Turn Back, O’ Man?
So the residential housing market is hot. Mortgage rates are on the rise (we’ve known this for a couple months now, haven’t we?). It’s now more affordable to buy than to rent. A lot of stories littering the national headlines both in and out of print of late give any property investor pause for concern. And what concern would that be? Well, check out some of the latest stories – here’s a brief sampling – and we’ll discuss the important ramifications for property investors later in this article. Consider these latest stories all part of a change in direction about to hit the residential property marketplace in the coming months…
The so-called “hot” housing market. Really?
A report from CNBC on August 26th, 2013 entitled “Home prices across the US defy gravity,” by John W. Schoen notes that “home prices are going up, up, up, but it’s not a bubble just yet. The surge in home prices over the past year may have some home buyers wondering if the market has gotten ahead of itself. Rising interest rates aside, housing prices in most parts of the country appear to have plenty of room to move higher if the wider economic recovery remains intact.” He goes on to say that “home prices have room to rise. A recent rise in mortgage rates is also spurring buyers to lock in rates before they climb further. “When start you see interest rates rise, people are going to want to jump in,” said Beth Ann Bovino, deputy chief economist at Standard & Poor’s. “All those people on the fence come back into the market. But that’s a good thing.”
Mr. Schoen also goes on to note that “higher borrowing costs could eventually price some buyers out of the market and slow the pace of home sales. Sales of new single-family homes dropped sharply in July to their lowest level in nine months, the Commerce Department reported Friday. Sales dropped 13.4 percent to an annual rate of 394,000 units, and the government also revised sharply lower its estimate for home sales in June.”
So what was the conclusion of this particular article? Mr. Schoen summed it up by saying “the continued pickup in the pace of home sales and prices will depend heavily on whether the job market continues its slow recovery and incomes continue to rise. That disposable income represents the buying power required to fuel the housing market’s continued recovery. And despite the recent jump in prices, homes in most local markets remain affordable by historical standards.” He goes on to note that “the cost of buying a house is still cheap in relation to the cost of renting, suggesting prices haven’t yet reached a point where they will cool demand, according to housing Capital Economics housing economist Paul Diggle. “The most reliable measure still suggests that housing is undervalued,” he said. Even if rising prices and rates don’t scare away potential home buyers, the continued housing recovery will depend on the availability of credit, which tightened considerably following the wave of rogue lending that fueled the mid-2000s housing bubble. Lenders are much choosier than they were six years ago, but there are signs they’ve begun to ease up a bit on credit standards as they compete for new borrowers. And after paring down a large pile of debt accumulated during the credit boom, those potential buyers are better able to take on a new mortgage payment.”
A hedge fund hedges its bets
Another headline in the Bloomberg News from August 23rd, 2013, blares out the following headline: “American Homes 4 Rent Said to Fire Workers After Reporting Loss.” This tale of future woes for the residential property market goes on to report about the recent misfortune to befall the property investing company American Homes 4 Rent. The article notes that “American Homes 4 Rent fired a group of workers, with a focus on acquisition and construction staff, after the housing landlord reported a fiscal second-quarter loss, according to a person with knowledge of the terminations. The company, owner of almost 20,000 single-family homes, has cut about 15 percent of its workforce this year, including an earlier round of terminations before its initial public offering last month, said the person, who asked not to be identified because the information is private…Single-family landlords have struggled to turn a profit while acquiring homes faster than they can fill them with tenants. Hedge funds, private-equity firms and real estate investment trusts have raised more than $18 billion to purchase more than 100,000 rental houses in the past two years.” The article goes on to report that “single-family landlords are seeking to take advantage of prices that fell as much as 35 percent from their 2006 peak and increased demand for rentals. The U.S. homeownership rate is at its lowest level in 18 years, and more than 7 million homes have been sold for a loss or lost to foreclosure since 2007, according to RealtyTrac.”
Slowing things down…
The upshot from this report is made very clear in the last part of the article, where it is noted that American Homes 4 Rent “ is slowing its property purchases, with plans to spend as much as $100 million a month on 800 to 1,000 additional homes…the company’s chief operating officer, said on an Aug. 21 earnings conference call. “As far as being able to put money to work, I mean we could easily ramp back up to $300 million-a-month pace if we have clarity that we would have that capital available,” he said. “But we don’t want to get too far out over our skis.” I think that euphemism for being cautious should be used by all property investors…I mean, you’d hate to fall face first down a steep, snowy cliff of rental property negative cash flow, would you?
