Tuesday, March 29, 2011

Market Fundamentals Return To Residential Real Estate Markets

KSIR Capital announced to deaf ears that "The era of the cash flow model" had returned to residential real estate investing in 2009.  Market participants were still chasing deals as prices fell.  Proudly belittling our cash flow model and promising that appreciation along with the $8,000 first time home buyer tax credit would leave us wishing we had listened. 

As we watched former tech-stock day-trading wanna-be types reach in front of a freight train of falling prices to pick up a penny we could hear them saying, "When the market comes back you will wish you had listened......."  Responsibility for proper management of capital precluded us from listening.

The proper model for purchasing non-owner occupied residential real estate is as follows:
  • R / (P + I) = X
  • X is the desired gross monthly rate of return*
  • R is the market rate monthly rent for the unit determined by accurate comparables
  • I is the amount of capital improvements needed to make the unit rent ready
Solve for P and you get the maximum purchase price that can be paid for the property.  This eliminates all emotion and fear of missing out on a deal.  If it does not fit the model then it is not a deal, move on.

*Gross monthly rates of return should be used in the model.  A separate calculation to determine how your holding company handles operating costs is appropriate. 

As the article below offers a clue that we may have again preceded the herd, new predictions are in order.  A bottom in residential real estate is near.  This bottom is not important to mark to the date but this will match the beginning of a new uptrend in gold bullion prices.  The second week of June 2011 appears to be the most probable date.

Also, this bottom will not form a V as it recovers on the chart.  In the future the herd will glance back to see that 3% annual growth rates in real residential real estate values succeeded the buyer's lost access to easy credit.  Nominal prices can not be predicted in this circumstance.

Click the headline for access to the full text

Cash-Paying Vultures Pick Bones of U.S. Housing Market as Mortgages Dry Up

Chairman of Delavaco Properties Andrew DeFrancesco
Andrew DeFrancesco, chairman of Delavaco Properties LP. Photographer: Mark Elias/Bloomberg
Delavaco Properties LP plans to spend as much as $30 million this year and $40 million in 2012 to buy bank-owned houses and condominiums in foreclosure-ridden South Florida. The private-equity fund will pay cash.
As lenders tighten mortgage standards and consumers stay on the sidelines amid a five-year slide in home prices, all-cash purchases are surging. The deals are done mostly by investors who can get properties for less than buyers needing loans, fix them up and resell or rent them.
“If there weren’t vultures out there, you’d have a city of dead carcasses,” Robert Theocles, an independent consultant for Fort Lauderdale, Florida-based Delavaco, said in a telephone interview. “It’s like the circle of life.”
A record 33 percent of existing-home sales were made to cash buyers in February, when an annualized 4.88 million properties changed hands, the National Association of Realtors reported March 21. That compares with 15 percent of the 4.82 million annualized sales when the Chicago-based trade group started monthly tracking of such purchases in October 2008.
In Florida’s Broward County, where Theocles is based, deals with no mortgages made up 69 percent of sales in February, according to Southeast Florida Multiple Listing Service data.
The national sales data don’t count homes bought in foreclosure auctions on courthouse steps, which are almost all cash-only transactions. The “lion’s share” of all-cash purchases are by investors, according to Walter Molony, a spokesman for the Realtors association, though the group doesn’t keep specific numbers.

Mortgage Bankers’ View

The weighted average FICO score for a home purchased with a Fannie Mae mortgage was 762 last year, up from 716 in 2006, the Washington-based mortgage finance company reported Feb. 24. Fannie Mae loans, which usually require a 20 percent down payment, had an average 68 percent loan-to-value at origination.
“It’s not surprising that the cash share has gone up if you couple both the number of distressed sales that are going on and the fact that, even outside of a foreclosure auction, mortgage credit is tightening,” said Michael Fratantoni, vice president of research at the Mortgage Bankers Association, a Washington-based trade group.

Rental Demand

The growth in all-cash deals occurs amid rising demand for rental housing as more homeowners go into foreclosure, Fratantoni said. The U.S. homeownership rate fell to 66.5 percent at the end of last year from a high of 69.2 percent in December 2004, according to a Jan. 31 Census Bureau report.
Mortgage financing to buy homes to rent is also shrinking, Fratantoni said. Residential-mortgage originations are expected to fall to $1.03 trillion this year from $1.57 trillion in 2010, his association said in a March 15 forecast. Investors submitted 6 percent of mortgage purchase applications in February, down from a 2007 average of about 10 percent, Fratantoni said. That’s a drop to about $6 billion in February from a monthly average of about $20 billion in 2007.
“What financing options will be available to investors in single-family properties who intend to rent them out?” Fratantoni said in a telephone interview. “That really has been cut back substantially.”
Delavaco, which hired Theocles as a consultant, financed about $400 million in deals last year, mostly in international oil and energy projects, said Andrew DeFrancesco, founder and chairman of the fund. Delavaco raises money from institutional and high net-worth investors in Canada and the U.S.

Delavaco Deals

The fund started buying homes in January 2010, acquiring about 70 foreclosed properties in Broward, Dade and Palm Beach counties with cash offers to get discounts, DeFrancesco said. While there’s still risk in Florida real estate, the downside is less than drilling for oil in the Ukraine or other places Delavaco has invested in energy projects, he said.
“Every time I drive by that house I know it’s there,” DeFrancesco said in a telephone interview. “I know the property and I know what county it’s in and I know it has a tangible value to it.”
The plan is to hold the properties between five and seven years, enough time for the market to absorb the glut of foreclosures and for resale values to rise, said Dallas Wharton, Delavaco’s chief operating officer.
In January, Delavaco paid about $32,000 for a bank-owned four-bedroom home in Pompano Beach, Florida, that had sold at the top of the market in 2006 for $285,000, Theocles said. Delavaco spent $11,000 to replace the interior sheetrock, plumbing and appliances. The house rents for $1,250 a month, and annual property taxes and insurance cost about $2,500, he said.
“We are the people that are going in, cleaning things up, renting the properties out to make nice homes for people,” Theocles said. “At the end of the day they’re worth a lot more.”

No comments: