FRIDAY, OCTOBER 1, 201
Now is the time to buy property, an opportunity of this magnitude presents itself once or twice in a lifetime. Phoenix area housing continues to benefit from demographic trends, while valuations and “timing, timing, timing” present a special opportunity. Thus, Phoenix housing is undervalued.
The Phoenix Metropolitan Statistical Area housing market crashed and burned! The overvalued housing bubble burst, correcting the inflated prices that had been driven to unsustainable levels. The prices of Phoenix, Scottsdale and Paradise Valley homes had risen over 50% in 2006. Free and open markets eventually correct, sometimes radically, to adjust to true economic value. Exuberance, mania, and now fear can distort the intrinsic value; sometimes for extended periods. As the bubble pushed prices to levels well above the historic trend, likewise the housing crash coupled with the harshest recession since the Great Depression has pulled prices down well below economic value and historic trend. The Housing Indexes of Case-Shiller and ECRI recognized a national bottom in April of 2009; locally in Phoenix, the Cromford Report confirmed the findings. The adage “Location, Location, Location” used to describe real estate investing needs to be changed to “Timing, Timing, Timing”. Phoenix housing is undervalued and a specialty opportunity exists.
Demand appears to be re-entering the housing market. In February of this year, 12 parcels were sold to builders for new housing developments, an event not seen for years. The University of Arizona Economic and Business Research Center, as reported by The Arizona Republic is predicting a doubling of new home permits from a little over 13,000 in 2009 to over 28,000 in 2011; growing to 35-40,000 in 2012 to 2016 as Arizona’s demographic trend re-asserts itself. Phoenix’s population is projected to increase by 1,000,000 in 9 year’s time. Many of the prior population forecasts have been too conservative, and some are predicting a population increase of 800,000 through the next 5 years, as climate, life style, and a continued shift to a service based economy support growth.
As properties are sellable in such areas as upstate New York, Allegheny and Cambria Counties of Pennsylvania, populations in the counties surrounding New Orleans, as well as the upper Midwest, such as Grand Forks, North Dakota will move to the Sunbelt states. These trends have been in place for years, and while temporarily stalled, will continue. A real estate investor’s horizon is by the nature of the investment typically a minimum of 5 years, but maybe forever if the investment continues to provide income and growth.
The speculators of 2005-2007 were doomed to failure. The over-valuation scenario was stretched to extremes and the investments would implode. The resulting debacle has also stretched valuation models to extremes; the descent did not stop at fair value though, but continued tumbling again to extremes. Prices in Metro Phoenix continued to decline in many opinions past fair value, and have over corrected dropping 30%, 40%, 50%, and even over 60% from the highs. Locally, The Cromford Report has indicated the overall MSA bottomed in April 2009; the year-over-year pricing of the market segments show a recovery in place. The largest segment, and perhaps the segment most impacted on the downside is the City of Phoenix, which leads the recovery with a 27% appreciation from April 2009 to April 2010. Scottsdale, still suffering from tight financing and correcting prices, shows an 11% decline. However, appreciation from the beginning of 2010 for the greater Phoenix Metro Area is reported by The Cromford Report to be over an 8% annual pace. Scottsdale and Paradise Valley are showing improvements as old inventory is being cleared. IHS Global Insight, a respected economic forecasting group, in its 4th Quarter 2009 Update projected Phoenix-Mesa-Scottsdale as over 22% undervalued. Has the market corrected from extremely overvalued to extremely undervalued much as a pendulum swings? If so, then timing is again the real estate investor’s friend. Perspective is needed.
In order to quantify value, one approach would be to weigh the advantage or disadvantage of homeownership versus renting. In 2006, a group of rentals in North Phoenix would consistently lease for $900.00/month. As a tenant, there is no monthly cost for maintenance; conversely, the tenant would not receive the benefit of tax savings nor principal reduction associated with the loan. These two factors can be argued to mitigate and nullify each other. However, the cost to own that rental had risen to $220,000.00, and the monthly payment would have been approximately $1450/month with the typical FHA loan. The payment differential was $550.00 per month greater to own than to rent; in a 6.5% interest rate environment, that equates to an $85,000 premium, or a 38% over-valuation. As the recession added more stress, the rents further decreased to $800/mn along with lower mortgage rates, which are currently less than 5.5%; the differential grew to $650.00 or a $114,000.00 premium – or 52% overvalued. The market corrected, then over-corrected, but correlated with the valuation model. Today that same property is available for $75,000. The payment would be $550.00, discounted $44,000 or undervalued by an astounding 58%, using current monthly rent of $830. Today the availability of rental properties is declining, and rentals rates are poised to move much higher, widening the gap in the opposite direction. Could this signal even greater potential?
A very simple tool for investors has been the Gross Rent Multiplier. Much as the Price/Earnings ratio is a guideline for stock valuation, the market is rich when it is high and cheap when it is low. In 2003 (prior to the mania), the GRM was typically 11-12 for an entry level single family home; rising to over 20 during the bubble. Today that multiplier has dropped to 7.5. The potential increase to a historical 11 Gross Rent Multiplier is over 46%, based on severely depressed rental rates, again confirming the potential explosion of gains. Using Historical Data and sine wave analysis point toward extreme valuations, and as the market normalizes these extremes have the potential of exploding upward. The Affordability Index is also confirming the ability of the average household to afford a much higher payment, which indicates there is plenty of room to allow for mortgage rate increases and price appreciation. Although by no means a “Foolproof Indicator”, taken together they are indicating a very low probability of future declines and a high probability of future gains, possibly explosive gains.
These indicators measure existing factors. Those homeowners liquidating their properties via the short sale process will be out of the market for a penalty period of currently 24 months. What happens to values as demand from former home owners returns after the 24 month penalty time frame? What happens to prices when end users rather than investment driven investors become the driving force in the market? What happens to a market that has absorbed the excess inventory, and additional supply may be 12-24 months away due to development and financing restrictions? What happens when the demographic trends re-assert themselves with net inward migration of 30,000, 50,000, or 100,000 new residents to Phoenix? What happens to prices if the $13 Trillion of stimulus starts to impact wholesale prices of lumber, drywall, and steel, and their prices start to climb 3%, 5% to 9%? Could a new immigration policy influence an even greater population increase?
Phoenix crashed and burned! That is old news. When an event that happens once or twice in a lifetime occurs, the likelihood of it re-occurring again is measured in decades not months. Can the group of rentals that topped at $220,000, and are now $75,000, rise to $100,000 to 125,000? Can the properties sold in 2006 for $500,000 that are now $300,000 rise to $400,000? In my opinion, YES and maybe more!! Buy that vacation home; buy that luxury condo; buy that investment rental; buy the unit close to school; help the children or grandchildren acquire a home of their own. In my opinion, an opportunity of this magnitude presents itself once or twice in a lifetime.