintenance a home requires can be quite extensive, from roof repairs to kitchen appliance checkups, and so it is naturally appealing to hire property managers. In the case where the occupants are not the homeowners themselves, property managers become more attractive. That is because the personal incentive of home maintenance of occupant-owners is absent for renting tenants. As the housing market shifts towards renter ship in the upcoming years, we will see a strong move towards investor ownership of rental homes. But unlike financial securities, this investor owned homes will need to be managed, and unlike occupant-owner homes, there is little incentive to doing it themselves.

What this all means is that we can expect to see large financial funds rush to buy rental properties, fix them up, and rent them out. In this new dynamic, property managers will greatly benefit from increased business volume. Ex-homeowners can hold on to the same lifestyle by renting. Additional saturation to the houses up for sale will be stalled. The market shift toward investor-owned homes provides a small solution to the housing market.

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Category: Housing Headlines, Investment Property, Real Estate Market

Comments (6)

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  1. pikio says:

    housing investment seems risky in this economic situation due to financial crisis and inflation rate.

  2. gakio says:

    i do not think that investing in real estate market at this time is reasonable. it is so risky...

  3. Yes Rent says:

    I didn’t understand about Return Estimates. Can you explain more on it?

  4. I want to get more knowledge about Return Estimates. Please share some more blogs related to this.

  5. What are the strategies which you follow for Changing Investment Model? I want to know about it.

  6. Nam says:

    I will talk about the investment model of rental properties which I hope will inform you guys more about Return Estimates.

    The typical hold in Real Estate investment is 5 years. At the end of the 5 years, you hope to sell the home for a profit. In the meantime, you get a cash flow through rents.

    For the rental property that you own, you make receive gains in 2 ways:

    1. rent collection = capitalization rate = roughly 10% in most markets

    2. price appreciation of the home

    Here’s quick example:

    Say I bought a rental property for 100k (worth 150k in good market conditions) and each year I earn 10k in rents. Over 5 years, I make 50k off that 100k just through rents. On top of that, the house appreciates in value. At the end of those 5 years, the price modestly rose to 120k. That’s a 70k or 70% over 5 years. This is earnings before taxes, interests, amortization, maintenance fees, etc.

    The 8% annual returns estimate I cited was from a Morgan Stanley housing publication. Their returns chart is on page 6

    excerpt: “Single-family real estate in the form of rental properties, is attractive from an asset allocation perspective as its returns have
    low correlation to other widely invested assets, attractive total returns over time assuming even a conservative average rental yield, as well as a favorable Sharpe
    ratio”

    http://www.thedominiongroup.com/wp-content/uploads/2011/11/Morgan-Stanley-SF-Report-Oct-2011.pdf

    Here’s a statistical survey of capitlization rates in hot rental markets.

    http://www.corelogic.com/about-us/researchtrends/asset_upload_file630_15478.pdf

    Pay attention to the bubble chart on the last page

    Thanks for your comments and hope to keep up the dialogue.

    Oh, I think it might be beneficial to you guys for me to mention that there is strong consensus that the housing market has bottomed out and will continue the upswing we have seen in recent quarters.

    And as for inflation risk, owning physical property is a hedge against inflation because the price is not sticky. Fixed-prices and fixed-incomes are the biggest losers in inflation.

    -Nam
    Analyst, AllPropertyManagement.com

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