Many of us are happy to see 2009, putting behind us the rising unemployment, lower housing prices, rising foreclosures, the plunging of the major market averages and evaporating consumer confidence that was part of 2008. The culprit of all this economic turmoil seems to be the plunging real estate market.
Although real estate played a part in the overall market decline, I thought a comparison of real estate with some of the major investment indices would better gauge the performance of real estate as an investment.
By using 1/1/2008 as the “buy in” date and 12/31/2008 as the “sell” date, we can compare how various investments have fared during this time period. I’ve eliminated items such as dividends, carry costs and other income or expenses to simplify the comparison. By doing so, we can compare the percentage gain or loss of each investment over 2008.
I choose to look at the performance of the three major stock averages: the Dow Jones Industrial average, the S&P 500 average, the Nasdaq composite, the price of oil and the national median home price (according to the National Association of Realtors).
In 2008, the Dow Jones Industrial average fell by 34 percent; the S&P 500 fell by 38 percent; the Nasdaq Composite fell by 41 percent; the price of oil fell by 53 percent and the median home price fell by 9 percent. Clearly real estate was the best performer of this comparison group.
The difference from price peak to trough over the past few years: the Dow Jones Industrial average fell by 39 percent; the S&P 500 fell by 53 percent; the Nasdaq Composite fell by 53 percent; the price of oil fell by 78 percent, the median home price fell by 18 percent.
Since peaking in 2007, national housing prices have fallen in value, but dropping 18 percent is not falling off a cliff, especially when compared to a drop of 78 percent in oil prices. By comparison, real estate was a far better bet in 2008 than any of the other indices used in this model. Granted there are other commodities that performed better than real estate in 2008, such as cocoa, but I wanted to look at major investment vehicles.
Much like the oil bubble, tech stock bubble and day traders, the real estate bubble was caused mainly by speculators and get rich quick schemers. Speculators buy and sell on a short term basis without regard for any market fundamentals. The bursting of the bubble has taken many of these short term speculators out of the market. This change in market dynamics provides an opportunity for real estate buyers to make a long term investment based upon sound fundamentals and realize nice appreciation of their investment.
Here are a few reasons to make a real estate investment in 2009:
Lower Home Prices: Housing prices have fallen to more affordable levels, in some markets moving back to 2003 prices. People looking to buy a home for long term use or investment have a better opportunity to own a home at a very good price. Lower home prices expand the number of people able to afford to buy and own home, creating a greater demand.
Historically low interest rates: 30 year fixed mortgage rates are nearing 5 percent and are expected to move to 4.5 percent or lower. Compared to 6.25 percent rates seen earlier in 2008, a rate of 4.5 percent would mean a monthly savings of $218 on a $200,000 mortgage. Lower monthly costs will keep people in their homes, reduce the number of homes on the market and lead to a stabile housing market.
Foreclosure Mitigation: The Federal government and private lenders are instituting plans to stem the tide of foreclosures by renegotiating mortgage payments, possibly reducing both interest and principal, to help people keep their homes. Successful foreclosure mitigation plans will reduce the number of homes on the market and help stabilize housing prices.
Affordability Index: National Association of Realtors findings show that housing affordability has improved dramatically, moving from 106 to 142. The study found that income rose from $57,612 in 2006 to $60,840 in 2008 and the percentage of income dedicated to pay a mortgage dropped from 23.6 percent to 17.6 percent.
Tax Incentives: Congress is considering tax incentives of 10 percent of the purchase price (up to $22,500) to offset the cost a home purchase. This tax incentive would be directed at first time home buyers, although there are discussions to broaden the incentive to include all home buyers in 2009.
FHA: There is a strong push to expand the mortgage market and spur home ownership. FHA guidelines will be broadened to allow for lower down payments (as low as 3% of value), lower borrower credit scores and reduced required documents in an aim to have more people qualify for a mortgage.
Mortgage repurchase: The Federal Reserve has announced it will purchase $500 billion dollars worth of mortgages from banks. This program is in addition to the expanding role and capital of Fannie Mae and Freddie Mac. Implementing this program will lead to greater availability of mortgage funds and more open lending standards.
Housing Inventories: Housing inventories have been moving lower in recent months, dropping by 350,000 units in the past three months alone. Even in a “slow” year like 2008, there were about 4.5 million homes sold nationally. OK, it is not the 7 million homes sold in 2005 but it is not zero either. New home starts have fallen to an annual rate of 625,000, nearly one-third of their peak in 2005.
Pent up demand: There is growing demand to purchase real estate from people who have been sitting on the side lines waiting for the dust to settle. As the market settles down there will be a growing number of qualified buyers looking to make a home purchase in 2009.
Employment: Consumer confidence is critical to any market improvement. The enormous stimulus package being considered and most likely implemented will bring more jobs. More importantly, a stabile jobs market will bring back consumer confidence and will spur spending. As a lagging indicator, the unemployment numbers will not reflect the improving economy early in 2009. Companies are slow to respond to change and the stimulus package will take months to be felt in the general market place. However, the later quarters of 2009 will show marked improvement in employment and consumer confidence.
It is already evident that the housing inventories and prices are beginning to stabilize. The combination of lower prices, historically low interest rates, a reduction in inventories, low new home starts, government mortgage capitalization, lower housing carry costs and huge tax incentives to spur buying will lead to a very good housing recovery.
Late first quarter and early second quarter 2009 will see increased home buying, a reduction in the number of homes for sale and stabilizing prices. In 2009, I feel that homes purchases could reach 6 million units, pushing inventory levels down by more than a million units to 3,200,000 and shortening the time of inventory absorption to 4 to 6 months. Any number under 6 months is considered a “hot” market. Home prices will begin to gain traction and improve by the 3rd quarter 2009. By first quarter 2010 we should see a normalized market.
No one can predict a market bottom, however it appears the worst of the market turmoil is behind us. The drive to stabilize and improve the housing market along with the general economy should stem the tide of any remaining downward pricing pressure and lead to an improved 2009 housing market.
It is in times of great distress that we are presented with great opportunities. There may never be an opportunity like this again to make a long-term investment into real estate.