Finding Solid Ground In An Uncertain Real Estate Recovery

REAL ESTATE TOPICS

The real estate recovery is gaining momentum, which should be good news for an industry that has lagged behind the rest of the economy. However, with the recovery has come a rapid growth in demand for traditional residential properties, and the market has reached the point where disciplined investors are moving beyond the returns made possible through cheap capitalization and highly leveraged residential properties and on to value added and enhanced commercial properties. In its Emerging Trends for Real Estate 2014, PwC and the Urban Land Institute noted that they expect growth to be sufficient to generate consistent and growing demand for commercial real estate across all property types, stating that this could be the “year when we see real estate fundamentals improve in sectors beyond the already very healthy multifamily sector—and in a number of markets—to a point where we could see above-inflation-rate rental growth.”

More importantly for most common investors, those rental property owners continue to do an excellent job of managing properties for growth and return despite the slow recovery, and real estate investors in general are feeling more optimistic about their ability to make money in 2014.

However, there are some hurdles to overcome before we will see a full recovery. Millennials — a driving force behind the housing market — are not buying homes because they are staying in cities where the cost of ownership is often too steep for the first-time home buyer, in part because they live, work, and play in different ways than previous generations. So far they have been more urban and less suburban then both Gen X and Gen Y; they don’t want to drive as much but do want to be mobile, and they don’t necessarily want to be tied to one geographic area. This shift in behavior has caused a corresponding shift in development activities and has led to new markets for urban rental housing, collaborative office space, and close-in warehousing to ensure same-day delivery from online retailers.

In response to this trend, real estate development over the past several years has been dominated by multifamily and build-to-suit opportunities. “We saw a big movement towards multifamily homes, and we focused our investments in that area,”writes noted real estateinvestor Tej Kohli.”It’s clear that’s where the action was, and we continue to follow through on those investments today.”

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Up and coming cities

Tying this back to urban areas trend together, developers have started focusing on potential growth cities outside the traditional high value areas. Sometimes dubbed “second tier cities,” the smaller metro areas are leading the pack when it comes to growth. Portland and the Great Northwest, Austin, and San Jose have seen greater increases in value than Los Angeles and New York. While the prices in these smaller cities are still high, they’re more affordable than the major metropolitan areas, which is one of the reasons why investors are cleaning up in these markets. The entry points are lower, and with sustained, calculated growth, the returns come back strong.”We are placing the majority of our efforts in second tier cities with visible economic growth because that is where we believe we will see the greatest return on our investment,” noted Kohli.

While these secondary cities are growing, investors still need to look at the entire economic picture of a metropolitan area before investing. For example, even though its already one of the most expensive markets in the U.S., investors are still focused on the Bay Area and its bevy of startup-created instant millionaires with large disposable incomes.

Before diving into a real estate investment, research the development, sales, and market trends. Have actual sale prices exceeded or dropped below listing prices? What has the rent escalation factor been over the 1-, 2-, and 3-year periods? Consider the impact of other development projects in the area and their impact on the local economy—if a new hospital is under construction, there will likely be a need for housing as new jobs come to the area.

There are great values available

Detroit isn’t the only place where you can buy a property for under $10,000 (sometimes much under). Investors with extra patience and the ability to make cash purchases can either renovate and flip the properties or simply sit and wait out the slump. The key for new investors is getting in the door at a price that allows them to add value to the property and still make a reasonable return on the investment. It’s still a seller’s market, and investors need to be ready to move quickly. With properties flying off the shelves at or above asking price in many markets on very short listing periods, it’s more important than ever for buyers to negotiate with a disciplined, logical plan: know your own non-negotiable points, areas for flexibility, and be prepared to work with the other side without giving in on key terms.

Alternative Investments

While investment opportunities exist for buyers, there are other options for investing in the real estate sector that have also seen strong returns over the last decade. Rather than direct ownership, many savvy investors are investing in real estate investment trusts (REITs) — a company that owns and manages a portfolio of income — producing properties. With the growth in rental markets, multifamily REITs have proven to be a consistently strong avenue for investors, often producing returns that exceed what traditional single-family home ownership has during the same period.

In Conclusion

In a nutshell, despite some real estate naysayers, both residential and commercial markets are proving to offer great earnings opportunities in 2014. Second and third tier cities are providing investors with great fertile ground as well. The investments are plentiful and varied across both residential and commercial depending on your taste.

Take the time to really ask yourself how much time and risk you are comfortable with and decide what investment vehicles best suit your style and go from there.

Much of your decision should have to do with how much time you can invest in market research. Take advantage of what you already know. REITs are a great way to invest as well and let others manage the details for you.