Prospects for Profitability in Real Estate | Market Conditions and Demographics Create New Opportunities

Many experts have concluded that the property market has finally hit recovery and they are now predicting the positive growth of the real estate sector in the future.

What professional investors understand is that real estate is very much a local business. What is happening in Phoenix, Arizona is quite different than what is happening in Miami, Florida, for example. If you dig even deeper, you will find that there are significant differences within these individual submarkets, too. Prices, rents, expenses and vacancy rates can vary from block to block in any city, depending on a multitude of things.

So as you read people’s predictions and opinions, just keep in mind that they are typically very broad statements about the industry. The good news is that there is an enormous amount of money to be made in the next several years, so get your team in place and begin your research.

Here Are Several Things To Consider As You Look To Invest

Interest Rates, Debt And Capitalization Rates

Real estate has dramatically benefited from low interest rates, which cannot go much lower. If you can borrow at less than inflation, then you should. It is one way to hedge inflation, which many believe is coming. On my entire portfolio, we have several hundred million dollars in loans of which we have fixed interest rates. What this means is that if interest rates go up, the property values go up, too. The cost of borrowing affects cash flow. If a mortgage payment is higher, then cash flow is less.

We are currently selling a few properties and have had many tours and offers on a property in Tucson, Arizona. We finally settled in on one buyer at a price of $14,750,000, and we were working on the purchase and sale agreement. During this time, Federal Reserve Chairman Ben Bernanke announced that it is likely that the Fed will provide less economic stimulus in the form of low interest rates.

This announcement caused interest rates to rise, which resulted in our buyer backing out of the deal. The buyer’s cash flow and return projections were based on the lower interest rates available when the offer was made. We figure that this increase in interest rates will cause about a $500,000 reduction in the price.

“If Interest Rates Rise As The Economy Improves In 2013, It Could Lead To Capitalization Rate Decompression. Investors Must Be Aware And Adjust Their Property Strategy Accordingly.”

The good news is that debt markets have fallen in love with real estate again and money is pouring back into the industry to finance new properties and refinance existing ones. Underwriting requirements are becoming less stringent, and loan-to-values are increasing. Multifamily investment is still strong following the recession. Such conditions raise concern that the U.S. could return to a period of too-lenient underwriting and over-leveraging, similar to the pre-recession boom. Keep an eye on this.

The capitalization rate is a rate of return on a real estate investment property based on the expected income that the property will generate. When interest rates are low, capitalization rates are typically low, too. So as interest rates rise, capitalization rates will also rise. This is especially important to property values when it comes to timing on the exit of a property.

Capitalization rates continue to decline in primary, secondary and tertiary U.S. markets, but are especially low in global gateway markets, posing risk to equity values if capitalization rates should rise significantly. If interest rates rise as the economy improves in 2013, it could lead to capitalization rate decompression. Investors must be aware and adjust their property strategy accordingly.

I have spoken and written about how demand can and will affect real estate pricing. I bring this up again because it is a fact and not speculation. An increase in the demand of anything will increase the price of that item. This leads me to the echo boomer housing demand.

The 80 million children born between 1982 and 1995 are now young adults. Like their parents (the baby boomers), these “echo boomers” affect the economy due to their numbers. But unlike their parents, who largely chose to live in suburban areas, they find a more urban lifestyle to be attractive, and many are willing to trade housing size for location, resulting in more demand for multifamily housing. Even micro housing is growing in popularity, with square footage measured in the low hundreds, not thousands.

While cities welcome the inflow of young professionals, artists and tech workers, suburbs are grappling with a shrinking tax base and potential decreased demand for existing homes. Officials in cities and suburbs alike are devising plans to improve housing options and mass transit to attract this population segment.

“While Cities Welcome The Inflow Of Young Professionals, Artists And Tech Workers, Suburbs Are Grappling With A Shrinking Tax Base And Potential Decreased Demand For Existing Homes.”

These echo boomers will follow jobs. Pay close attention to cities that are progressive in this area. In writing this article, I simply Googled, “Where are echo boomers moving?” There are numerous articles on this subject. The point here is like the great Wayne Gretzky quoted, “I skate to where the puck is going to be, not where it has been.” The same is true for investing in real estate; you want to invest in areas that people are moving to. Increases in population create demand in that area and drive prices up.

One thing to also consider is the growing burden of student debt. When college students are graduating with an average of over $25,000 in debt, their spending is greatly restricted – and they’re less likely to form households of their own. Already, a growing number of graduates have been moving back in with Mom and Dad, and that’s having an effect on the residential housing market.

Betting On Old Age

Demand for medical services and facilities will continue to increase because of changing health care needs of aging baby boomers and the expanded health insurance coverage created by the federal Patient Protection and Affordable Care Act. Demand for hospitals, clinics and other medical facilities (including pharmacies, physical therapy and diagnostic facilities) will follow, as will housing for professionals drawn to jobs in medical careers.

The National Investment Center for the Seniors Housing & Care Industry estimates that the number of people 75 and older (those most likely to need seniors housing) will grow at a rate of approximately 2.1 percent annually during the next decade, and intensify significantly between 2021 and 2039. Between 2021 and 2025, for example, the population of those aged 75 and older will increase cumulatively by 22.8 percent.

On the medical side, the graying population in the United States is ramping up the need for outpatient facilities and the typical medical building of the past is going away. We’re going to see more outpatient, urgent care and wellness centers, along with free-standing emergency departments (EDs). These facilities are emerging as evidence of how preventative care has become the critical component of most systems’ strategies for driving down healthcare costs. Wellness centers, patient education and resource centers and free-standing EDs figure prominently in those strategies. The idea is that these facilities will serve as anchors in critical healthcare markets.

Younger Americans, many already struggling with student loan debt, will also see potential changes to their own insurance coverage and the increased burden of caring for aging parents. This will affect housing affordability and demand.

Investors are looking to the repurposing of offices, retail, industrial space and even movie theaters for medical use. Repurposing is an attractive option for hospitals as it enables them to move quickly and cost effectively into a market.

What I am doing personally is investing with the basic fundamentals of demand and supply. As long as investors focus on cash flow verses capital gains into markets that will see future demand of population and jobs, they will be fine in the long run.

About The Author

Ken McElroy is the co-partner of MC Companies in Scottsdale, Ariz. He is the author of the best-selling books, The ABC's of Real Estate Investing, The Advanced Guide to Real Estate Investing, and The ABC's of Property Management. McElroy is also a contributor for The Real Book of Real Estate by Robert Kioysaki, and The Midas Touch by Donald Trump and Robert Kiyosaki. McElroy's fourth book, The Sleeping Giant, is dedicated to the new class of entrepreneurs who are emerging in today's economy. For editorial consideration please contact editor@jetsetmag(dot)com.

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