In recent years, interest rates, housing inventory, vacancy rates, and cap rates have fallen dramatically.
If we were to think of real estate investments as a “see saw” on a playground, falling interest rates, homes available for sale, vacancy rates, and cap rates for income properties are leading to rising residential and commercial values because they are inverse to one another.
On the other hand, rising interest, vacancy, inventory, and cap rates usually lead to falling property values, so the “see saw” can go the wrong way also.
Longer Ownership Time Periods
The average homeownership tenure for sellers at present (early 2015) is 10 years. Between 2001 and 2008, the average length of ownership for properties was closer to just 6 years.
Between 2008 and 2014, the average homeownership tenure slowly increased to 7, 8, and 9 years. Since more homeowners are staying in their homes for longer periods of time, the supply of available quality homes to purchase may continue to stagnate or fall, partly due to lack of significant new home construction since 2007.
According to the real estate data site Zillow (www.zillow.com), their 3rd Quarter 2014 report noted that renters were spending upwards of 30% of their monthly income on their rental payments. Yet, homeowners were spending only half of that number (15%) on their mortgage payments each month.
The primary reason why owning homes and other real estate assets is much cheaper now is because interest rates have fallen to historical lows.
30-Year Fixed Mortgage Rates are tied directly to the 10-Year Treasury Yield Trends:
January 1, 1980 – 10.80%
January 1, 1981 – 12.57%
January 1, 1982 – 14.59%
January 1, 1983 – 10.46%
January 1, 1984 – 11.67%
January 1, 1985 – 11.38%
January 1, 1986 – 9.19%
January 1, 1987 – 7.08%
January 1, 1988 – 8.67%
January 1, 1989 – 9.09%
January 1, 1990 – 8.21%
January 1, 1991 – 8.09%
January 1, 1992 – 7.03%
January 1, 1993 – 6.60%
January 1, 1994 – 5.75%
January 1, 1995 – 7.78%
January 1, 1996 – 5.65%
January 1, 1997 – 6.58%
January 1, 1998 – 5.54%
January 1, 1999 – 4.72%
January 1, 2000 – 6.66%
January 1, 2001 – 5.16%
January 1, 2002 – 5.04%
January 1, 2003 – 4.05%
January 1, 2004 – 4.15%
January 1, 2005 – 4.22%
January 1, 2006 – 4.42%
January 1, 2007 – 4.76%
January 1, 2008 – 3.74%
January 1, 2009 – 2.52%
January 1, 2010 – 3.73%
January 1, 2011 – 3.39%
January 1, 2012 – 1.97%
January 1, 2013 – 1.91%
January 1, 2014 – 2.86%
January 1, 2015 – 1.88%
February 1, 2015 – 1.68%
(Note: January 1, 1980 10-Year Treasury Yields were over 10 times higher.)
Falling Cap Rates & Rising Multi-Family Apartment Prices
Income-producing properties like multi-family apartments (5+ units) are typically valued using a combination of their Net Operating Income (NOI) each year divided by the commonly used Cap Rate (or “Capitalization Rate”) for the immediate area.
The cap rate may also be considered as the expected rate of return for a prospective buyer for the property (NOI / Cap Rate = Price).
Vacancy rates have fallen significantly in many U.S. regions in recent years, which has lead to increased tenant demand and rental prices paid. Lower vacancy rates + higher gross income = A much improved NOI. The combination of higher NOI divided by near record low cap rates = higher prices.
Properties with lower cap rates are typically considered safer and more stable long-term investments, while properties with much higher cap rates are considered riskier. Riskier properties with higher cap rates are then sold at discounted prices to investors willing to take calculated risks for either the short or long term.
Between 2002 and the first quarter of 2008, the average national cap rates for commercial real estate properties fell dramatically (250 basis points) from 9.3% to 6.75%, according to data released by Stout/Risius/Ross Global Financial Advisory Services. This 250 basis point drop was the largest compression or drop off in cap rates for commercial real estate in U.S. history at the time.
From 2008 to 2014, cap rates fell from 6.75% to 4.4% for the prime U.S. metropolitan regions (e.g., Los Angeles, San Francisco, Seattle, New York City, and Boston). Some of the most prestigious mid and high rise commercial properties had cap rates fall to 3.9%.
Properties like prime apartment buildings valued using 4% cap rates are most likely going to sell for close to all-time record high price ranges.
Economics 101: Supply and Demand
If my neighborhood has 100 homes for sale within a very close radius in my subdivision, the glut of homes for sale will probably far surpass qualified buyers for the area. As such, the entire community will experience much lower sales prices.
Conversely, a relatively small supply of homes for sale combined with an increasing number of qualified buyers will usually lead to much higher sales prices.
Back during the depths of “The Credit Crisis” in 2008, there were approximately 3.8 million homes for sale. Additionally, there were probably another several million “shadow inventory” homes available to purchase from owners, banks, or mortgage service companies that weren’t listed for sale on the local MLS (Multiple Listing Service) to the general public.
Now, after years of selling these millions of listed (and unlisted) homes to buyers such as hedge funds, Wall Street firms, crowdfunders, and wealthy individuals who purchased literally hundreds or thousands of homes at a time in bulk, the most current projections for listed homes in the USA in 2015 are closer to 2 million.
As we move forward in 2015, we shall hopefully continue to see improving economic and housing trends, which bodes well for the real estate investment sector. In real estate as well as in life, it’s not a question of whether we may eventually get knocked down and fall at some point. Rather, the question is whether we’ll choose to get back up and continue to rise–just like we’re seeing with prices nationally.
Real estate can be fun–like riding a see saw on a playground when we were kids. So let’s thoroughly enjoy the good times as well.
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