So what’s so hot about single family homes in 2012? Low costs of borrowing, excellent spreads between rental prices and mortgage payments, and a minute uptick in job growth. Elsewhere, investors are padding the real estate market with fresh cash to make their foray into the rental business.

Single Family Homes as Investment Property

The market for single family homes isn’t propelled solely by live-in buyers. In fact, even hedge funds have stepped up their interest in tangible property, purchasing homes to rent as perennially falling rates allow for higher returns on invested capital.

Single Family vs. Mutli-Family Property

Single family homes are usually off-limits for investors seeking cash flow. Multi-family homes offer much larger returns relative to the sales price, partially due to the limited interest for multi-family property. The real kicker is in the details – a collection of events favors single family homes over multi-family property as an asset class.

The single family home advantage can be broken down into a few key components:

1. Appreciation – Single family homes tend to appreciate faster than multi-unit properties because of a changing demand curve. Investors tend to have much greater access to capital more reliably, whereas live-in demand ebbs and flows with employment. Investors using leverage to purchase a single family property have significant cash-on-cash upside on any uptick in property values.
2. Liquidity – At any given time there are far more buyers interested in a single family home to live in rather than a multi-unit property. For one, higher prices for multi-family units leaves out much of the market interested in owning a home. Secondly, few people interested in a single family home are interested in the rental business – even at a discount, few people would agree to make the switch to live in a multi-family home. Besides, it’s likely much of the market for live-in homes is already seeking to escape a shared wall with another person.
3. Potential tenants – This is purely anecdotal, but the experiences of other landlords suggests that the rental pool for single family homes is better than the rental market for duplexes or apartments. Single family renters are more likely to be established families – people interested in living in the same place for a considerable period of time due to job proximity, school districts, or neighborhood choice. Lower turnover boosts rental profits, as the home experiences fewer vacancies and less tenant-to-tenant maintenance like painting and landscaping.

From Catalyst to Exit Plan

Hedge funds are notorious for higher portfolio turnover. Institutional interest in single family homes suggests that funds see a catalyst for a smooth exit, with large cash on cash returns. So what do hedge funds see that other investors might not? Why would hedge funds (an investor class typically disinterested in collecting rental checks from individual families) favor single family homes over multi-family homes?

It might have everything to do with the macro.

The 2010 census reveals just how rapidly home ownership changed in the last three decades. In 1980, 22.1% of people aged 15-24 owned their own home. In 2010, only 16.1% of the same age group owned a home. The same decline in homeownership is also found in the 25-34 age group, with 51.6% of people 25-34 owning their own home in 1980 compared to 42% in 2010.

This shift is not as noticeable when one studies all age groups. Some 64.4% of Americans owned their home in 1980 compared to 65.1% in 2010. The aggregate reveals an opposite trend; homeownership has increased despite lower homeownership rates among younger Americans.

Starter Home Appreciation

Individuals aged 15-34 (more importantly, those aged 25-34) were the make-up of the housing boom – the people who purchased starter homes in cramped suburban neighborhoods for the opportunity at the American dream.

Is the American dream really dead? Did those 15-34 give up on home ownership forever? Not exactly. A more likely cause and effect sequence can be found in employment. At the end of 2011, 23.7% of Americans 16-19 were unemployed by official measure. Those aged 20-24 faced an unemployment rate of 14.2%. Meanwhile, unemployment for all ages was 8.6%.

Suffice it to say that the best new source of demand might just come from this age group – the age group most likely to experience the fastest employment growth. This is also the age group that would be most interested in inexpensive single family homes so popular with investors. Given the available financing (FHA requires only 3.5% down), any increase in employment can quickly change the dynamics of the buyer pool for single family property.

So there’s the exit. The alignment of trends looks far too perfect – a single source of demand is temporarily forced out of the market, rates are at record lows, and unemployment among a core demographic is testing new highs.

Continued job growth will only fuel the capacity for would-be buyers to snatch up inexpensive homes favored by landlords, and continued stagnation only fuels the necessity for others to rent. If unemployment stays near its highs, the rental market enjoys continued strength. If unemployment falls, new buyers come in to push up prices for single family homes.

For hedge funds and for individual real estate investors, this appears to be the perfect storm. Limited cash outlays for leveraged property plus high rental rates and a culmination of factors supporting future appreciation makes single family homes a fantastic wager for the long haul. As with any investment, we will have to wait and see how this plays out, but whether or not housing appreciates in value, rental checks will roll in as investors ride out the dip.

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Investing In A Rental Property is from Investor Junkie Copyright © Empowering Media, Inc.

When I met my girlfriend, who is now my wife, she already owned a ranch in Suffolk County Long Island. The house was nothing special. It was well kept and fine as a starter home, especially for a some who was single at the time of purchase. My wife worked hard to purchase it in 2000. She put the standard 20% downpayment, and a 30 year mortgage.

