We’ve seen a lot of volatility in the global economy these past few months. Headlines are warning us about all sorts of economic uncertainties, like the trade dispute, a worldwide economic slowdown, and geopolitical issues. It’s enough to upset the stock market, but should real estate investors be concerned?
Constant headlines about an impending recession could be a self-fulfilling prophecy, as confused consumers and investors pull back their spending and start saving. Anyone who experienced losses during the Great Recession of 2008 does not want a repeat. However, it’s important to understand that the real estate market is very different today than it was last decade.
Mortgage Loans Are Solid
In 2007 and 2008, adjustable rate mortgages were in the process of resetting to higher rates. Millions of homeowners had qualified for their home loans with low teaser rates, and could not afford the new adjusted payments. This, of course, led to mortgage defaults, and subsequently millions of foreclosures nationwide.
Today is a very different story. According to the St. Louis Fed, delinquency rates on single family residential mortgages continue to decline. In Q2 of this year, delinquencies hit a record low of 2.59%, down from 11.54% in 2010.
Back in the early 2000’s, subprime loans were abundant. That is not the case today.
Credit Karma looked at credit scores from TransUnion for about 1 million Credit Karma members who took out a first-time mortgage between August 2017 and August 2018. It found that the average credit score among those homebuyers ranged from 662 to 730, depending on where they live. These borrowers needed high credit, low debt to income ratios and proof of their ability to afford the mortgage payment with a two-year job history and plenty of reserves.
The Dodd-Frank Act of 2010 heavily regulated banks and lenders. While some no-doc or low-doc loans may still be available from private lenders, they represent a very small percentage of home loans today and require high credit scores and high cash reserves.
New regulations just this year have made it even more difficult to qualify for a mortgage. In March of 2019, the FHA informed lenders it would require even more stringent standards to applicants with high debt and low FICO scores.
Home Equity at All-Time Highs
Owner equity in real estate has hit new highs of $18 trillion. That’s up from the last peak in 2006, when home equity reached $14 trillion. It slid to $8 trillion in 2012, which means that equity has more than doubled in just 7 years.
“Tappable” equity (equity that homeowners can borrow against) reached an all-time high of $6.3 Trillion this year, according to Black Knight. That’s 26% higher than the last high in 2006.
Even if we do see a recession, borrowers may be less likely to walk away from their homes if they are locked into monthly mortgage payments that are lower than rent and their homes carry their nest egg.
If you are waiting for the next foreclosure crisis so that you can cash in on underpriced, distressed homes, you could be sitting on the sidelines for awhile.
Lack of Housing Supply vs. Demand
There simply isn’t enough affordable housing to meet demand today. Home builders got hit hard by the last recession, and they have been slow to come back. In the meantime, the U.S. population has grown by over 25 million people since 2008 and household growth has increased by 10 million. Builders have not kept up with demand.
Adding to the lack of supply, the short-term rental business is booming, when it did not exist in 2008. Today, approximately 600,000 homes are now being used as short-term rentals according to Reuters. This new business has effectively taken long-term residential units off the market.
New medical technologies that didn’t exist last decade are keeping more seniors at home. “Aging-in-place” has become more commonplace, effectively tying up more housing that normally would have been released onto the market.
According to Insight, the shortfall of housing supply ranges from a low of 0.9 million to a high of 4.0 million housing units, as of the second quarter of 2018. According to Freddie Mac’s website, “If supply continues to fall short of demand, home prices and rents are likely to outpace income and household formation will fail to reach potential.”
Housing inventory levels started to grow a bit last year when interest rates increased. While news stations proclaimed we were in a “housing slump,” in reality the market was balancing out. Inventories increased slightly and price appreciation slowed down a bit, which was good for buyers.
When interest rates started to decline this past summer, home sales jumped. Now, housing supply is down by as much as 10% for affordable new homes priced under $200,000.
Robert Dietz, chief economist of the National Association of Home Builders, says: “Five years ago that share was 1 in 5, and 10 years ago it was 40% of new home sales were priced under $200,000.”
He added, “It’s not just the overall supply of new construction that’s gone down, but the supply of starter homes, so it’s the affordability challenge at the entry level that’s been a particular challenge,”
Inventory levels for homes between $200,000 and $750,000 is flat and starting to decline.
Due to the high cost of construction, builders have been bringing pricier homes to market, but that’s the category with the most supply. Inventory of homes priced above $750,000 was 4.7% higher in September compared with September 2018.
