The American Dream
Given the real estate situation over the past few years, many people might think that home ownership is no longer part of the American dream. In fact, nothing is further from the truth. A recent poll conducted by NAR and Harris Interactive proves that home ownership still remains a dream of most Americans, makes a positive difference in family relationships and finances, and adds to the notion of feeling connected to a community. Responders to the NAR-Harris poll, which were both homeowners and renters, cited financial security as the most important factor in home ownership (96% for home owners, 71% for renters). And, they are right.
- Data from the Federal Reserve shows a very real disparity in wealth between homeowners and renters. In 2007, the median net worth of home owning families was $234,200 compared with $5,100 for non-home owning families. Before you dismiss the gap as a product of the housing boom, the difference in the late 90s was $168,200 to $5,400.
- When you compare median net worth to median earning, homeowners come out ahead again. The net worth of homeowners is about 2 to 3 times their before-tax income while the net worth of renters is only 20 to 25% of their before-tax income.
- Home ownership tends to be a slow wealth builder. In many ways, it acts more like a savings account than an investment. Each mortgage payment is like making a savings deposit.
There are benefits to society as well for home ownership. Homeowners typically feel better connected to their community because they live in their homes longer, are more likely to know their neighbors, and participate in community activities.
For a long time, America has been defined as the place where you can live the dream and homeownership is still very much a part of that dream.
New Home Mortgage Rules that May Hurt Not Help the Housing Market
You may have seen reports that the federal government is proposing new mortgage finance rules under which only home purchasers who can afford a minimum 20% down payment on a conventional loanwould get a shot at the best interest rates and terms. It’s true and here are the new guidelines:
Strict mandatory debt-to-income limits. Under the proposal, to get the best mortgage rates, you would need to spend no more than 28% of your gross monthly income on housing-related expenses, and you couldn’t have a total monthly household debt that exceeds 36% of your income.
There would be no flexibility to go beyond these ceilings, unlike in today’s marketplace in which Fannie Mae and Freddie Mac consider debt-to-income ratios along with other factors through their electronic underwriting systems. At the moment, Freddie Mac has an overall debt ratio limit of 45% of an applicant’s stable monthly income.
To refinance your existing mortgage and replace it with one carrying the best interest rate, you’d need no less than a 25% equity stake in your house to qualify. If you sought to take any additional cash through a refinance, you would need 30% equity. Today’s requirements are usually not as strict.
Pristine credit standards. For example, if you were 60 days late on any credit account during the previous 24 months, you would be ineligible for a mortgage at the best terms.
These proposals were released at the end of March by banking, securities, and housing regulators, along with the Department of Housing and Urban Development. The agencies were required by the 2010 financial reform legislation to come up with new standards for low-risk conventional mortgages.
Under the law, loans that do not meet these strict tests will be pushed into a less-favored, higher-cost category. Banks would need to set aside 5% of loan balances in reserves to cover possible losses from defaults. This extra capital cost would inevitably be passed on to consumers.
How to Save $67,960 in this Economy
When Standard and Poor’s downgraded the US Debt rating, everyone thought interest rates would go
up. So far, however, the opposite is true. In fact, rates are the lowest they have been in 50 years. At the
same time, CDs are generating almost no return, the stock market is up and down like a yo-yo, and the
10-year T-Bill as at 2%. So, what works in this scary economy we are experiencing, especially given
slower growth and higher unemployment?
The answer lies with real estate. It’s affordable again, the rates are low so money is cheap, and with
real inflation coming in at 3.5%, if you hold on to it for 5 years it should appreciate. For example, in
yesterday’s world, a $450,000.00 borrower with a 5% 30-year fixed loan would pay $2,416 a month or
$419,652.00 in interest over the life of the loan. Fast forward to today. With a rate of 4.3%, the monthly
payment is $2,227.00 with a payment of $351,692.00 in interest over the life of the loan. You enjoy
$67,960 in savings.
So, while some suggest waiting to buy real estate, you should buy real estate now and then wait. When
rates do start to move up, and they will, you don’t want to look back and say “I wish, I should have, and
why didn’t I.”
The Rental Market is HOT!
Investors who purchase apartments are seeing better deals now than at anytime in the past. In contrast to housing, where prices are low, inventory is growing, and loans are difficult to get, apartment vacancies are down, rents are near all times high again, and cash flow can be positive from day one.
