The top indicator for assessing value in real estate markets

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These days there’s a lot of good data on residential real estate markets. Here are examples of a few of the metrics than can be helpful to keep tabs on: 

  • Days on Market
  • Median sale price
  • % of homes that sold above list price
  • % of homes that had a price drop
  • Inventory (number of homes on the market)
  • New listings
  • Months of supply
  • Number of homes sold

But if we had to pick one statistic that captures both the short-term and long-term trends of a market, it’s the price-to-income ratio. We have written about this metric before, which is simply the median sales price for residential properties in a given market, divided by the median income for that market.

It makes sense that household income and housing prices are connected. A household obviously cannot spend all its income on a mortgage or rent. People have to eat, fund retirement accounts, pay for college, have fun, service other debt, etc. Spending too much of one’s income on housing can be risky, as over-extended homeowners found out the hard way in 2007-2008.

As we’ve discussed previously, financial experts have established rules-of-thumb for determining an appropriate ratio of home price to household income. Given x amount of income, how much house can a home buyer afford? Most advice you’ll hear is that you shouldn’t spent more than 2-3x your income on a house. Anything beyond that can be risky to one’s debt-to-income ratio, both on the practical/day-to-day and bigger picture financial levels.

When assessing the value and risk of a given real estate market, an investor can extend the 2-3x logic. If real estate investors in a metro area have thrown caution to the wind and are chasing houses at 4 and 5x median income, then you might want to be careful investing in that market. You could still find attractive individual properties, but if RE prices are spiking well beyond income, caution is warranted.

On the other hand, if home buyers in a market are not paying up when buying a house, we might view that market at less risky. The sweet spot for investing in a housing market: Solid median income growth coupled with non-speculative home buying.

According to Zillow, between 1985 and 1999, the average Price-to-Income ratio for all U.S. real estate markets was 2.79. But in the 2000’s, it started to drift upward, past the 2.5% mark, primarily as a result of historically how interest rates making mortgage financing more affordable. In the 2000’s, the average U.S. P-I ratio has been 3.07. It is currently 3.54.

One of Aloha’s current favorite markets is Indianapolis, IN. Its average Price-to-Income ratio between 1985 and 1999 was 2.87. It’s average P-I ratio in the 2000’s has been 2.68. As of 2018 year-end, Indianapolis’ P-I was 2.63. With solid, albeit unspectacular, median income growth, Indianapolis is a solid place to invest in real estate.

The same can be said of Cleveland, OH.

 And then compare the above charts of Price-to-Earnings Ratios with San Jose. While investors have made lots of money in the California coastal markets, many of these real estate markets look like potential 20%+ corrections waiting to happen.

Looking at the Price-to-Income ratios of the top 40 U.S. metro areas, we can see that the Midwest remains the most affordable region for home buyers, and on balance offers some of the best opportunities for investors.  The highlighted markets below are Aloha lending favorites, and illustrate our ongoing appreciation of the value proposition of Midwest real estate.

February is historically a lower-earning month for the Fund, given there are fewer days of interest charged and collected.  The Fund’s fifty-month run of positive performance, since its inception, continues.  We are working diligently to get the best returns possible for our investors, at the right risk trade-off. As career investors know, few investments have a return stream with this level of absolute returns and consistency.  

As always, feel free to reach out with questions and interest in working with Aloha Capital in this excellent investment–Aloha LTD Income Fund.

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