Up until Friday, it looked like the real estate market was on a tear. Existing home sales, which comprise about 90% of the residential housing market, and housing starts both surged to eight-year highs in June, and the median sale price for existing homes hit a record $236,400.
In addition, confidence among homebuilders has climbed to its highest level since 2005, before the housing market collapse; inventories are tight; and the commercial real estate market has appreciated so much that the Federal Reserve highlighted its concern with rising “valuation pressures” in a report earlier this month.
On Friday, however, the Commerce Department reported that new home sales fell almost 7% in June, usually one of the busiest months of the year, and lowered sales numbers previously reported for April and May.
Are these signs for investors to buy real estate now, especially before the Fed starts raising interest rates, or signs that they should hold off because the housing market is poised to slow or stall?
“The easy money has been made,” says Greg McBride, chief financial analyst at Bankrate.com. “Now that prices are higher you’re not going to get the appreciation in price that you did when you bought at the bottom.”
McBride also cautions about buying real estate for investing purposes because homeowners “already have a lot more real estate exposure than they think. They need to bulk up their equity allocation before adding a lot more real estate to their portfolio.”
But that’s not what many Americans appear to be doing. A Bankrate poll conducted earlier in July found that real estate was the number one investment choice for Americans with cash to spare. Twenty-seven percent of respondents chose real estate, compared with 17% who opted for stocks and 23% who opted for cash equivalents. Real estate was especially preferred among investors in the West and in urban areas, between 30 and 49 years old and with incomes between $30,000 and $50,000.
For those investors who do want to own real estate — and hopefully have already bulked up their equity holdings — there are some key issues to consider.
Are they buying real estate for a steady stream of income or capital appreciation or both? “Buying for income stream can make a lot of sense,” especially for retirees looking for more income than a short-term bond or bond fund can provide, says Eleanor Blayney, a consumer advocate for the Certified Financial Planner Board of Standards, about direct property purchases. “Cash flow can be enhanced through depreciation, and you can deduct a lot of expenses.”
But Blayney cautions that investing in property is complicated, requiring time and attention and lots of money not only to buy a property but also maintain it, including paying a property manager if you’re not handy and living nearby.
That’s why Richard Kagawa, a financial advisor in Huntington Beach, California, who says he loves real estate and owns several properties by himself and with siblings, recommends direct property investment only to “well-heeled clients” and requires at least 50% down payment. “This way you probably can cover your mortgage with your rent minus expenses plus see some positive cash flow,” he said. For those investors who don’t want the headache of being a landlord, there are other choices. They can buy shares of a real estate investment trust, which, in turn, owns and manages income-producing real estate and/or the loans that finance those purchases; or shares of real estate ETFs or mutual funds, which own REITs, real estate-related stocks like home builders and home improvement companies, or both.
S&P’s Residential REITs Index has gained 4.6% year-to-date in price alone, excluding income, so its total return is even higher, but it has come under pressure from the expectation of higher interest rates, says Cathy Seifert, equity analyst at S&P Capital IQ.
“When you look at REIT stocks in rising interest rate environment it’s important to look at what kind of debt is financing its operations — is it fixed or not, capital structure, the mix of debt on the books, because the degree of leverage can vary substantially,” says Seifert. She notes that rates are not the only variable that impacts REITs. There’s also the labor market and income growth, household formation and demand for retail and residential space, including multifamily housing.
Now investors can also participate in crowdsourcing real estate marketplaces, helping to finance direct investments in residential or commercial developments. Ben Miller, co-founder and CEO of Fundrise, which provides crowdfunding real investments online, says this cuts out the middlemen and reduces fees as a result. He likens the site to a private equity fund invested in commercial real estate and available online for a minimum $5,000 investment. With his site, investors buy into the debt that financed the property and collect a high yield — currently near 13% — for a period of roughly two years.
His typical investor is “40-something, a business professional in finance, tech or real estate who probably owns mutual funds and ETFs and is looking for alternatives … someone pretty sophisticated.”
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