Rent Dilemma
We are remodeling and went today to look at a condo to rent. The condo is new and similar units are selling for approximately $500K to $520K. The association fee is $200 a month. I figure - using 20% down and a 7% return on equity - the condo would have to rent for $3,300 a month. This would cover debt (interest-only in my assumption), property taxes, the association fee and provide the 7% return. The asking rent is $1,800. I figure the owner is carrying at least a $900 negative every month. This is nuts. Real estate is an income play. I don't get the logic of buying a property that will not provide at least a 7% rate of return. But as a short-term renter, I like it.

This should be a measure of the over priced real estate market. Rents are going to have to increase significantly or prices are going to have to drop to narrow this disparity. A quick calculation shows that the condo should be worth about half its current price - $260,000 not $520,000 - to justify its $1,800 rent. This covers debt, taxes, association fee and provides a 7% return on equity to an investor. If I owned this property with a $520K basis, I'd be scared. I bet the owner did not run any numbers and thinks future appreciation will erase all his negatives. Good luck.

Private Equity Opportunity
Private equity firms have been buying REITs at a dramatic pace. I don't think the private equity guys are buying the firms as a bullish statement on the real estate market. They like REITS because REITs are moderately leveraged, typically 50%. The public equity markets start discounting REIT shares when the debt gets too high. This acts to keep REIT debt moderate. Private equity investors have no such constraints. Moderately leveraged REITs offer private equity firms a chance to leverage the real estate assets to much higher levels. The debt can be used to repay the private equity firms. I think the private equity guys will sell assets as they either repay debt or unload properties that don't fit in a portfolio. This should be an opportunity for small real estate firms, like tenant in common sponsors or other nimble real estate investors. If the private equity investors get over extended there will be many bargains.

Wild West
Interesting article about the Phoenix housing market and the speculation that drove up prices. People are walking away from their deposits on new homes and "For Sale" sings are prevalent. It is interesting to hear "experts" who expect that the downturn will only last a matter of months. I think it will be years not months. The wild card that will determine the length and severity of the downturn will be finance. People who bought on speculation to "flip" houses, or could not afford the house to begin with, and used exotic mortgages to finance their acquisitions are the ones that will decide the future. If they walk away from their mortgages when they reset, the downturn will be ugly, (and watch for the herd mentality if people start defaulting). If the loans are refinanced the downturn will be modest. Phoenix will not be alone.