The writing’s on the proverbial wall
And yet another sobering story comes from the article “Signs This Real Estate Class is Set to Roll … Over” by Steve Mauzy’s blog of June 14, 2013. In it he notes “Axiometrics – an apartment data and research firm – reports rent growth slowed to a 3.1% rate in April, the slowest pace of the past 32 months. Falling rent growth is nothing new, though. Axiometrics reports rent growth has been moderating since July 2011. Rising property prices coupled with falling rent growth is hardly a recipe for real-estate investing success. Unfortunately, any fallout in the investment market won’t be contained to investors. Innocents are at risk as well. In many markets, investors are involved in up to 30% of residential real estate transactions, thus helping to elevate home prices – rental and owner-occupied alike. If the latter buys into an unsustainable trend, he could find himself underwater a few years later should investors start exiting en masse if the numbers no longer work.” This is quite the splash in the face of the average property investor in the U.S. But a cautionary tale nevertheless. It is time to take heed of all of these warning signs.
Hold ’em or fold ’em?
And lastly, a recent article entitled “Why I Sold My Rental Property” by Wyatt Investment Research, in their blog of August 23, 2013 notes that the current “hot market can offer both opportunity for profit and opportunity to get burned. The opportunity to profit arises when there are lots of buyers who think prices will continue soaring. And the opportunity to get burned happens by following the crowd, and assuming that the bubble will never burst. Once again, residential rental real estate is a hot market. Vacancies are low and rents are high. What’s more, vacancies have been falling and rents have been rising for some time. According to data from Reis Inc., a property-research firm, unrelenting rental-price increases have pushed national apartment rents to their highest level since 2007. Concurrently, national vacancy rates are now at a 12-year low of 4.3%.” They go on to say that “the residential rental market includes both apartments and single-family homes. Investors – landlords and property flippers – have been a driving force behind the housing rebound. Today they account for up to 25% of purchases. And their buying spree has helped lift the national median existing-home price 13.7% in the last year. Single-family homes have also been swamped with institutional money.” Get the picture? The tell-tale signs of impending problems for the residential rental market are becoming clearer by the day now. In this particular article, the author also tells how “property developers are following the money, and new construction has surged. Apartment building completions in the top 30 metropolitan areas of the country more than doubled. And more apartments are on the way, with new permits to build multi-family homes reaching a new high.”
A smart choice – or stupidity?
He also then goes on to describe his recent investment decision: “Of course, all real estate markets are local markets. Until recently, I owned a single-family rental property just north of metropolitan Denver, where vacancies are at a 13-year low. Rents are also at a multi-year high. I bought the property since 2003, and it’s been a solid income investment. It’s consistently provided monthly rental income of 15% to 20% above my costs. When my last tenants moved out, I could have negotiated a 12-month lease with new tenants willing to pay 20% more than what the previous tenants paid. But instead of finding new tenants, I decided to sell the property. The reason was simple: I don’t expect real estate to stay hot much longer.” He then goes on to explain his rationale why he would sell out now, when his cash flow was so excellent – “there are a few obvious reasons. Multi-year trends in both vacancies and rents are unsustainable. I expect more multi-family units will mean lower rents. That aside, the market simply looks and feels like it’s approaching a melting point. For evidence, look no further than bidding wars for homes that hit the market.” So he cashed out, rather than riding his cash cow.
A wise choice, or a huge mistake? Well, let’s take a look at the meaning all these articles in the news of late have been saying. Clearly, the upshot of so much national attention on the apparent rise in residential house values while rents have also been zooming upwards – until very recently that is, points to an indication that the residential rental boom is about to go bust. With homes being more affordable than rental rates nationally now, coupled with the slow rise in mortgage rates this Summer, it would appear that property investors should be wary about their calculations for the short term in increased cash flows due to yearly rental bumps. And if institutional investors, like hedge funds that specialize in residential single family homes, find their bottom lines dropping due to this rental rate bust starting to happen, then look out for these large funds to unload their worst-performing homes – en masse. This, of course, will create a glut of single family homes on the market, which will naturally depress home values in the short-to-mid-term range of the next few months through the end of next year at least.
Be wary, but remain calm and in control
What’s a small property investor to do? Well, for one, revise your cash flow projections, to make sure your property will remain comfortably cash-positive in the short run. In addition, since unlike a large hedge fund, you only have to appease yourself and not thousands of investors, determine at what level you are willing to ride out the coming storm that’s about to adversely hit the rental marketplace, as well as home values in general. If you’re OK with your current projections, then by all means, stick. Selling your property only produces more costs as you convert it to another asset class. You may stick with real estate – commercial is hot and steady right now –making for an excellent choice in real estate conversion possibilities. Again, be wary of the costs to do so. It just may be simpler to revise your market value and cash flow projections downward, ride out the short term, and continue to milk your investment property cash cow – but just not at its current level. ‘Cause it certainly ain’t sustainable…
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