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6/23/13: Clues in the News – Students, Supply and Standards

Recent headlines proclaim that real estate is back!  While we’re happy to hear positive reports on real estate, the last run-up in response to Fed hyper-stimulation compels us to dig a little deeper.  Fortunately, there are lots of clues in the news that provide important insights into what’s happening in housing and what’s behind it.

In the studio to decipher the mysteries of the current headlines:

  • Your Sherlock Host, Robert Helms
  • His elementary Whassup co-host, Russell Gray
  • The Godfather of Real Estate, Bob Helms

After several years in the dumper, single family home residential real estate is making a comeback.  Recent headlines declare that a housing recovery is well underway.  Fed chair Ben Bernanke is hinting that he may begin to “taper” off the unprecedented levels of quantitative easing pumped into the world’s financial system every month.

Sounds great!  But is it?

It depends on how you look at it and what you do in response.  Sometimes it’s easy to get lost in the trees, but don’t worry.  That’s why we’re here.  We’ll take a look at the market from a bird’s eye view.

First, let’s talk about rising home prices.  Where have we seen this movie before?  Oh yeah, after the Fed pumped a gajillion dollars into the economy to calm things down after the dot com bust and 9/11, real estate went crazy from 2002 to 2008.  Many people made a TON of money.  Very fun.

But then a not so funny thing happened on the road to riches.  The financial markets imploded when it was discovered that the “growth” everyone was so giddy about was based mostly on air.  That is, the underlying fundamentals were weak. So market values were much higher than incomes and affordability said they should be.  Ahhh…it all seems so clear now.  That’s what we love about hindsight…it’s 20/20.

The other great thing about hindsight is that it helps you recognize a mistake when you’re making it again.

So… is this housing recovery real?

Well, if you bought a property in the last few years and it’s gone up substantially, you might say, “Who cares?  I’ve got gobs of equity!  Just look at my balance sheet!  Isn’t it pretty?”

If you bought in the last boom and have been stuck with an underwater property that you’ve been keeping on life support, you’re probably thrilled all your sacrifice is now appears to have paid off.  We’re happy for you.

But just like last time, today’s run up in values begs the question: what is all this appreciation based on?  Is it sustainable?  Remember, when it comes to equity, the market giveth and market taketh away.

To figure all this out, we watch the news.  Hidden in the headlines are insights into what’s going on – along with lots of invitations to do more homework.  And when it comes to real estate investing, we love homework.

Understanding that real estate, like many markets, is driven by demographics, when we saw an article titled, “Here Comes a Millennial Housing Boom”, it caught our attention.  After all, look what a profound impact the baby boomer generation had.  And the millennial generation is even bigger!

But this isn’t your parent’s America.

We also discover that Gen Y’ers are facing a different set of challenges that some folks say will hinder those millennials from jumping on the housing bandwagon…even if they wanted to (more on that in a moment).

One of the biggest obstacles facing the next big wave of home buyers is student debt.  Today, many young adults are graduating with huge amounts of inescapable debt. This negatively impacts their ability and willingness to take on mortgage debt.  And without lots of entry level jobs being created, some graduates are doubting the value of that expensive diploma.

Speaking of expensive paper…

Millennials are looking at their parents’ recent experience in home ownership and are saying, “Really?  No, I don’t think I’m in a big hurry to take on a 30 year debt obligation on a property that might unexpectedly tank in value.”  And who can blame them?  Perhaps as home prices escalate, they’ll have a sense of urgency to get in before the market gets too out of reach.  OR…they may decide to move to a more affordable, lower taxed area (we think there will be much more of that in the future).

Now to entice Millenials (and anyone with a pulse and a paycheck) to take on more debt, lenders are starting to lower lending standards.  Remember, a deposit at a bank is a LIABILITY to the bank.  To offset this liability on their balance sheet, they need to create an asset.  From a banker’s perspective, your loan is an ASSET.  As the Fed pumps the system full of dollars, most of them end up in banks, which now need to make loans.

Again, where have we seen this before?  It seems eerily familiar.

Still, as borrowers, we love easy money.  But as we discovered in 2008, easy money can skew values to the upside.  And when the easy money goes away, so do the values.  So if all your investing is based on passive appreciation (no fix up or other increase in utility), it’s smart to pay CLOSE attention to where that appreciation is coming from.  And don’t ever bet the farm on it.

If supply is limited and demand is high, then competition for available product can push prices higher.  If demand is fueled by strong and growing incomes, then you can have greater confidence in the stability of the values.  That is, the fundamental under the values are more solid, therefore the values are more solid.

But if the price appreciation is based on a temporary shortage and/or a loosening of credit, the underlying value drivers can quickly change thereby quickly changing values.

So when we saw this headline: “Supply Crunch to Take Steam Out of Home Sales” it also caught our attention. What’s causing the supply crunch?  Will builders respond decisively and build more?

Builders want to build.  That’s how they make their money.  They’re like flippers on steroids.  But they won’t do it if there are no buyers or the market won’t give them a high enough price to make it worth the effort.  Because of the flood of foreclosures on the market for the last several years, homes in many areas have been selling below replacement costs.  In such conditions, builders can’t afford to build.

Now that some markets will allow builders to sell at replacement cost plus some profit, they’re coming out of the woodwork and starting to build.  No surprise, given the recent increase in home prices, that builder confidence has increased.  They see values reaching a point where they can begin adding to the supply.

Of course, from our perspective, the increases in new home building combined with the flushing of more foreclosures into the market puts a little downward pressure on prices by increasing supply.  Rising interest rates adds to the student debt issue and soft jobs market to further hinder affordability (demand).   But will looser lending offset this downward pressure?  Only time will tell.

Here’s the concern:  If the only thing propping up the housing market is easy money, then you can expect more price volatility.  So if you’re investing for short term capital gains without adding any utility to the property (i.e., pure speculation based on the rising home prices), be VERY CAREFUL.  Get in and out fast.

Of course, we don’t really consider that kind of activity “investing”.  It’s the real estate version of day trading.  It’s a business.  The IRS looks at it the same way, which is why your short term capital gains are taxed like ordinary income.

If you’re a long term investor, this market offers a lot of opportunity.  In many markets, prices are still relatively low based on rental income, in spite of the recent price run ups.  Looser lending just means easier access to loans, which if used responsibly, can magnify your equity growth rate, so we’re happy there.  Interest rates, though rising, are still ridiculously low compared to cap rates.  What’s not to like?

If you’re a real estate syndicator (building a portfolio with investors’ money), a little bull (as in positive sentiment) in real estate should make it easier to attract investment capital.  And if the stock market continues to gyrate in hyper-reaction to anything the Fed says, many investors will be ready to take their stock profits and find something less nauseating.  You can help them.  Check out our Secrets of Successful Syndication seminar for training on how to set up your own real estate investment fund.

In any case, it’s a good idea to watch the headlines for Clues in the News.  Staying aware and informed is a great way to recognize opportunities and challenges in time to take appropriate action.  Because at the end of the day, information with action is useless.  We’re much more into Education for Effective Action™. 🙂

Enjoy this edition of Clues in News!

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