Today’s low interest rates will certainly help more people buy a home this Fall, and probably into 2020. But it’s important to understand that there is an affordability ceiling. Prices can’t rise forever, no matter how low interest rates go. Rents can’t climb forever either.
Slowing but Growing Economy
The theme of 2020 will most likely be a “Slowing but Growing Economy.” In other words, expect to see growth, but it will likely be slower than the past decade.
A new supply of homes will be slow to market. Sales will be strong in affordable housing, moderate in median-priced homes and slow in high-priced properties.
The current real estate cycle is indeed ending, and we are entering a new cycle of “normal” and “stable.” We are certainly not falling off a cliff.
Strategies for Real Estate Investors in 2020
While many of us long to return to 2012 so that we can pick up cheap real estate with double digit cap rates, that doesn’t exist anymore.
We are in an environment that requires a careful study of fundamentals. Strategies used over the past decade will not work in 2020 and beyond. Landlords will have to accept lower returns as rents stabilize. Proformas should not assume rising rents.
House flippers will need to be more careful when calculating returns, and must get a great bargain at the outset. Repair costs need to be accurate, along with the cost of marketing, taxes, insurance and debt service. There will be less forgiveness when prices are stable.
Developers should look for ways to provide more affordable housing. This may mean smaller floor plans on smaller lots, or building up. At RealWealth, we are also not taking on any builder debt. Instead, we raise enough money to acquire the land and build the first phases. Debt is what took builders down in the last cycle.
We recently had economist Harry Dent on our other podcast, The Real Wealth Show, to give us his forecast. He’s been predicting a financial reckoning for a long time and has often been described as the voice of “doom and gloom.” But there’s always a positive and negative to many of these economic scenarios.
Rentals Will Do Okay
This podcast includes highlights from that interview, including what to expect during the next downturn, and some emerging real estate trends. As most economists will tell you, it’s not “if” we’ll get hit by another recession, but “when” and Harry expects that to happen in another two or three years. While that may impact other parts of the economy and real estate, Harry believes that rentals will do okay.
He says, millennials have already been flooding the rental market. Many of them are saddled with student debt so they can’t afford a down payment on a home, while others choose to rent so they won’t be tied down. But, one of the newest trends that could have a big impact on the future demand for rentals, is the increasing number of seniors who are renting. He was surprised, telling me that data from RentCafé shows there are 9.4 million renters who are 60 years of age or older. And he says, that number is expected to “double” by 2035 to 18.6 million.
Surge in Senior Renters
What’s driving this big surge in senior renters? They are retiring and Harry says that many haven’t saved enough money for their retirement so they are also downsizing.
Some may choose to sell or rent their McMansions in the city, and rent in the suburbs where it’s less expensive. He expects 10% to 20% of baby boomers to decide that renting is the best option. But, something that investors need to consider is the kind of rental they’ll be looking for. Harry says, they’ll want rentals with amenities, like dog sitting and plant watering and a one-level home with no stairs, along with other conveniences.
Investors should also look for opportunities to buy these McMansions, when seniors decide to sell so they can downsize into owner-occupied homes or rentals. Harry says those homes could be a good buy for investors preparing for a surge in Millennial renters who will want larger home so they can raise their families.
He also talked about another idea — that big McMansions could make good assisted-living facilities for retiring boomers. It may not be as easy as renting a home to a family, but he says that some people are creating small assisted-living facilities that might house 7, 8, or 9 people who pay up to $10,000 a month. He says, the cash flow can be substantial for individuals who want to take on the challenge.
Whatever you do with that kind of investment, you probably won’t go wrong. As Harry says, “There’s not going to be a surplus of homes in the United States.” He says, those bigger homes will grow in value in step with inflation. So that’s not a lot of appreciation, but with the potential for cash flow as a rental, and the tenants paying off the mortgage, real estate investors can do well. Harry says, “That’s why I think the people who invest in real estate for the income and rentals are going to be the long-term winners in the future.”
Harry’s full interview offers other pearls of wisdom about the rental market along with his views on the U.S. economy, the next recession, investing in gold, and why you might want to add long-term bonds to your portfolio. You can listen to his entire interview on The Real Wealth Show. It’s episode #718.
If you would like to learn about the strongest markets for investing in real estate today, visit our website. Click on the invest tab to learn about areas with strong job and population growth, and where home prices are still affordable, and are in the path of progress.
Also consider coming to our upcoming event on November 7-8.