A little less than a month ago, the Federal Reserve Board Chair Janet Yellen raised interest rates once again. Hidden amongst most people’s holiday preparations, the increase was not significant, yet it was a clear indication that the days of Quantitative Easing are ending, and Quantitative Tightening will rise. Earnings growth and cash flow growth will be driving the markets.
It means that interest rates for mortgages will continue to increase in 2018. Combined with higher market prices, this may pose certain challenges for the Real Estate Investor. Before we look at predictions for the upcoming year, let’s take a quick look back.
The past year was a mix of good and bad news as far as real estate investing went.
It was good news for all real-estate investors that property values were near peak levels in 2017 for many markets. Most properties purchased in the past eight years have completely rebounded and are now in the black.
The bad news from the past year? Property values were near peak levels in in 2017 for many markets. This is because inventory was relatively low while demand from frustrated renters wanting to own homes increased steadily throughout the year. The supply of deeply discounted property had dwindled. While there is a traditional steady trickle of these properties, the easy availability, and huge margins that investors enjoyed over the past few years are fewer and farther between. That will make buying property this year more challenging.
In addition, new tax laws will create some confusion in the early months of the year. The tax bill will negatively impact property values by reducing the mortgage interest deductions. It changes the capital gains extension on residences, capping property tax deductibility.
There are benefits to the new plan. The “like-kind exchange” will be maintained. This is an exemption that lets a business avoid taxes if it reinvests profits in another business, except in the case of commercial real estate development. It will lower taxes on pass-through businesses—partnerships, S-corporations, and limited liability companies (LLCs).These corporate entities allow business income to “pass-through” to the owner, thereby paying a personal income rate, as opposed to a business rate.
Truly the best of times and the worst of times.
How will real estate investors navigate low inventory, high prices and rising rates and new tax laws?
Real estate investors will be working with a market where property values are high and in which interest rates are expected to rise more consistently than in the past few years. While rates are still below 2%, the 25-point increase in December was hinged on strong employment and better-than-expected economic growth. The Fed is forecasting three more rate hikes in 2018. For the investor, this means higher and higher interest on properties that will continue to increase in price.
To continue to make profitable investments – and avoid the danger of overpaying, investors will pursue a wide range of strategies. Now more than in previous years, investors will be focusing on specific geographies, asset classes, and financing strategies. Nowhere is this more evident than for residential real estate.
Disasters
Recent months have seen an almost ghoulish real estate market in disaster areas. Texas and Florida saw a surge in the purchase of flooded or otherwise damaged homes following hurricanes Harvey and Irma.
In areas where the lack of flood insurance meant that homeowners were left to recover from the damages on their own, investors quickly stepped in to purchase water damaged properties to restore neighborhoods and generate profits.
Gentrification
The gentrification of lower class neighborhoods will continue in many major markets. The stuff city planners and tax assessors dream of, the renovation of old and low-income properties adjacent to trending neighborhoods will continue to offer young professionals affordable options for housing along with amenities such as modern kitchens and baths next to trendy neighborhood restaurants and businesses.
Millennials were slow to enter the housing market, but as they have started settling down, they are buying homes at rates equal to their parents. In fact, single millennials are more likely to own a home than prior generations of singles. Home prices have shot up so quickly in recent years that the latest wave of these young professionals say they are having a hard time making the finances work – even in these up and coming areas. This brings the third strategy into focus.
Creative Financing
The economic downturn of the last decade necessitated options in creative financing for real estate. When mortgages became more difficult to qualify for, new solutions were necessary. Many investors now call themselves Deal Architects or Deal Engineers to denote the skills they acquired in working out deals with creative financing.
Even though the wave of foreclosures and bankruptcies that were ubiquitous in the past decade are dwindling, there are other issues impacting the financial qualification for housing.
High rents and debt from consumer spending and student loans have made it difficult for young households to save up for a down payment.
Moreover, with prices rising steadily, even a small increase in mortgage rates could put people finances just over the edge of affordability.
In light of these issues, creative financing remains a popular option for would be homeowners who still do not qualify for traditional mortgages.
As a result, individually tailored purchase agreements will continue to trend upward in 2018. Lease to own will dominate the smart investor’s plan. This is also an attractive option for young families who can afford the monthly lease payment, but don’t have enough for a traditional down payment. For the Real Estate Investor, it guarantees a steady source of income from residential real estate without the traditional issues landlords face.
Conclusion
It is clear that 2018 will bring many opportunities to the smart investor. Climate change will surely strike again creating opportunities for rebuilding. Perceived scarcity combined with the continued gentrification of lower class neighborhoods will offer many opportunities for deals with creative financing and potentially significant monthly income. Changes in tax law will leave some scrambling while others will find a way to profit.
For the seasoned investor and savvy financial partners, this could mean a return on investment anywhere from 6 to 12% on a safe and secure investment model.
For the families and neighborhoods, this offers the chance to grow and prosper in their new homes.
2018 may be the year of the win-win solution everyone had been hoping for.
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Sources:
Lynda at Sonoran Sun | Private Equity Investments
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Further Reading:
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