Some Investors See Promise in Housing Market

Falling prices and rampant foreclosures are not the stuff of healthy housing markets. But to some real estate investors, the dismal market can signal that it is time to invest.

So what if cities like Phoenix and Las Vegas have regularly appeared on RealtyTrac's list of top 10 foreclosure markets quarter after quarter? Or if the National Association of Realtors is reporting that more than one-third of all existing homes for sale in America are "distressed," meaning they're in foreclosure or approaching it?

To some investors, the persistent price declines and prolonged sales downturn signal something positive: The possibility of future profits.

Just ask Christopher Yates, president of CM Yates Real Estate Investment. Yates, who is based in Colorado, has invested in residential real estate since 2003. He bought a Las Vegas home for $226,000 in 2003 and sold it about a year later for $370,000, making a tidy profit. He's avoided Las Vegas since 2005, but is now planning a return — by way of Phoenix, another hard-hit market.

"It's time," he says. "The Las Vegas area is really landlocked, and prices have to go back up eventually."

A house in Las Vegas similar to the one he sold for $370,000 three years ago now fetches just $200,000, he says, happily. Because the rental market in Las Vegas is relatively healthy, it's possible for him to buy a house like that now with a sizable cash down payment and operate it profitably as a rental. Had prices not fallen, this wouldn't be possible.

Investing in these markets requires a strong stomach, and a lot of patience.

The risk of future home price declines rose in 94 percent of 381 metropolitan areas last quarter, according to PMI Mortgage Insurance, based in Walnut Creek, Calif. Prices are likely to be down more than 20 percent this year alone in Las Vegas, Phoenix and many California and Florida markets, with no clear sign yet of a bottom.

Investors wading back into these troubled markets say they are buying for cash flow rather than for the quick appreciation that was possible in frothier times. Investors who can get a fixed-rate loan and find tenants to pay rent steadily can afford to hang on for a long time until housing prices rebound.

"You don't wait for the bottom of the market," Yates says of sale prices in the markets he's investigating. "You wait till it makes sense."

Nationally, existing-home prices in September 2008 were 9 percent lower than a year earlier, according to the National Association of Realtors. Several recent reports have shown home sales activity rising as buyers are lured in by falling prices. Even if prices continue to fall, many investors say they can wait for the market to rebound as long as they can get cash flow from renters.

"I was one of the people criticizing the enormous amount of investor activity over the past three or four years," says Andrew Jolley, a partner at Capsource in Henderson, Nev. "I think in some ways we're now helping the market by purchasing inventory, but real recovery will have more to do with the credit market improving."

At Capsource, Jolley and three partners have a portfolio of about 30 single-family homes in Las Vegas. They're looking for more, and while there is competition, the seller is often a bank or lender, meaning foreclosure is already complete and investors can negotiate with an institutional owner rather than an individual seller.

"It's difficult to call the bottom," Jolley says. "But it certainly feels close. Inventory has declined, sales have risen. But pricing is still on the decline. When pricing stabilizes then we'll know a turnaround is under way."

Leonard Baron, a professor at San Diego State University, has made 60 offers in the suburbs of San Diego during the past six months. Some sellers refuse to negotiate, he says. But he expects to succeed in closing two purchases in the near future: A single-family home for $200,000 (down from $435,000 in 2005) and a condo for $95,000 (down from $175,000 in 2005).

"Those are huge price drops," Baron says. "But keep in mind 56 of my offers were rejected. And the new prices reflect the current market."

Baron mostly made offers on foreclosed properties, which he characterizes as a "big appeal" for investors who want low prices and have time to work through the red tape or bat around negotiations with an institutional seller.

He says he plans to "buy and hold" the properties he is buying, rather than try to renovate them and sell them quickly. Because prices have fallen so far, he can get rents that allow him to make money managing the property over time, rather than just hold and hope for appreciation as investors did during frothier times.

"The old rule was that you tried to get 1 percent of the purchase price per month in rent," Baron says. "Those numbers haven't been seen for a long time in San Diego. But they're out there."

In fact, Baron says he can make money off properties if he can fetch rents just 0.7 to 0.8 percent of the purchase price per month, of about $1,500 a month for a $200,000 home.

"It's tough to get loans now," he says. "But in San Diego, as long as a property has some redeeming qualities there will be multiple offers on it."