Most real estate investors are aware of the terrific positive cash flow opportunities with cash-on-cash returns in double digits on single family homes. Yet many have chosen not to invest out of fear that the value of their investment property will fall. How founded is that fear? Consider what the numbers tell us.
Take the example a $60,000 1100 square foot, 3 bedroom 1 bath house in Salt Lake City, Utah, already renovated with a tenant paying $700 per month. With a 20% down payment, and allowing for mortgage payments (PITI), property management, maintenance and vacancy, the property will still return well over 10% per year (over 15% if the tenant stays in place and takes good care of the property.) That is clearly a great return on investment. But how much downside is there? Will the $60,000 house materially drop in value?
Prices will not fall if there is adequate demand for housing. Consider that if the foregoing tenant were to purchase that same house with 5% down with an FHA loan at a 5.5% interest rate, his total monthly payment (PITI) would be about $436, about 38% less than the $700 he pays in rent. Plus, his savings would be even greater because his interest payments and property taxes are tax-deductible. So it is compelling for the tenant to buy instead of rent. When we hear of pent-up demand for purchasing homes, this is one of the main reasons why.
So why doesn’t he buy? He sure wants to. It boils down to making the down payment and qualifying for the loan. Generally, the greater challenge is the latter. With the mortgage default rate so high, lenders have greatly tightened their standards, so it is harder for prospective homeowners to qualify for loans. However, the Obama administration has unveiled a number of initiatives to address this problem and enable people to once again purchase homes, such as a 10% tax credit (up to $8,000) for first-time home buyers in 2009. As these initiatives take root and more people can qualify for loans, housing sales will increase significantly, as there is huge pent-up demand. This, in turn, will stabilize prices, and will likely cause prices to begin rising.
Properties today have such strong positive cash flow that they effectively mitigate the downside risk in further slippage in home price. Also, while prices have fallen throughout the United States, in some areas of the country prices have fallen only slightly, such as in Mississippi, as these areas never had a speculative housing bubble like the East and West coasts did. So there is less downside risk in these markets, generally in the center part of the nation. With the pent-up demand for housing soon to be unleashed and compelling cash flow returns, there has never been a better time to invest in real estate.
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