Investment Home Sales: Can Anything Slow Down This Trend?

According to a recent article published by the National Association of Realtors, buyers of residential investment properties still held strong in 2016. This volume rose by 4.5 percent from the previous year driving up prices by 8.0 percent. Data showed the primary reasons buyers purchased investment property was to generate a steady monthly income. Investing in residential real estate is a way to not only generate a monthly cash flow but to also watch the asset grow in value. Consider most any other investment class such as stocks or mutual funds. A stock or mutual fund can provide a dividend and fluctuate in value but does not generate income each month. While a particular stock can increase in value it can also fall in value, or worse, become worthless should the publicly traded company go bankrupt. Real estate values cannot go to zero and investors understand this fact.

Investors have been warming up to real estate in recent years as home prices in most areas have stabilized. Prices for housing nationwide finally surpassed the 2006 level in 2016 after taking 10 years to recover from the credit market bust in 2008, this according to a recent article appearing in Forbes. Beginning in late 2008, credit markets essentially dried up. Mortgage giants Fannie Mae and Freddie Mac were taken over by the federal government and both are now taxpayer owned entities. For a time, mortgage companies were wary of approving a mortgage loan in fear of a “buyback” in case Fannie or Freddie determined the loan did not follow underwriting guidelines.

Over time however, lending guidelines returned to a more common sense approach as mortgage lending requirements relaxed compared to their more rigid stance, making it easier to qualify for a home loan. This has led to more new homes being built as home builders see higher wages for consumers and relaxed credit guidelines.*

Interest rates are still at relatively low levels keeping financing costs in check and boosting cash flow. But, will these trends continue? What can derail the demand for rental housing?

Interest Rates

If the primary reason real estate investors buy real estate is due to the cash flow and equity appreciation, then rising rates will create a cash flow crimp. As rates increase investors can offset the rise with higher rents but that can’t continue forever. Earlier this year, Federal Reserve Chair Janet Yellen announced the FOMC will continue to gradually adjust interest rates higher and markets could expect three rate increases in 2017.** The most recent rate increase was this past March when the Fed upped the Federal Funds rate by another 0.25%. This moved followed a 0.25% bump last December. If the FOMC does in fact raise rates two more times by the same amount in 2017, that’s one full percentage point above where they were in December 2016.

And speaking of rising rates, do you remember QE? Quantitative Easing became part of Wall Street lexicon as the Fed began a bond-buying binge scooping up mortgage bonds and now holds some 1.75 trillion in mortgage-backed securities. This activity kept bond prices artificially high keeping yields low. But as the Bloomberg article points out, at some point the Fed will get out of the bond-buying business as the economy strengthens. This could lift 30 year mortgage interest rates past 6.00 percent within a three year period.*** According to Freddie Mac’s weekly mortgage interest rate survey, the 30 year fixed rate averaged 4.05 percent as of May 11, 2017. A jump from the 4.00 percent range to over 6.00 percent would have obvious consequences.

Demographics

As more and more baby boomers retire, buying power is shifting to the so-called Millennial class, those aged somewhere between 18 and 32. Think back 10 years ago and see what this group witnessed first hand. Foreclosures, bad economic news, layoffs…it wasn’t a very pretty time. As they mature, they may not be all that excited about buying real estate and decide the more prudent thing to do is rent and not buy. This has been fortunate for real estate investors but it could very well be that Millennials are shifting toward home ownership as they get older and their careers begin to stabilize. An overall decline in the number of renters could signal an eventual reduction in rental rates simply due to the laws of supply and demand. Today, Millennial purchases account for 45 percent of all purchases, according to a study released by CNN Money.

It’s not hard to imagine those aged between 18 and 32 are more mobile than someone say 45 or 50 years old planning for retirement and owning their own home. They’re much more likely to get transferred by their company or simply decide they’re tired of where they live and decide on a move at the end of a 12-month lease. If they decide that Chicago isn’t the place to be and want to move to Austin, Texas they can. They’re not tied down to a mortgage. However, Millennials are getting older and are seeing an economy on the mend. They’re ready to settle down and own a home and stop the cycle of renting.

Certainly there doesn’t appear to be any sort of a real estate collapse due to rising rates and demographics. Rising rates are a sign of an economy that’s improving and the Fed steps in to make sure inflation won’t be a threat in the future. Yet for real estate investors these two factors, rates and demographics will have a direct impact on their investments. Investors know that owning real estate over the long haul is a more prudent practice and are prepared to weather any storm. There really doesn’t appear to be anything that will completely derail the investment real estate market, but there very well could be a slowdown.

*These 5 Trends Will Shape the Housing Market in 2017, Fortune Magazine, December 29, 2016

**Fed Raises Interest Rates for Third Time Since Financial Crisis, The New York Times, March 15, 2017

• **Everyone is Suddenly Worried About This U.S. Mortgage Bond Whale, Bloomberg, February 5, 2017

Jeffrey Lawrence Kirsch is a mortgage expert in the United States. He is an expert in non-performing loans and distressed mortgages as well as social impact investing. He writes about commercial and residential real estate.