Why is it a good time to invest in apartments? Rents nationwide now average $991, which is up from $930 in 2006. In the San Francisco Bay Area, the average rent has gone from $1,025 in 2006 to $1,200 in 2011. This is partly due to fewer rental units available as well as less new building being done over the last few years. This is evidenced by the national vacancy dropping to 6.2% in the first quarter 2011 from 8% a year ago. Additionally, demographic trends are also favorable:
- 3 million young adults now living at home will equal about 1/3 of rental demand going forward
- 2.8 million homes and another 5 million homes will have been in foreclosure by 2012, which
means 2-3 million families will have to rent for up to 7 years
If you are looking at purchasing an apartment, here is what to consider:
- You want a property that produces at least 6% return on cash investment in the first year
- If the property requires a property manager, plan on a 2-4% fee
- Repairs, etc. run about 5-6%
- Expenses should not exceed 40% of income
And, if you don’t want to be an owner, consider a real estate investment trust (REIT), which are popular again. They typically pass along on average 90% of their income to their investors and currently some are returning 20%+ on the initial investment.
The Magic and Frustration of Real Estate
The real estate market can be both magical and frustrating all at the same time. In many parts of the Bay Area, such as PaloAlto, the Sunset, Burlingame, or Mill Valley, it’s as if we are back in the 2004 real estate market where every property hadmultiple offers and lots of them were all cash offers. In other parts of the Bay Area, however, like Oakland, Novato, Vallejo, and parts of San Jose, the market is much softer and has not yet rebounded. Sales still happen in these areas, but only if the property is priced right. Additionally, much of the inventory is still made up of foreclosures and short sales. Even if these areas may not be hot, they still present a great opportunity for investors and first time homebuyers. It is amazing how locations a few miles apart can see diverging trends.
While markets like Palo Alto can bear price increases, multiple offers, and a healthy pace of sales, there are several other markets throughout the Bay Area that cannot. In real estate, it is all relative. Each sale needs just one seller and one buyer. The value is determined by who is the seller, the profile and capability of the buyer, the support of the lender, the type of real estate you are buying or selling, inventory, days on the market of the competition, list / sales price of past sales, and whether you are in a negotiating situation or a competitive world fighting against all cash multiple offers.
The key to navigating all of this is education. You need to know what market you are selling or buying in and what will it take to get the house sold or to buy one. The rules are not only different in different areas, but they can also change daily based on what is selling and at what price point. Additionally, the media confuses us even more. ZIllow will tell us that home prices fell 3% in the first quarter, the steepest decline since 2008, and Fiserv Inc. is predicting home values still have 5-10% more to decline. Yet, this is not what homebuyers who are trying to buy a home in Palo Alto or the Sunset are experiencing.
So, what does all of this mean? What we can say is that what should be is sometimes, what seems logical is sometimes, and what can be often is just because it can be. That’s the magic and frustration of real estate. There are no set rules and the journey is often not the one we expected. In the end, buy in a good location, take out a conservative loan, and wait 5 years. From Palo Alto to Novato, real estate will reward you.
Expect a Shift in Building Trends
When home building comes back, it will look much different than it does today as trends and needs have shifted. By 2015, housing development will see the following changes:
- Master planned communities will look different and be styled to appeal to more buyers.
- How planned communities look will depend on their location in the country.
- Builders will think more in terms of life style rather than type of buyer (first-time, move-up). Things to consider or multi-generational living, baby boomers that might want single floor living, low maintenance, and lots of amenities,
etc. - The bigger is better trend is declining and the median size of new homes is either holding steady or declining.
- A home that has a smaller lot with less landscaping and room for vegetable plots is more appealing.
- People want flexible, open spaces that are energy efficient.
What’s Hot in Real Estate – The Rental Market
Investors who purchase apartment houses see better deals now than in the last four years. In contrast to housing, where prices are low, inventory high, loans are difficult to get, and 40% of the market is foreclosures or short sales, the rental market (especially apartments) have rents growing, vacancies declining, and can produce cash flow that is positive from day one. In fact, rents nationwide now average $991, which is up from $930 in 2006. Here in the San Francisco Bay Area, the average is $ 1,025 to $1,200, because there are less units available here and there has been very little building in the last few years.
So, if you are thinking about investing in a rental property, think apartments and here is what you should look for:
- A property that produces at least 6% return on your cash investment in the first year.
- Expenses that do not exceed 40% of the gross income
- A cap rate percentage the higher the better and a debt service coverage ratio that is the lower the better
- A property that gets you to break even or cash flow positive day one
And, if you don’t want to be an owner, consider Real Estate REITS– they are hot again. They pass along on average 90% of their income to their investors each year and are returning in some cases 20% percent.
