What does the coming year promise for residential real estate investing? Will it be a good time to try your hand at buying a foreclosure and renting it out? Will rising home values be a positive or negative factor? Where will the best markets be for investors?

For investors, who account for one out of every five homes sold in America, 2012 was a year of change. The inventory shortfalls that drove price increases around the country were particularly acute among foreclosures, as lenders slowly increased processing in the wake of the Attorneys General agreement. Several dozen well-financed hedge funds entered the REO-to-rental business, spending billions to acquire distressed properties. The result was fierce competition in some markets for available foreclosures and short sales, driving up prices and squeezing out first-time buyers. As a result, the investor market share in home purchases fell from 27 percent in 2011 to around 20 percent as the year ended.

Overall, however, 2012 was a good year for investors. Demand for single-family rentals remained strong, and rents rose in most markets. Financing was affordable and available for individual investors. Cash flows and returns were good. It was the year that residential investment truly came into its own, helped by Warren Buffet’s comments on CNBC: “If I had a way of buying a couple hundred thousand single-family homes and had a way of managing them, I would load up on them and I would take mortgages out at very, very low rates…. If I was an investor that was a handy type, which I’m not, and I could buy a couple of them at distressed prices and find renters, I think that’s a leveraged way of owning a very cheap asset now, and I think that’s probably as an attractive an investment as you can make.“

Real estate investing trends to watch in 2013

The geography of foreclosures is changing. The “sand states” of California, Arizona, Nevada, and Florida, which dominated foreclosures and investor activities from 2007 until this year, are no longer the best markets to find the best deals—with the possible exception of some Florida resort markets. Today the action has moved to the Midwest and Northeast, home to most of the judicial states where slow processing has piled up inventories and higher unemployment. New Jersey, Illinois, Ohio, Wisconsin, Connecticut, and New York are reporting greater foreclosure discounts—the difference between foreclosures and “normal” home sales—than sand state markets. Want a good deal on a foreclosure? Try Milwaukee, Baltimore, Philadelphia, Cleveland, or Hartford.

Short sales are where the action is. For the first time ever, sales of properties in some stage of foreclosure (pre-foreclosure sales) outnumbered sales of bank-owned properties (REO) in the third quarter, as short sales continue to gain market share at the expense of REOs and sales of completed foreclosures at auction. With a few exceptions where large backlogs of foreclosures have piled up, as with the markets cited above, in most markets short sales are where the action will be in 2013. Find a Realtor expert in the short sale process to help you find deals.

Rising home prices have a silver lining. Prices are rising fastest at lowest-price tiers, especially foreclosures and short sales, because of tight inventories and increased demand from hedge funds. Higher prices cut into investors’ profit margins in the short term, but in the long term they increase the value of investment properties, making it easier to borrow more money and to sell at a greater profit. Rising values also raise rents because rents and home prices move hand in hand. Prices are projected to rise at a slower pace in 2013, from 1 percent to 3 percent, compared to the 4 percent to 6 percent experienced in 2012.

Tight lending standards will keep single-family rental demand strong. As the economy improves, more young people are forming households and will want to buy a home. However, many first-time homebuyers are experiencing nightmares getting financing; only half of all applications are being approved today. Potential buyers are forced to rent until they can qualify for a mortgage, bolstering demand for rentals, especially single-family rentals, which are more popular with young families.

Hedge funds will increase the value of single-family rentals. While the big money from Wall Street is compiling portfolios of hundreds of properties by buying foreclosures right and left, it’s also hungry for properties that have been renovated and rented. If you own one, you might get an offer you can’t refuse.

The coming months could be the best yet for real estate investors, whether for individuals or for the investment partnerships loaded with private equity cash that are active in many markets today. If you’re thinking of trying your luck at real estate investing, the stars could be aligned for you in 2013.

Steve Cook is Executive Vice President of Reecon Advisors and covers government and industry news for the Reecon Advisory Report.

During his 30 year career in public relations and journalism, Cook has been a print and broadcast news correspondent, served two Members of Congress as press secretary, was a senior executive in the world’s largest independent public relations firm in Washington and Chicago and was vice president of public affairs for the National Association of Realtors from 1999 to 2007.At NAR, Cook supervised external communications including news and editorial coverage, video production, speech writing and communications strategic planning. He helped to manage NAR’s multimillion dollar network advertising program.

Cook is a member of the National Press Club, the Public Relations Society of America and the National Association of Real Estate Editors, where he served as second vice president. Twice he has been named one of the 100 most influential people in real estate. He is a graduate of the University of Chicago, where he was editor of the student newspaper. In addition to serving as managing editor of the Report, Cook provides public relations consulting services to real estate and financial services companies, and trade associations, including some of the leading companies in online residential real estate.

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