HomeUnion’s director of research services was featured on Market Wrap with Moe Ansari for a second time on December 30. Hovland and Ansari discussed the trends driving the real estate market in 2017, some of Hovland’s top investment picks, and a number of pitfalls first-time investors should learn to avoid.
To listen to the show, head over to Market Wrap with Moe Ansari
Full Transcript available below:
Ansari: Welcome back, everyone to Market Wrap. I’m Moe Ansari, and you’re tuned in as you’ve been doing so for over 28 years now. And as always wherever you are across the nation, you can pick up the phone and give me a call. I would be more than happy to share with you my nearly thirty-nine going on forty years of trading experience.
But for the next few minutes, hold the calls, and let me go to our guest line. On the line is Steve Hovland. He is the director of research services at HomeUnion. During his tenure at HomeUnion, Mr. Hovland has invented a propriety system to identify cap rates for investment homes across the nation, generated a list of the best markets for investors, authored a white paper on national and microeconomic trends shaping nearly thirty investment housing markets nationwide, and issued a number of economic briefs. Mr. Hovland, welcome to Market Wrap.
Hovland: Hey Moe, thanks for having me on your program.
Ansari: It’s lovely to have you back Steve. The Fed is expected to raise interest rates 3 times next year. Many are concerned about the impact on the real estate market in 2017. What is your view?
Hovland: While we also agree that the Fed will raise interest rates 3 times, I think Goldman has come out and said that they believe the Fed will raise it 4 times. That’s probably a little aggressive. And interest rate increases will certainly impact the housing market, and that’s what they are designed to do. They are designed to cool off the economy. But I think that it’s going to have a more targeted approach than most people see. We expect interest rates to impact the top of the housing market, maybe the top 30 percent of homes, in terms of price. That’s where we’ve seen a lot of the overheating taking place over the last few years. Whereas at the bottom of the market it’s still affordable for most people to be able to purchase a home, especially in some of the less expensive markets across the country.
Ansari: So, how much of a factor should rising rates be for someone who wants to invest in real estate?
Hovland: Well, it’s going to make it harder to invest. They are going to have to do more due diligence. The pool of potential investment properties is going to shrink as interest rates go up, because prices plus rents and higher cost of capital – a lot more deals just won’t pencil out for investors. So, it’s going to impact them. The more quickly an investor acts, obviously the better for them. And keep in mind the market is moving well ahead of the Fed right now. So the market is actually pricing in these interest rates before then Fed actually announces them. So, we think it’s important for investors to move quickly if they want to take advantage of historically low interest rates.
Ansari: So you think they have to move now before the rates go up, but rates have already gone up in quite a few of these areas. Do you think prices will retrace because of rates going up, or do you think they will plateau for a period of time?
Hovland: I think prices are going to retreat in some markets. If you look at some place like Orange County, coastal Southern California, the Bay Area, New York, what happens is that home prices have been set by principal mortgage payments. As mortgage interest goes up, principal is going to have to come down in order for the buyer pool to remain interested in purchasing those homes. So we do expect a retreat in home values in some of the overheated areas in the country. On the lower end of the scale, we don’t think rising interest rates will impact home prices nearly to the degree that we are seeing in coastal areas.
Ansari: So you’re thinking at the lower end it’s not affected but in the higher end it’s going to be a big deal. What are the markets you find are the best markets and the worst markets? Give us the top three and worst three right now, according to the way you identify them, using cap rates for investment homes.
Hovland Well if you’re looking at the worst markets to invest in right now, it’s really San Francisco, San Jose, and New York. And a lot of the reasoning behind that is that rents are going down, but cap rates are still extremely low in those areas. So, it’s very challenging to identify a property and then underwrite it for decreasing revenue over the next year, year-and-a-half. Those are the areas I would avoid investing in right now. It’s like buying a stock that you know is going to go down, earnings are low. The best markets are strong job growth markets. As long as you can stay away from areas where the impact of new apartment construction is going to siphon demand way from single family rentals. But the best strong job markets right now – Dallas is the strongest job engine in the country, Austin is a great job market, and construction isn’t impacting investment homes too much since it’s highly concentrated, and I really like Jacksonville. Jacksonville is late to the recovery, it has a great military presence there, so you have a great renter base, and rents are going up very significantly over the past year, and we expect stronger growth next year as well.
Ansari: Seattle also topped the highest growth list. Why was Seattle? I think prices have already gone up in Seattle, haven’t they?
Hovland: Prices have gone up a lot in Seattle. Seattle is a fantastic market. It’s nipping at the heels of those Bay Area markets. Because you have Amazon and Microsoft up there. It’s a great tech market. But the home prices have gone up dramatically. So when you look at something like Seattle, Seattle is what San Jose and San Francisco were a year go, so it’s at the top of the list, but it’s due for a correction probably in the next twelve months.
Ansari: Do you think at this point if you were an investor in real estate, you would be very cautious with the market, and the go-go days of investing in real estate like they were in 2010 and 2011 are behind us right now?