Flooding the World with Dollars Affects Everything Including Real Estate
On November 3rd of last year, the Federal Reserve chairman announced another round of quantitative easing, which really translates into purposefully expanding the supply of dollars and raising projections for inflation. Called QE2 for short, the Federal Reserve is buying up to $600 Billion in long-term Treasury Securities from January 2011 through June 2011. In other words, the Fed is creating new money out of nothing as they exchange T-certificates held by banks for a deposit of previously nonexistent dollars into the bank. Officials say QE2 is necessary to get the economy going and reduce unemployment, which is perhaps true in the short-term. It also makes prices on US goods more competitive around the world as it causes the value of the dollar to fall.
When you look at the long-term, however, the release of billions of new dollars is really a backdoor temporary solution that carries long-term ripples. It keeps interest rates low, but artificially so. Once the easing is over, rates move up and quickly. As mortgage rates increase, commodity prices soar and they are already. There is a rush to purchase gold and silver and everything gets more expensive. Real estate will be affected too – the higher rates prices some buyers out of the market and prices may go up, but it will be related to the bubble of inflation not true appreciation.
The Revised Estate Tax
The tax cuts in 2001 by Bush lowered estate taxes over 10 years. These cuts brought the existing estate tax rate from a high of 55% to 35% over a 10-year period. The 35% estate tax rate was to stay in effect through the end of 2009. Then, estate taxes were set to disappear in 2010 and finally return to pre-tax cut levels at the start of 2011.
Now, there are changes that have taken place for tax years 2011 and 2012. The new law sets the federal estate tax rate at a flat 35%. In addition to this lowered rate, there are additional benefits:
- The number of people affected by the estate tax are reduced as estates under $5 million are not subject to any taxation. The limit was previously $3.5 million.
- The $5 million estate tax exemption is now portable, which allows for easier post-death planning.
- After the death of the first spouse, any unused portion of the spouse’s $5 million exemption may go into the other spouse’s estate.
- The bill now increases the total lifetime exclusion for gift giving to $5 million (previously $1 million), but unifies the estate gift and generation skipping taxes.
- This revision also gives estates of 2010 the choice of whether to use 2010 or 2011 estate tax rules. This is important because even though in 2010 there was no estate tax, there was a change in the capital gains tax of the estate. Prior to 2010, estates got a stepped-up cost basis (value to current market) for any assets in the estate. Thus, a property bought 20 years ago for $100,000 that is worth $500,000 today, would go into the estate as $500,000. But, in 2010, it would go into the estate
at $100,000 and the heirs would have to pay a capital gains tax on the difference.
House Hunting: 3 Ls and 4 Cs
While house hunting, keep in mind the 3 Ls and 4 Cs.
The 3 Ls
- Location, location, location. You can redo the house, but you can never change the location. What’s important in this area is commute time, schools/parks, shopping, and community events.
- Land or lot size. This is another thing that you cannot change. Also, is flat important? Is a large lot necessary? What if it slopes or has an odd shape? These could all affect adding on, putting in a pool, etc.
- Layout. Does the layout work for your needs? Are there enough bedrooms? Are they together or do you want them on separate floors? Is the kitchen an open space? Layouts can be changed somewhat, but they are costly.
The 4 Cs
- Condition. Is it in mint condition or is a redo needed? Will a redo be major or minor,/li>
- Color. This is simply a cosmetic issue. Don’t run from pink décor or flocked wallpaper if the house a good location and good bones. Color can easily be changed.
- Clutter. Don’t let a homeowner’s clutter stop you from visualizing your furniture in the house. Focus on the architecture, layout, and style of the home. Sellers take their clutter with them.
- Cleanliness. A dirty home means sellers will get lower offers. That might be a plus for you. You get a bargain and can then paint, clean up, redo floors, etc.
Recasting – A New Way to Cut a Mortgage
Whether you have a jumbo loan or a conforming loan, you might be able to use a little-known strategy called recasting to lower your payments for a small fee. Recasting or re-amortizing allows a borrower to lower their monthly payment on an existing fixed-rate loan without having to apply for a new loan and without having to pay a reappraisal fee. Here’s how it works:
The borrower asks the loan service if he/she can put a large sum of money against the existing mortgage. Ordinarily, this allows a borrower to pay down the loan, but he/she would still have the same monthly payment. With recasting, the mortgage payment would be reduced to match the new lower principal balance. Each lender sets their own fees and requirements to recast. The loan must also be in good standing and permission must be secured from the loan service.
Mortgage recasting resembles a “cash-in” refinancing, which is a newly popular strategy in which a borrower pays down principal on an existing loan in order to qualify for a new loan with a lower interest rate. In recasting, the borrower pays down the principal, but the interest rate and number of payments remains the same.
So, what is the advantage to recasting? Unlike a refinance, there are almost no fees or costs.