After we got married, we decided we needed to move closer to New York City. It would be closer to work, and closer to most of our family. My wife works in Nassau county, and her commute was a killer. Some days it would take 1 1/2 hours. In just 4 years, her car had almost 100,000 miles on it. One snow day it took her over 3 hours to get home. That was the last straw that broke the camel’s back.

So in late 2004 we decided to start looking for a new home. The requirement was it had to be in Nassau County, close to her work, and a moderately priced house. For those not familiar with how expensive Long Island can be, it’s not uncommon for a “modest” house to go over $400,000 even in today’s market. Taxes are also outrageous, but that’s a story for another time.

We found a house we wanted, and decided to sell her house ourselves. If you remember early 2005, the real estate market was on fire. We figured we could easily sell the house ourselves, and we were right. After our initial open house we immediately got three offers. We determined a mother and daughter offered the best terms. They owned no existing home, so it was quicker for us to get into our new home. The other buyers had existing properties they had to sell first.

The Buyer’s Terms

This is where the story gets interesting. After we accepted their offer, we soon got a call asking if we increase the price so they could get cash out at closing. Our basement wasn’t finished. They wanted to use the money to complete it, and pay off some other bills. We initially were a little hesitant, but accepted the new terms after consulting our lawyer.

Then my wife went to closing and found out the terms of their mortgage with the bank. My wife had to sit through long signing process by the mother and daughter. It turns out they took out two mortgages, one was fixed, and the a other balloon payment at some determined date. When my wife came home and told me this, I knew this wasn’t a good sign for them. They not only took money out at closing, but also had two mortgages. If remember correctly, it came to 110% of the value of the home. All of it was a no money down deal. What was not to like for them? They were in a house with nothing down.

The Oh No Phone Call

Fast forward to 2012. Two weeks ago I got a phone call from a collection agency asking if the number they called was still associated with our old address. When we moved, we kept our old number by using VOIP. We frequently get telemarketing calls thinking we still live at the old address. I assume this collection agency used a reverse lookup directory, and found our number. They asked by name for the mother and daughter who we sold the house to. I pretended to not know anything, and hoped they would no longer call us.

After I hung up the phone, it got me wondering if their house was for sale. Sure enough after looking on the Interwebs the house is on the market, and it’s a short sale. In simple terms, this means they probably haven’t paid their mortgage in months, and more than likely years. It’s now a matter of time before the house is foreclosed on.

Who’s Responsible For This Foreclsoure?

Now this leads me to the question about the mother and daughter, and their financial responsibility. I don’t know their financial situation directly. I don’t know if they lost their jobs, or experienced a medical condition. Historically these are both common reasons for financial hardship. I suspect, after first speaking with them, they were barely able to afford the home to begin with. In normal economic times, they probably wouldn’t qualify for a mortgage.

In a microcosm, who’s responsible for this foreclosure? Is it:

• The mortgage broker for getting them qualified for the two loans?
• Us accepting their terms?
• Buyers own fault for getting a home at any cost?
• Wall Street for creating complex financial instruments, by repacking asset backed securities?

At least in this specific case, and in most cases, I would have to fault the buyers. They were the ones actively pursuing buying a house. No one forced them to sign a paper, and buy the house. Just because you qualify for something doesn’t mean you should do it. There is fiduciary responsibility on their part.

It seems like today’s social environment we really like to put blame on others. At least in my opinion, that’s a sign of weakness, not strength. You can’t control real estate markets, government incentives, or “evil bankers” for giving you a loan. You can only control your actions, and no one else. Nobody cares more about your money than you. This certainly applies to signing a mortgage with your name on it. You could say in some respects they were duped in getting the loan. In someways that might be true, but anyone with simple math skills would realize the terms of this loan were insane.

I’m familiar with the backlog of shadow inventory of foreclosures in New York. It’s possible to live mortgage and tax free, for three years. They bought the home from us for $380,000. It’s currently being sold as a short sale for $249,999.

The owners have absolutely no skin in the game, and logically makes sense for them to strategically default. No way could they ever recoup the decrease in value, than the time the ding on their credit would last. In theory they could be socking away a lot of money per month not paying. I’m assuming they are able to still pay the mortgage. I don’t know specifically, but they could be playing out this possible scenario. This is especially true, if a balloon payment is coming due soon. While I feel sorry for their situation, I don’t have any remorse if this is the path they have chosen. If it is true financial hardship, the home ownership only sped up the process.

You might say, “OK the mother and daughter you mention were perhaps financially uneducated”. Maybe so, but it still doesn’t make it right no less. Without financial consequences, moral hazard will exist. The next example I discuss shows just this.

