Condo vs. Stock Market?
Opportunities Still Exist For Smart Investors
By Michelle Martin
With the stock market hitting an all-time low in 2008 and the gulf coast real estate market now at its lowest inventory level in more than five years, current investors may be wondering which market has the greater potential for greater returns. Stock market, real estate and mortgage professionals all agree that market conditions—both in real estate and stocks—have changed significantly in the last five years. Choosing between stocks and real estate is not a simple decision for most individuals, especially those who may not be experienced investors or knowledgeable about the many different issues and risks involved in each market. Industry experts discuss these critical concerns from their unique perspectives to help investors determine which option is right for them.
The collapse of the housing market and media attention given to Ponzi schemes like the Bernie Madoff fraud that cost thousands of investors billions of dollars have caused some investors to tread more cautiously in recent years. Dec McClelland, AAMS (accredited asset management specialist), with Edward Jones Investments of Gulf Shores, Ala., believes investors are wise to be cautious and more educated about their investments. “One of the biggest mistakes I’ve seen is investors putting their money into something off the advice of a friend, basically investing in a ‘hunch,’” he said. “Investors should work with a financial investment firm that has a good reputation and high customer service rating. Investors should be familiar with the stocks they choose—perhaps a product or service they use personally—know its historical rate of return, and determine what amount of risk they’re willing to accept.”
Many stock and real estate investors assumed a lot of risk over the past decade. In fact, McClelland describes the 2000-2010 period as a decade of rapid fluctuations. “The 2000-2010 decade is the so-called ‘lost decade’ because people who invested in real estate or stock have not made significant gains,” he said. “Some years had good returns and some negative. The Dow Jones securities index, for example, hit an all-time low in March 2008, trading in the 6,000s. Now, it’s trading in the 12,000s. While there has been a significant amount of return for investors in the last two to three years, most of the return in this ‘lost decade’ was from compounded dividends over the long term.”
Long-term investment, McClelland believes, is key to making returns and weathering market fluctuations in stock and real estate. He doesn’t recommend stocks or real estate for short-term investments, explaining, “Overall, being invested is not a matter of timing but spending time in the market. To maximize opportunities for the best return, stock and real estate alike should be considered long-term investments. They both can net good returns in the short term, but not historically,” he said. “Many real estate investors who have bought in the last three to five years, for example, would likely take a loss if they were to sell in today’s market. And some securities investors, who may be more reactionary to market fluctuations, don’t consider the long-term potential and decide to sell quickly at a loss. But in both cases, investors could see a good return if they were committed to a long-term investment.” McClelland said he recommends sticking with investments for at least five years, because securities that pay dividends will compound after five or more years.
McClelland believes there are good opportunities in both stock and condominium investments. “Stock investors have done very well over the long term because they have instinctively known when to buy and sell,” he said, “and smart real estate investors also can do well if they know when to buy and sell. There are a lot of similarities: Both stock and real estate investors need to know how much they can invest, their objectives and the risks involved.”
The biggest difference between stock and real estate investments is ownership, McClelland said. Stock investors purchase securities at the current market price out of pocket—but they have immediate ownership of the stock until they decide to sell it. Real estate investors have less out-of-pockets expenses, usually just the down payment for the mortgage loan—but they don‘t actually own the property until the loan is paid. “Securities are much more liquid than a condominium or real estate, which is only worth what someone is willing to pay.”
Still, McClelland believes ownership in a condominium or other real estate is an important part of an investment portfolio. “I advise my clients to consider real estate as a long-term investment goal. It’s important to diversify; don’t put everything in one basket.” He said investors also considering real estate should meet with an experienced agent to outline objectives and evaluate the risks, just as they would consult with him on securities investments. “Do they want to buy a condominium to sell in 10 to 15 years, or do they want to pass it down to their kids and grandkids? An experienced, reputable Realtor should be familiar with the marketplace for at least 10 years, know the current market conditions, and determine the properties that best match investors’ objectives and price range.”
Kevin Corcoran, CDPE (certified distressed property expert) and CCIM (certified commercial investment manager) candidate, has studied gulf coast real estate market conditions since joining RE/MAX of Gulf Shores in December 1999. He has been broker/owner of the agency since June 2004 and holds a broker’s license in both Alabama and Florida. According to Corcoran, condominium prices are more attractive than ever—making it more affordable for investors to purchase a second home along the gulf coast.
“Market indicators like lower inventory and increasing demand suggest that now is a great time to consider a purchase,” he said, noting that the number of condominiums sold increased from a low of 691 in 2008 to 964 in 2010, while the average price dropped from a high of $531,178 in 2006 to $258,008 in 2010. During the first quarter of 2011, two-bedroom condominiums sold at an average $232,680, which represented 94 percent of their list price. “This is our lowest inventory for active listings since fall 2005, because sellers have been disappointed in market conditions. But, in any cycle, there has to be interest and demand for pricing to go up. Demand has increased, but many of the buyers today are bargain hunters looking for great value. Buyers are gradually re-entering our market.”