Hovland: I mean the market performance for both single and multifamily, the best years of this cycle are likely behind us. So, I think we saw the peak of the apartment market in the second quarter of last year. The housing market still has a little strike to it, but that probably peaked last year as well. So, it’s still a great investment opportunity but when you have capital and you want to place it, you have to do your due diligence. It’s like investing in the stock market. Right now, it’s how much legs do these individual stocks have. So you have to be very selective. Whereas, in 2010 you could throw a dart at a map and any investment property would be a great investment property. The stock market was very similar at the same time you could invest in just about any stock, and the stocks went up. So now you have to really do your due diligence and find the right investments.
Ansari: We’re talking to Steve Hovland, director of research services at HomeUnion. Steve, does this list – you have a report entitled 8 Pitfalls to Avoid When Investing in Residential Real Estate. The first is chasing high yields. Why is this not a good idea to get high yield. I mean you want to get the highest yield possible on your investment, don’t you?
Hovland: Sometimes. The yield is associated with the risk though. So when we’re seeing new investors or people who haven’t entered the real estate market, what they’ll want to do is chase yield with zero reflection in terms of what that means in terms of risk. So there are high yield properties out there. You can buy an $80,000 home in this country and rent it out still for $700. But when you think about the tenant profile of someone who will rent for $700 when the mortgage is $400, these are typically not the most financially responsible tenants. So you have to stay on top of those properties. They are very management-intensive, you’re going to see a lot of turnover and those sorts of things. So most of our investors – they are doctors, tech employees, that sort of thing – and they don’t want to be in a situation where they are facing vacancy over and over and over again. You can definitely make money. Donald Sterling made a ton of money buying high-yield apartments, but it’s a very niche area, and it really requires more of an expert investor – someone who understands the local laws and handles it that way.
Ansari: And if you’re doing it as a passive investment, you don’t want to be involved in trying to evict people, and trying to fix the home up every two months, and try to get rented out again, and three months later go through the whole process all over again.
Hovland: Exactly. Putting tile in looks easy on a YouTube video, but it’s really not for everybody.
Ansari: That’s correct, and that’s why the management cost goes up. So the yield could look very attractive, but there are hidden pitfalls there that they have to be aware of. What is another pitfall that somebody needs to be careful about?
Hovland: I think one of the big pitfalls, or one of the things that people overlook, is that when they are investing in a single-family property, they are typically not investing in a property similar to the one that they live in. So, many of our investors are much more well-off. So, they live in newer properties, or properties that have been updated recently. So the appliances are newer, and things work better. So one of the things they overlook is the frequency by which things can break in an older property. These happen, and renters typically don’t take care of their properties as well as a homeowner would. And as a homeowner, some things that are easy to fix, and you would never call someone out to do that. I can give you an example from one of my investment properties. A renter called and said that the front door won’t close, so I had to call and send someone out to slide a strike plate under the lock, which is a very easy fix – very quick – but it’s not something that the renter is going to do. You have to send someone out, and that is going to cost money.
Ansari: So it’s underestimating the cost – that’s another of the biggest problems that people do. What is your overall outlook for the housing market in 2017? Where are the best opportunities? You said Dallas and Austin and Jacksonville were good. How about Phoenix and Scottsdale and Las Vegas, where we have not seen a tremendous amount of appreciation?
Hovland: I think Phoenix and Vegas have quite a bit of upside right now. So this is something I’ve been looking at more and more. I think those markets look great. The nice thing about Vegas is as the economy improves, people start going on vacations and Vegas is making money again. A lot of that has to do with people going and visiting Vegas, so I think that Vegas has a lot of upside. And they didn’t build a ton of apartments; developers have just stayed away. In Phoenix, they are building not a ton, and a lot that is focused around the university, so I think Scottsdale is an improving market for single-family properties. South Scottsdale, or towards Downtown Scottsdale we are seeing improvement there. So I think those markets – I think Phoenix and Las Vegas have a lot of upside next year. The market as a whole – I think we are going to see home prices tick up about 4 percent, and we should see rent growth in that same neighborhood. Even though we are going to see a decrease at the top of the market, there is going to be enough strength at the bottom to push median home prices up.
Ansari: So if you’re not in the absolute top of the market, you’re going to be ok. As long as you do your due diligence, and get all your homework done. And that’s just like any other investment. If you’re going to make an investment it’s not that easy. You have to go get your homework done before you start investing in anything. That’s what you’re really trying to emphasize here.
Hovland: For sure. And that’s what we do. We do the due diligence for the investors. You probably wouldn’t’ go buy $200,000 worth of stock without talking to a financial advisor. Why would you go buy a $200,00 real estate asset without understanding what the pros are actually doing, and not trying to do it on your own.
Ansari: Steve, thank you so much for taking the time to be with us today. Have a wonderful holiday, and a great new year.
Hovland: Thank you very much, Moe I appreciate it.
Ansari: That’s Steve Hovland, he’s the director of research services at HomeUnion. 8 Pitfalls to Avoid When Investing in Residential Real Estate. Call right now, get your free copy. If you’re looking at real estate, do your homework, folks. And then if you want some detailed work, obviously HomeUnion can help.