Dennis' Mortgage Blog

Question of the week:  Is now a good time to buy income property?

Answer:  We get this question a lot about not only income property but about single family residences as well form prospective new homeowners.  Everyone has an opinion, for every “yes” there is at least one or more “no” responses to this question.  Without providing a definitive yes or no I will provide some information so you can determine if the market is right for you to dive into, or continue in, the investment real estate market.  For this discussion I am assuming “investment property” to be one to four units that you will not occupy.

The residential income market is soft, softer I feel than the single family market, and the main reason is the difficulty in financing non-owner occupied purchases and units.  Combine the two and look to finance a non-owner occupied three or four unit building and the lending gets as restrictive as it gets.  Interestingly the investor mortgage market is not that much tighter today than it was pre-meltdown for conventional loans (Fannie Mae/Freddie Mac), unlike the single family market.  Many of the guidelines we are using are close to what they were pre-2008.  Some of the loan-to-value ratios are tighter, and some lenders are being more restrictive on whether rents will be used for qualifying, other than that no major changes to impact most investors.  The most significant change is how rental income is considered in qualifying.

 Because the lending from Fannie and Freddie has always been somewhat restrictive for investor mortgages the relative erosion in market conditions due to foreclosure is considerably less than the single family/condo markets due to foreclosures.  Most of the property declines in the 2-4 unit properties are as a result of overall market conditions, or because landlords have lost properties due to other factors besides being upside down.  Since most investment properties have been purchased with 25% or more down and turn a break even or better cash-flow owners are in a better position to ride through the down markets.

The primary factor limiting financing for investment properties is the use of rents for qualifying.  Prior guidelines allowed 75% of the rents on the subject property to be used for qualification purposes.  If the fourplex you were considering purchasing had rents of $4000 per month then $3000 per month would be added to the application for qualifying.  The loosest guidelines for qualifying rental income today are based upon your experience.  If you can show a two year history of property management then a few lenders will allow 75% of the rents for qualifying.  (Two year history is determined by two years tax returns showing rental income.)  Without the history you must qualify for the property with no rent credit, and many lenders follow this guideline even if you are an experienced investor. 

What this means is that if you are a homeowner and are looking to invest in some rental property for the first time you must qualify for the mortgage to purchase the property with both the full PITI (principle, interest, taxes, insurance) for both your current residence and the new property.  If your current housing payment is $2750 per month including taxes and insurance and you are looking at a $650,000 duplex with 25% down you will have a PITI of approximately $3400 for qualifying; your income must therefore support total monthly payments of $6150 per month plus any other debt such as car payments and credit cards. 

A second factor, or limiting factor 1-A, is cash for down payment.  Depending on the loan amount the minimum requirement is either 25% or 35% down, prior limits would allow 20% down for non-owner occupied purchases through Fannie Mae and Freddie Mac.  Given the high value, even after market price deterioration, of Southern California real estate in most of Los Angeles and Orange Counties, the amount of money need for a three or four unit building can be as much as some single family homes.

The investment market is soft primarily due to the increased income and cash needed to qualify for and obtain financing.  Reduced opportunities for financing soften a market, in the case of residential units this is having a far greater impact on values than foreclosures.

Is now a good time to buy investment property?  If you can qualify and are looking for a long term investment and feel that the market provides you with a good opportunity then perhaps it is; if you feel the market will decline substantially in the next several months then perhaps not.  Keep in mind, making investment property even more affordable in this market are the incredibly low interest rates—under 5% for three and four unit buildings with 25% down is pretty incredible.

Have a question for me?  Ask me!

Back in “normal times” whenever the Fed would lower interest rates mortgage rates would temporarily spike.  The reason is that each time they lowered it reduced the chances of them reducing further in the future.  The converse was true if they raised the short term rates.  We saw that effect return this week.  Fed minutes were released earlier in the week and they said they were poised to move.

What move for the Fed?  Since the Fed discount and funds rates are near zero the Fed can do little to move rates lower—unless they pay banks to borrow, which with the rate markets they are already doing.  Worried that inflation is well below the target of 2% and that the economy is growing too slowly to increase employment the Fed’s primary tool will be to purchase more assets.  “Assets” defined as Treasury debt and/or more mortgages.  Faithful readers will recall that in March the Fed stopped a $1.25 Trillion purchase program for Mortgage Backed Securities.  A purchasing program that pushed mortgage rates below 5% and kept them there.

Pushing more money into the economy by purchasing more assets is thought to keep interest rates at rock bottom.  Rock bottom rates are supposed to encourage companies to borrow money to expand and grow.  Rock bottom rates have done nothing to encourage banks to lend money.  Mainly because while one arm of the Fed is out there buying debt to stimulate the economy the other arm of the Fed is crawling into bank balance sheets and discouraging “risky” lending.

Meanwhile balance sheets are flush.  With all the money flowing from Washington into the economy none of it is being spent, at least not on new jobs in the private sector.  Banks are tighter than ever and borrowing money for the Fed at zero percent and then lending overnight at nominal rates that generate free profits—while 0.5% (one-half of one percent) may not seem like a lot, what if it was on $100 million?  That’s half a million for a night of moving money from account A to account B and back to Account A.

Bank accounts are flusher.  Companies in business are hoarding cash, I have mentioned before that non-financial companies are sitting on nearly $2 trillion in cash.  For the past year while unemployment increases those with jobs are earning more and spending less.  Personal savings is up and rising.  CEOs in the skyscraper and the CEO in the home-kitchen are saving money to see what is next for the economy.

In the meantime economic news continues to hurt incumbents.  With less than 3 weeks to go until the midterm elections, and the thankful end to the ads and mailers, economic data is giving little ammunition to incumbents.  First time unemployment filings increased to 462,000 individuals.  Retail sales bumped up in September, 0.6% higher than August , but core inflation numbers are stagnant.  Consumer prices are up 1.1% from last year, and only 0.8% if energy and food are stripped out.  This low increase created some more anti-incumbent sentiment for seniors and Social Security recipients who will see no increase in their checks due to the lack of inflation. 

In the meantime the only sector spending goes by Uncle Sam.  The federal deficit increased $1.3 Trillion in 2010, a little lower than last year—but an elephant that loses ten pounds is also a little lighter.  This is the concern moving forward.  The Federal deficit that requires a ton of Federal borrowing, which pushes a ton of cash into an economy where no one is buying at any level.  This concern has bond markets skittish and poised for react very negatively at the slightest hint of economic stability.

Rates for Friday October 15, 2010:   Rates bounced off last week’s lows for conforming loans as Mortgage Backed Securities were under heavy selling pressure each day.  We are still seeing big swings daily in the market, not a good float situation, if you have your rate take it and don’t get greedy for a little less.

FIXED RATE MORTGAGES AT COST OF 1 POINT*

30 year conventional                             3.875%             Up .125%

30 year conforming-jumbo                    4.25%               Up  .25%

30 year FHA                                         3.875%             Flat

30 year FHA jumbo                              4.000%             Down .125%

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. 

Please note that rates quoted are based on average of several lenders for a purchase transaction with 20% down payment with an impound account for taxes and insurance and a minimum FICO score of 740; APR is not quoted as it is dependent upon specific loan amounts, lenders and services selected.  Numbers provided are for comparative purposes only.

Thanks for the feedback from those who provided it last week on my switch to Constant Contact.  I am always open to feedback so if you have any please pass it on!

Is it too early to buy pumpkins or wait another week?  Or are we too late? 

Have a great week,

Dennis