The Opportunity
It would have been hard to say “US property investing” with a straight face a few years ago. The country’s property market was in the dungeon, wracked by falling prices and an excess supply of houses for sale, and it was clear that the economy was facing harrowing troubles. How quickly things change.
Now investors far and wide have taken a new interest in a market once ascribed a ‘hands off’ warning. Rumours of yields you wouldn’t get anywhere in Australia have surfaced, and the American economy looks healthy enough to pay the gossip a listen.
The sniff of opportunity, quite ironically, has much to do with the very reason the US property market was performing so badly during the GFC. With prices still ridiculously low from the foreclosure crisis at the end of the last decade, but a bottom in sight for falling prices, there’s very much a feeling that now is the perfect time to buy.
“The rewards can be great,” says Lachlan McPherson, chief investment analyst at US Invest, a company that assists investors in getting into the market. “If you invest in a quality area, it is not unusual to see your property returning a net yield of 10% per year.”
McPherson says many areas in the US remain staunchly undervalued and are at prices well below what they were before the GFC hit. These areas are home to quality properties that have plenty of room for capital growth and such a disparity between what they can produce in rent and what they cost that they can pay themselves off in less than 10 years.
Spurring this high-rent, low-cost environment is that, since the recession, many Americans remain unable to own their homes and desperately need rental accommodation.
It doesn’t hurt either that the Australian dollar is still reasonably strong. By Aussie standards, US property is dirt cheap and it is well within the realm of possibilities to buy houses with cash or with equity in your home.
Australian investor Jason Simpson knows all too well how the US chips currently stack up. After suffering a personal injury, he decided to take charge of his financial destiny and started researching how to create a passive income through US property. He now tries to help other Australians navigate the market through his organisation Cash Flow Gold and says that even though the message has been dampened by a lot of noise from spruikers, the US property opportunity is bigger than many realise.
“In many of America’s submarkets, prices are still only at half of where they probably could be, so the possibility of finding a quality property that is significantly undervalued is still there,” Simpson says. “Buying US property is also a good way to diversify your asset base,and even opens up tax deductible travel to America. You just have to know what you’re doing.”
Behind the Foreclosures
In late 2008, years of loose credit, Wall Street greed and outright fraud collided with America’s struggling underclass to create the perfect financial storm.
Up until that point, the US lending sector had been content to abide by the rules it had gradually adopted since the Second World War, namely that there were no rules. Banks were lending to anyone they could.
It didn’t matter who could afford a loan. If an American wanted one, the banks would find a way for them to get it. Banks even wrote out home loans exceeding the value of their customers’properties.
In many areas, lax lending practices came in the form of subprime loans: high-interest mortgages designed for people with poor credit. It was a system that was bound to come crashing down.
People with poor credit ratings and lower incomes are more likely to default if they have loans with high interest rates and fees. As soon as the employment market in many states began to weaken (coupled with a history of poor saving regimens among ordinary Americans), foreclosures became a common occurrence.
With a sudden glut of foreclosed properties for sale, the American property market as a whole was beset with disaster. Housing prices tumbled as a vast supply of cheap properties cut a hole in what was considered fair value for a home.
Yet the foreclosure mess did not affect every area in the same way. Urban neighbourhoods in certain parts of the country remained relatively stable. The largest price swings were in America’s sunbelt states, which spread west from Florida across the southern United States through to California. These were the areas that had boomed the most before the GFC.
“What overseas investors should keep in mind is that, like in Australia, there are plenty of different markets, not just in every state but in every community within that state,” says Cash Flow Gold’s Jason Simpson.
“Some markets still haven’t reached a bottom yet, while others have been recovering for some time. It is critical to conduct due diligence. If you study the market you’ll know where you can safely spend your dollars and where to avoid."
How to research US Property
Trying to research a market of more than 300 million people, with close to 100 million dwellings, may seem daunting but, according to Simpson, the key is having the full address of any property you’re interested in, including the street number and zip code.
“Often what happens is that the people trying to sell these houses to overseas investors don’t give out the full address, only part of it. You need every single detail,” says Simpson.
“With the zip code and the street name and number, you can pretty much hit Google straight away and find almost anything you need to know about that property. There are at least 50 different websites that will tell you the complete history of past sales.”
Simpson says the most important thing to look for is what the two buyers just before you paid. “If there’s a history of decreasing sales prices, you should be very cautious.”
An example of a ‘dodgy’ deal can be perfectly illustrated with numbers. Say a property is being sold for $50,000. An investor looks online and discovers the last buyer paid $150,000 in 2006, but the buyer before him paid $200,000 in 2002. If this is the case, it is highly likely that $50,000 may be too much and the property could be near worthless. The house could be in an abandoned settlement or be the only house on an empty street, boarded up and derelict.