New York Times Economics Writer Not A Financial Genius

Let’s use an example of some who should have known better, but didn’t. New York Times economic writer Edmund L. Andrews wrote a book about his experience called “Busted: Life Inside the Great Mortgage Meltdown“. He presented himself as the common man who was bamboozled, by the banks, mortgage brokers, the Federal Reserve, and wait for it… the Bush administration. When Edmund does blame himself, he goes off in detail why it’s still not completely his fault.

While I haven’t read his book, I read a number of reviews on Amazon and detailed reviews on the web. I also read the New York Times article article he wrote. This quote in the article sums up the guy’s stupidity:

The only problem was money. Having separated from my wife of 21 years, who had physical custody of our sons, I was handing over $4,000 a month in alimony and child-support payments. That left me with take-home pay of $2,777, barely enough to make ends meet in a one-bedroom rental apartment. Patty had yet to even look for a job. At any other time in history, the idea of someone like me borrowing more than $400,000 would have seemed insane.

Too Many Financial Mistakes

For a normal person with common sense and an economic background, all sorts of warning bells should have gone off. Instead he kept pursuing, in his words his “insane” goals. How is the fault of other parties he puts blame on? The fact of the matter, he was hoping to beat the system, and lost big time.

After reading his article and finding more backstory of Mr. Andrews, I have absolutely no sympathy for the guy. Every step of the way he made many financial mistakes. After all he wrote about the very stuff he was doing in the New York Times. You would think a guy who writes about the economy would know better right? Instead he followed his heart, and not his head many times throughout his saga.

The story gets even better though. In his book he fails to mention his new wife’s serial bankruptcies. One before his marriage, and one during his marriage soon after term limits of the first bankruptcy expired. How is that not a critical part of the story? It shows no concern of debt obligations, and lack of financial responsibility. Instead he paints a much subdued story if this could happen to him, it could happen to anyone. His story reeks of elitism, and entitlement to things he never deserved in the first place.

Mr. Andrews fully knew he could barely afford the mortgage. He also knew his new wife was a homemaker who hadn’t worked in twenty years. Somehow she was going to make up the $60,000 diference to cover other expenditures with a new found job. The story gets worse. I discovered the book deal downpayment he received, he didn’t use to pay down his mortgage. Instead he was trying to force his bank to lower his loan principal.

This isn’t to say that others weren’t involved in the mortgage crisis. As he details in his book, there are certainly many people to blame along the way. But for a well educated writer, who should have known better, he made many personal and financial missteps. In a display of moral character, Ed Andrews was also fired from his job at the National Journal, for inappropriate behavior.

When one cannot manage their own personal finances, I for one do not take their economic advice seriously. This is akin to listening to a doctor’s advice to stop smoking when they themselves smoke.

Readers: Now that we have some perspective, what do you think about the financial crisis? Do you think the ones who took out a loan should be responsible for their own actions? Otherwise how we prevent moral hazard?

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Our Home Is Being Foreclosed is from Investor Junkie Copyright © Empowering Media, Inc.

What is the 1031 Exchange Rule?

The 1031 exchange rule is set up to ensure that you are accomplishing a “like-kind” exchange with your investment property. This means that you need to do more than just sell a property and buy another. There are specific qualifications that your properties need to meet, and there is a procedure the IRS expects you to follow. Some of the requirements of a 1031 exchange include:

• Both properties (the old and the new) must be held for investment purposes, or they need to be used in a business. So, you can exchange an office building for raw land, or exchange a single family rental home for a multi-family property. There are other acceptable exchanges as well. The important thing to remember is that you can’t involve residential property or sell your real estate and try to do a 1031 exchange for other asset classes, like notes or stocks.
• You have 45 days from the close of the original property to identify the new property you want to purchase. You have 180 days from the time your sold property is transferred to the buy in order to complete the transaction on the new property.
• You can’t access the proceeds from the first transaction. This means that you can’t use the money gained from your sale. If you could use the money, it wouldn’t exactly be an exchange. The IRS would come in and expect you to pay capital gains taxes on your earnings. Instead, the transaction is handled by a qualified third party. All of the funds remain with that third party, and are used to complete the exchange once you have determined on a replacement property. As you might imagine, the 1031 exchange is not a DIY investing project.

You should also be aware of the impact of “boot.” This is something extra received during the course of the exchange. This might be a different property, cash, or some other investment or liability. Any boot that is added to your exchange transaction is subject to taxes.

A 1031 exchange isn’t designed for you to sell an investment property and then pocket the cash or invest the cash in a different asset class. Instead, it’s meant as a tool to help real estate investors find a new opportunity, and to accomplish the new investment without the capital drain that comes from paying taxes on their gains. If you want to replace one investment property with another, the 1031 exchange can help you accomplish this without too much trouble.

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1031 Exchange Rule – How To Use In Real Estate Investing is from Investor Junkie Copyright © Empowering Media, Inc.