Housing is the sector of real estate most watched … and worried about … by economists, politicians, journalists, bankers, and investors … from Wall Street to Main Street.
That’s because housing, quite literally, hits us all right where we live.
We can all relate to it and housing is both an objective and subjective measure of individual and national prosperity.
Housing has certainly been in the financial news of late …
Housing Starts Surged in December. Don’t Expect It to Last
New Risk to World Economy: Synchronized Housing Slowdown
Wall Street Journal, 1/28/20
As you can see, there’s both “good” news and “bad” news. Of course, buried inside of all that is opportunity.
So we think it worthwhile to look at housing through the lens of a tried and true investing strategy which could prove timely in today’s market conditions.
But first, let’s set the context …
Despite low interest rates (and largely because of them), housing is expensive relative to incomes.
That’s a problem for both renters and prospective home buyers … and why affordable housing is a hot topic today.
It’s also why we’re strong advocates of leaning towards affordable markets, neighborhoods, and price points. Demand tends to be stronger there.
We think it wise to be positioned below the top of the range. If interest rates rise or there’s a recession, people above will flow downhill to you.
Meanwhile, be prepared to survive a notch or two below your current price point. Otherwise, you may lose more demand leaking out the bottom of the range than you gain flowing in from the top.
In other words, ALWAYS compete for the loyalty and rent checks of your tenants … even in a high demand market.
Those who push rents to the margin of the range are the first to feel the pullback. Like equity, all rent retraction is at the margin. High rents hurt first.
That’s because when tenants start to feel a financial squeeze, giving a 30-day notice and moving to someplace more affordable is a relatively easy thing to do.
And don’t get suckered into thinking there’s no inflation or high employment based on the highly publicized and potentially “adjusted” official data.
Pay attention to the real world … because that’s where your tenants live.
From a home buying perspective, demand comes from first-time home buyers entering the market and pushing things up.
That’s why pundits are concerned that the average first-time home buyer age has risen to 47 years old.
Perhaps young people would rather rent than own? Maybe. But even if true, we wouldn’t bet on that lasting.
Sure, Millennials saw their parent’s real estate experience turn sour in 2008 … but that’s now 11 years ago … and a LOT of equity has happened since.
Most Millennials we know would like to own. They see prices rising and affordability getting away. Meanwhile, rents are climbing.
So we think Millennial demand will be a substantial factor in housing going forward. Demand is already growing … and it’s a wave you can likely ride over the next 10 years or more.
Also, Millennials are among a large group of Americans standing to inherit about $764 billion THIS YEAR alone.
We’re guessing next to paying off student debt, buying a home is near the top of the wish list for some of those heirs … adding some additional capacity-to-pay to fuel demand.
And speaking of capacity-to-pay …
Interest rates remain crazy low … and aside from a collapse of the dollar or a seizure in the bond markets (which could easily happen somewhere down the road) …
… there’s not much in the near-term to suggest interest rates will rise substantially.
In fact, with the amount of debt in the system, it could be argued there’s FAR more downward pressure than upward.
Still, because you don’t know, it’s not a bad time to stock up on inexpensive good debt. Just be VERY attentive to marrying it to durable income streams to service it.
Of course, another much discussed hindrance to Millennial home ownership is the now infamous and mountainous levels of unforgivable and inescapable student debt.
But in terms of student debt defaults and the resulting dings to credit, it’s only less than 15% of borrowers.
That means 85% of Millennials are chugging along making those payments … and presumably preserving their very valuable credit scores.
Of course, making those student loman payments hinders a young person’s ability to save for a down payment on a home. They start later and it takes longer.
And if a young person doesn’t have parents with equity they’re willing to re-position into a home for junior, or they aren’t on the receiving end of a chunk of that $764 billion inheritance …
… the lack of a down payment is perhaps an even bigger hindrance to Millennial home ownership than student debt.
And even though there are low down payment programs out there, they come with higher interest rates, private mortgage insurance, and larger loan balances …
… all of which converge to make the resulting mortgage payment much bigger than low interest rates can offset.
So that elusive 20% down payment dramatically increases the affordability of home ownership for many Millennials.
ALL this adds up to a great opportunity for real estate investors …
There’s a simple, time-tested strategy to leverage your cash into long-term equity … while preserving your credit and avoiding virtually all land-lording hassles.
It’s “equity sharing”.
In short, a cash rich investor supplies the down payment to a credit worthy owner-occupied home buyer.
The credit partner gets the loan, makes the mortgage payment, and lives in the house for the long term.
After a predetermined period of time … usually 3 to 10 years … an appraisal is done.
Any equity growth net of capital investments (reimbursed to the partner who made them) is split at a previously agreed upon rate such as 50/50.
Of course, there are some legal agreements which need to be put in place … and the borrower needs to work closely with a mortgage pro to make sure nothing is misrepresented in the loan application.
But equity sharing is a profitable way for Main Street investors to help the next generation of homeowners get into the market … so both can ride the long-term equity wave.
The borrower gets a home of their “own” … to live in, care for, and fix up for their personal enjoyment and prosperity.
They don’t feel or act like tenants … and they’re in for the long haul.
And with their name and credit on the line, they’re HIGHLY motivated to make the payment … even if it’s higher than they could rent a similar home for.
They don’t move to save a few bucks the way a tenant would because they have housing stability, tax breaks, long-term equity growth, and pride of ownership.
Meanwhile, the investor gets half the amortization and appreciation over the hold period … and next to no management headaches.
Plus, the investor has no property management expense, no loan on their credit report, no turnover or vacancy expense.
Equity sharing is a great way for an investor to leverage cash without as much risk as traditional land-lording.
Equity sharing is really just a form of syndication and a simple strategy for taking advantage of current market conditions.
For the cash partner, you get to invest in housing for the long-term, while mitigating much of the downside risk in the short term.
For the credit partner, you convert your housing expense into housing security and long-term equity. Half of something is better than all of nothing.
And when it’s hard to find rental housing that cash flows after expenses, equity sharing is a way to ride the housing bull with far less risk than traditional land-lording … while helping a young person get on board the real estate equity train.