No one can be sure exactly when the market peaks, but we are close enough now to make selling a great idea. When should you sell your properties? This column explores why I think now is a great time.
Today's real estate markets continue to experience a gigantic inflow of financial capital. This trend is most evident in the single-family home market, which has been achieving record sales and prices. From 1999 to 2004, the median price of existing single-family homes sold in the U.S. rose 38.1%.
In California, the median price jumped an incredible 109.3% during that same period. Total existing U.S. home sales in 2004 surpassed 6.7 million, a record that is on track to be broken again this year.
These high sales and prices have been partly stimulated by interest-only, variable-rate mortgages that require a low down payment and which are calculated to attract those households least capable of supporting home ownership. Yet apartment rents have not risen nearly as much because so many prospective renters are experimenting with first-time home ownership.
A similar wave of capital is flowing into non-residential markets as well. Prices of well-occupied office and industrial buildings with few leases expiring soon have been bid to amazing levels — with low cap rates. The chief lending officer of one of the nation's largest sources of mortgage finance recently remarked, “We are engulfed in a Niagara of capital.”
The executive lamented that interest rate spreads were being compressed by the immense supply of capital looking for real properties. Consequently, she suspected that loan-underwriting standards were weakening across the board.
Returns are always relative
Real estate, including REIT stocks, has performed much better than other stocks, bonds and cash since 2000. None of the major stock indexes has returned to its 2000 highs after crashing dramatically. When the world's central banks lowered interest rates to help counteract the 2000 stock crash, and liberally supplied liquidity, bonds lost their appeal but real estate gained in attractiveness.
In spite of Wall Street claims of “perfect rationality” in stock markets, investors are heavily influenced by their recent past experiences. So, they fear stocks and love real estate. Hence, stocks have continued to move sideways this year. As a result, investors the world over have finally decided real property is an asset class of its own and deserves to absorb a notable amount of their resources.
Another factor favoring real estate is the relatively high dividend or cash-flow rates it generates compared to the alternatives. Those incentives attract retiring baby boomers and the pension funds that must help finance their futures.
True, the Federal Reserve has adopted a policy of raising short-term interest rates, a reversal of its former policy. From 1982 to 2004, after sharply escalating rates to halt inflation, the Fed steadily lowered interest rates as inflation gradually ebbed. This was a huge boon to real estate. Now the Fed is worried about a resumption of inflation, so it has started raising rates. But so far, the response to the Fed's efforts among long-term real estate borrowing rates has been weak. This trend will continue as long as the wave of capital into real estate endures, unless there is an even sharper drop in the international value of the U.S. dollar.
Why Sell Now?
Given life's uncertainties, it is never possible to identify when property markets are precisely at their peak before that peak passes. But it is possible to estimate when property markets are close to their peak, and that time is now. Conditions highly favorable to sellers cannot last forever, especially with huge U.S. deficits in the federal budget and trade balances looming. So many investors want to buy good-quality properties at top prices that owners probably cannot lose much by selling.
Two questions remain: (1) If I sell now, will I miss a further rise in prices? (2) What can I do with the money? The answer to the first question is that no one can predict the exact high point, but we are surely near it now. If you wait too long, the market could quickly turn less favorable. The answer to the second question is that I do not know any great high-paying alternative use for the funds you receive.
So, I recommend that sellers just sit on their gains and wait for market conditions to change. Pay the capital gains tax for once! Experience proves that something attractive will arise, even if you do not get great returns while waiting.
If you own properties that you never want to sell because they produce such great returns, then disregard my advice. But if your properties are near their peak earning power, or need renovation, or are just run-of-the-mill properties, seriously consider selling them now.
Anthony Downs is a senior fellow at the Brookings Institution and a visiting fellow at the Public Policy Institute of California. He can be reached at [email protected].