Another common problem is that certain properties can be dirt cheap, not because they’re in an area where there have been a lot of foreclosures but because that area is in decline.
As US Invest’s Lachlan McPherson warns, things that seem too good to be true usually are. “What a lot of investors don’t realise is that they have so much more to lose than just rental income,” he says. “The results of things like property damage, vandalism and theft can actually cost more than what your investment is worth.”
McPherson adds that even though rental yields can be considerably high in certain properties, there is a ceiling. Yields can reach a point where they suspend belief. More than 20% should set alarm bells ringing. When there are those kinds of numbers, terrible conditions are often attached.
“We see horror stories all the time of people that were sold properties in Detroit, Las Vegas and similar areas for as little as $20,000,” McPherson says. “[Then] all of a sudden the tenant stops paying rent, steals appliances and rips out all the wiring, which presents a bill in excess of $20,000. Now the investment has turned into a liability and is unlikely to ever make the investor money.”
Growth drivers
To be sure you’re purchasing in an area where properties are discounted but are likely to attract future capital growth, McPherson advises sticking to some of the same rules you’d use when purchasing in Australia.
“There needs to be economic growth, growing employment, diverse industry and some kind of limitation to the future supply of properties. If an investment area doesn’t meet these basic criteria you should probably steer clear.”
Detroit is a classic example. The city was one of the first major urban markets to collapse,and it is among those markets taking the longest to recover. With June 2012 a watershed moment in the US housing recovery, when prices increased in 19 of America’s 20 biggest cities, Detroit was still lagging back, registering a month-on-month drop of 3.6%.
Even Detroit locals recognise that city properties have their problems. Detroit resident Ali Baydoun, chief sales officer for Metro Property Group, who has been active in the real estate market for over a decade, notes that there are multiple areas and properties that investors should avoid.
“The development of the suburban areas, suburban sprawl, led to many affluent Detroiters leaving the city for the growing affluent northern suburbs. In 1967 there were race riots in Detroit, which triggered ‘white flight’, in which much of the city’s white residents left in droves. This left pockets of the city sparsely populated, leaving homes in these areas vacant and with poor upkeep,” says Baydoun.
“On the West Side of the city, the best example of this would be Brightmoor… which has become a symbol of urban decay,” he says. “The majority of the homes are non-brick – aluminium or vinyl siding –and were built for the city’s working class in the 1950s.”
In trying to avoid other areas that might be just like Detroit, McPherson says you should use some common sense. “It comes down to more than just city and suburb,” he says. “You need to analyse school zones, streets, even which side of the street the property is on.”
The rental culture
While getting the locality and property just right should be Australian investors’ highest priorities, they should also prepare for some stark differences in rental culture.
One of the more significant is that Americans tend to occupy their rental homes for much shorter periods than Australians. Simpson says this is partly to do with the school system.
“You’ve got elementary school, middle school and high school, then uni, so there are four different schools the children will be going to in a short space of a few years,and many families like to move closer to their children’s new schools as they grow up. It puts you in a pretty good position as an investor if you’ve purchased close to a popular school.”
Forecasts for entire US market
A final consideration for any investor interested in US property is how the market as a whole is likely to cope over the next couple of years. Will it return to boom times? Will there be a double-or triple-dip crisis?
The answer lies somewhere in between. Investors need to see the US housing market in perspective. While the GFC represented a massive slump for the market, it was also coming off particularly good times. US housing developers are much like their Australian counterparts. When times are good they tend to overbuild and develop more properties than the market actually needs. This eventually results in an oversupply, causing the property market to go into an inevitable cycle of boom to bust.
It is even happening now. Forbes recently reported that improvements in the US housing market result from a simple phenomenon: construction of new housing units has been less than the growth of demand. It is estimated that about 1.5 million housing units need to be built every year to account for population growth, but last year total dwelling constructions ran at just over 600,000 and are expected to hit 750,000 this year. In contrast, at the peak of construction in 2005 there were 2.5 million housing units built.
“There should be a [slow] recovery across the bulk of the US market,” says McPherson. “Home values in many places are still below construction costs, and American consumers are in a far better financial position than they once were. They are starting to get credit again from banks, jobs are on the rise, and Americans are once again looking to enter the real estate market.”
Simpson agrees and points to growing activity among hedge funds as proof that there’s a sense of the market coming back to life over the next few years.
“Warren Buffet recently commented that he thinks there is a huge opportunity to get into the housing market and start doing ‘rehabs’ on properties. When someone like him says that, people start paying attention.
"In fact, you’ll find that a lot of hedge funds are now wiping the floor at auctions. There’ll be something like six or seven representatives of different funds at the auction, and they wouldn’t be there unless there was a great opportunity to make a profit.”
