Is Now the Time for Investing in Real Estate?

By David Sterman
January 19, 2011

What’s the opposite of a bubble? Whatever word applies, it surely describes the housing market.

Whereas asset bubbles are highlighted by fast-rising prices and a frenzy of transactions, a housing bubble is characterized by steadily dropping prices and stagnant activity.

But if you connect the dots, the nation’s most lame asset class looks set to move back into favor. Nobody wants to see a bubble ever again, but a strong case for investing in real estate may finally be in the making.

Time for a Rebound?

Of course, we’ve heard this sentiment before. In 2008, economists thought the housing sector would hit bottom and rebound in 2009. That forecast got pushed out to 2010, and then, well, people stopped trying to predict a rebound altogether. Home prices peaked in the second quarter of 2007 and have been falling ever since.

It’s easy to conclude at this point that housing has been down for so long -- and so many investors have been burned -- that the sector will never come back. As a contrarian, I like to hear that kind of talk.

Case-shiller-20-city-index-for-investing-in-real-estate

So why be bullish now? Because all of the ingredients are finally in place.

  • First, we need to see low interest rates. Check.
  • Second, we need to know that demand exists. The U.S. typically creates 1.0-1.5 million new households each year, but housing starts have been at half of that rate in recent years. Many are choosing to double up or stay at home, simply deferring demand that will eventually be unleashed.
  • Then, we need to see the cost of home ownership decrease until houses are bargains again. In many U.S. markets  that is surely the case.
  • In addition, consumers need to see that the economy is not going to slump further, placing their employment situations in peril. In recent months, there is an increased consensus that we have indeed been able to avoid the dreaded “double-dip” recession.
  • Lastly, we need to see an upturn in job creation. Even modest job growth, say 100,000 new jobs per month, is enough to create a sense that there will be ample buyers interested in purchasing a home. Recent employment data implies this process has already begun.

You’d never know that the stars are aligning by simply looking at housing statistics. Sales activity and pricing both remain weak, creating a self-fulfilling prophecy of negativity. Conversely, signs of an upturn in activity and pricing would create an entirely different perspective. I know a number of people that are keen to buy homes, but would rather wait to see prices stop falling. A little spike in prices and many of them will get off the fence.

Multiple Positives

For many, the move from renting to home ownership makes simple sense: Monthly payments apply toward equity, and 15 or 30 years down the road, homeowners have a significant asset as part of their financial retirement plan. Many others appreciate home (or apartment) ownership as a path to rental income

In many instances these days, home prices have come down so much that mortgage payments and rental income rates are roughly equivalent. In the past, real estate investors needed to put up with negative cash flow in the early years of being a landlord. Looking ahead, it gets better as mortgage rates stay constant, but rental rates rise as housing sells drive up the prices in a given area. Ten years down the road, a typical homeowner can expect to derive significant positive cash flow. And when the mortgage is fully paid off, that rental income can become a major source of retirement funds, complimenting social security and 401(k)payouts.

Perhaps the most compelling reason for home ownership is as an investment. Bargain hunters are beginning to snap up newly discounted properties in Florida, Nevada, Arizona and elsewhere. Properties that fetched $300,000 a few years ago can now be had for $200,000 or less in certain areas. It may take some time, but many of those same properties may well be worth $300,000 or more in a decade or so.

Exposure Through Stocks and Mutual Funds

For existing homeowners that have little interest in purchasing another home, all of this logic still applies to housing-related investments. Stocks such as Toll Brothers (NYSE: TOL) and D.R. Horton (NYSE: DHI) hold long-term appeal, as I discussed in this article on housing stocks as the surprise sector for 2011.

Investors looking to simply make a broad-based investment in housing stocks can go with an exchange-traded fund (ETF) such as the iShares Dow Jones U.S. Home Construction Index Fund (NYSE: ITB) or the S&P Homebuilders ETF (NYSE: XHB), which mostly focuses on homebuilders, but also adds a few home furnishing and home improvement retailers into the mix.

Have housing stocks hit bottom? Perhaps. But maybe home values will fall another 5% or 10% before a bottom has been reached. That still means we’re pretty close. Waiting it out until the housing sector is healthy again likely means missing a 20% or even 30% move in housing prices and even bigger gains in housing stocks. Even if you’re not quite  prepared to act, this is the time to do all of your homework so you can move quickly when the time is right.