Real Estate Investment: Return on Investment and Cash Flow Calculation

• By Andrew Jeffery
• On Thursday August 13, 2009, 12:20 pm EDT

The only question that really matters in the housing market right now is the following: Does the recent strengthening in sales data signal an imminent bottom, or are we smack in the middle of a dead-cat bounce?

 

Nevertheless, there are some key factors to watch that will provide clues as to how long this rally’s legs really are, and what could trigger a reversion in the miserable state of the market we’ve become accustomed to over the past 4 years. Here are, in my mind, the top 3 “tells” to watch when it comes to the direction of the housing over the next 6-12 months:

 

1. Jobs

 

In the words of HousingWire’s Paul Jackson, “If housing is central to recovery, and jobs are central to housing, and jobs aren’t doing very well — what’s the real forecast for housing?”

 

Despite jobs data that appears to have stopped getting worse, the employment outlook in the US remains dismal. Government-backed loans through the Federal Housing Administration (FHA), Fannie Mae (FNM), and Freddie Mac (FRE) dominate the mortgage market right now, all of which have strict requirements for job stability. This means that even if companies start hiring again, recently laid-off workers will still have a hard time qualifying for a mortgage.

 

Furthermore, even though layoffs have slowed, the majority of firings that occurred in the past year haven’t yet resulted in mortgage delinquency. As struggling homeowners gradually succumb to the pressures of losing a job, default and eventual foreclosure can occur many months after the layoff itself. We’re yet to see any material improvement in default data, especially in high end markets. See, “What Does Employment Mean for the Market?”

 

2. The FHA

 

The FHA offers taxpayer-backed insurance for mortgages that are underwritten to their specific guidelines. Originally intended to provide home loans for low-income borrowers by requiring minimal down payments and overlooking blemished credit records, by the end of 2008, FHA loans accounted for almost 40% of all new loans — up from less than 5% at the beginning of 2007, according to data compiled by Lender Processing Services (LPS).

 

In distressed markets, where ongoing foreclosure moratoria are keeping bank-owned homes off the market to artificially limit supply, FHA borrowers make up the vast majority of buyers. This has helped the likes of Wells Fargo (WFC), Bank of America (BAC), and Citigroup (C) unload foreclosures at higher prices, but it has prolonged the eventual recovery as banks slowly bleed out distressed homes into the market.

 

To help alleviate the housing crisis, Washington upped FHA limits so that in some areas, buyers can get an FHA loan for as much as $719,000. This widening of FHA’s lending criteria has helped buoy many mid-tier markets, as borrowers can now buy $500,000 or $600,000 homes with a paltry 3% down. (Just ask Toll Brothers (TOL) if the FHA helped boost sales in the past 6 months. See, “Robert Toll, Robber Baron.”)

 

If the FHA tightens its guidelines or lowers its loan limits, look out below, as a huge source of liquidity for the housing market will evaporate.

 

3. November 30, 2009

 

This November, the $8,000 first-time homebuyer tax credit expires. If I were a betting man (which I’m not), I’d wager if the market stumbles even slightly between now and the end of the year, a new tax credit will be issued in some form. (They may extend it regardless of how the market performs.) Even if the credit is extended, many first-time homebuyers are already scrambling to make purchases while they can still get a check from Uncle Sam.

 

To wit, check out the advertisement currently running on ZipRealty, a popular online real estate brokerage:

 

Circle November 30 with a big red pen, because first-time buyers now account for fully one-third of purchase transactions according to the National Association of Realtors. If this demand dries up, sales could resume their downward spiral.

 

The bottom line is this: The outlook for housing is murky, at best.

 

Low-end markets are benefiting from government support on both the supply side (foreclosure moratoria) and demand side (tax credits, FHA) of the equation. Meanwhile, high-end markets — as defaults on prime mortgages keep rising and the job market remains lousy — are seeing steep home-price declines.

 

Anyone touting housing’s so-called “bottom” is likely trying to sell you something — namely, a house.

 

Nothing contained in this article is intended as a solicitation for business of any kind or for investment in the firm.

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Tags: Housing Market Conditions, Real Estate Investment

This entry was posted on Thursday, August 13th, 2009 at 5:20 pm and is filed under Opinion. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.