While condominium prices may be more affordable, Corcoran cautions investors to consider and understand all the factors associated with a condominium purchase, including the strength of the condo owners’ association (COA); monthly COA dues and other costs associated with ownership; insurance assessments and taxes; and their risk tolerance for tropical events like hurricanes. “COAs are required to carry ‘all-inclusive’ hazard coverage, which is a major element in determining monthly COA dues that all condo owners must pay,” he said. “Fortunately, condominium insurance rates stabilized much faster than detached dwelling coverage after the tropical events of 2004 and 2005.”
Corcoran also discourages condo investors from relying too heavily on rental income as a means of paying for the condo. “With a certain percentage of buyers, rental income is a consideration. While it may serve as an offset for the holding cost of a condominium, the rental income should not be considered to pay for the unit.” He said a ratio of 10-12 to 1 (sales price to gross rental income) is considered strong when weighing the impact of rental income.
Likewise, Corcoran does not recommend condominiums as short-term investments—relating the experience of many non end-users who entered the market in the mid-2000s, hoping to make short-term holds and “flip” the units for short-term gains, but were left “upside down” in their investment when the market turned. “Gulf-front condominiums, like any real estate investment, should be a long-term investment. I have always thought the key to sound investing is to buy near the bottom and to sell near the top in a cyclical market. To predict equity gains is above my level of expertise.”
For most investors, owning a condominium is about more than just equity and the potential for profit at re-sell; for many, it’s as much an emotional decision as a financial one. As Corcoran said, “If condominium investment was strictly about ROI and equity, we wouldn’t have so many buyers coming from several hundred miles away to buy here. The gulf coast area is beautiful, and the chance to have a second home along the beautiful gulf coast is an emotional and exciting opportunity for investors. Families that can consider such a purchase are blessed.”
According to Corcoran, more than half of the condominium sales brokered through RE/MAX of Gulf Shores last year were cash purchases. For the other half, investors may find financing more difficult today. “The majority of condo financing is through conventional mortgage loans that require 25 percent down,” he said. “There are some unconventional 80-percent loans, but mainstream lenders are looking for a 75 loan-to-value—meaning an investor could purchase a $400,000 condo with 25 percent down, or $100,000, and a mortgage loan value of 75 percent, or $300,000.” Well-qualified investors may have even more and better mortgage options, Corcoran said.
Jim Hood, vice president of mortgage banking for Vision Bank in Destin, Fla., said he has noticed a steady increase in both applications and closings for condominium purchases. Vision Bank has offices in both Alabama and Florida that serve many gulf coast communities. “Though we are not anywhere around the number of applications/approvals from the peak, we are definitely off of the bottom,” he said.
Hood estimates that 99 percent of condo buyers are investing in second homes, which have stricter loan requirements. “For second-home condo buyers and other real estate investors, we like to see more reserves (cash) in their banking accounts after closing and pay closer attention to both their credit and collateral,” he said. “It is challenging, almost impossible, to find a typical 30-year fixed product for second-home condo buyers. The majority of condo buyers will have to settle for a ‘portfolio’ product like an adjustable rate mortgage (ARM) with a rate starting around 5.5 percent.”
ARMs aren’t as risky as the public may perceive them to be, Hood said. “Not all ARMs are bad; investors just need to be aware of the terms. The ‘index’ is what the finance rate is based on (such as the LIBOR or one-year U.S. Treasury Bill). Another important factor is the ‘margin,’ which is added to the index to determine the first rate of change. Then, the CAPS will indicate the maximum rate of change in a 12-month period and the maximum for the life of the loan. A 3/1 ARM with a 5/2/2 cap, for example, would have a start rate of 5.5 percent for 36 months; the 5/2/2 cap means that the rate would not increase or decrease more than 5 percent per year, with the first change topping at 2 percent.” Hood said Vision Bank’s “portfolio” ARM is an alternative finance option that helps make condo ownership more possible for investors.
Typically, mortgage lenders require condo investors to provide a budget and to complete a standard questionnaire as part of the application and approval process. Hood encourages investors not to get discouraged. “The biggest piece of advice I could give to potential condo investors is to visit their banker, discuss the property they’re considering, and complete the application. Then, let the banker go to work researching the different options available,” he said. “Financing guidelines for secondary homes are a little tighter now, but many investors are finding that owning a gulf coast vacation home is more affordable and more of a possibility than ever.”