Housing market conditions create challenges … and opportunities …

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
MarketWatch, 1/17/20

Housing market falling short by nearly 4 million homes as demand grows
CNBC, 1/21/20

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.

06/07/15: Ask The Guys – All About Loans with Two Expert Guests

After our last episode of Ask The Guys, we asked Walter, our email room manager, to rummage through our email inbox and gather up a bunch of listener questions about loans and lending.  And he came up with some gems!

So we dialed up our lending brain trust and convened in our Dallas studio to answer your questions about loans and lending.

Behind the microphones and ahead of the yield curve for this episode of The Real Estate Guys™ radio show:

  • Your well-capitalized host, Robert Helms
  • His living on borrowed time co-host, Russell Gray
  • Residential investor lending specialist, Graham Parham
  • Commercial lending specialist, Michael Becker

After several years of tight money, it’s nice to be able to talk about getting loans again.

Even better, lenders are beginning to to get more creative in looking for ways to attract new borrowers.

But while that’s good news, it means savvy investors need to stay on top of the ever-evolving underwriting guidelines.  That’s why it so important to have one or more mortgage pros on your team.

So when Walter dragged in a bag of emails full of lending questions, we called on our lending gurus, Graham Parham and Michael Becker, to help us answer.  In fact, we made them do all the work. 😉

We talk about what happens when you’re fortunate enough to have equity and want to use a cash out refinance to access it for additional investment.

We discover that…from a lending perspective…not all properties are the same.

For example, a condominium might be in great shape…and your credit score and debt-to-income ratios might be amazing…

But if there’s too many renters and not enough owners living in the complex, your condo might be “unwarrantable”.

That means the government subsidized lenders, Fannie Mae and Freddie Mac, don’t want to make the loan.

Bummer.  Now you can’t get the cheapest rates.

However, all is not lost.  Because while Fannie and Freddie might shun your deal, there’s an emerging group of private money lenders who can probably help you.

Of course, it’s more expensive compared to Fannie and Freddie.  But probably better than leaving your equity trapped and idle in a property.

We also talk about HELOCs (Home Equity Lines of Credit).  These are nifty tools that allow you to have what is essentially a revolving line of credit against the equity in your property.

For a while…in the wake of the mortgage meltdown…lenders were shutting these credit lines off en masse.

Today, lenders are advertising to attract HELOC borrowers.  Happy days are here again!

Of course, we don’t think it’s smart to count on HELOCs for essential liquidity.  After all, the lender can shut the line off at will.

But they can be VERY handy tools for tapping equity…and only paying interest when you have the funds drawn.  Nice.

One of the issues borrowers are facing is income documentation.

It SEEMS like documenting income is a good idea.  After all, who would lend to someone who doesn’t have enough income to make the payments?

BUT…as our good friend Robert Kiyosaki always reminds us…there are three sides of the coin.

In the case of income documentation, most self-employed people are working diligently with their tax advisor to MINIMIZE (legally) the amount of income showing in their tax returns.

But when it comes to borrowing, the lender wants to see LOTS of income.

It used to be that lenders understood this, and would allow a borrower to “state” their income…rather than prove it.

As long as they had good credit, savings, and a legitimate source of income, the lender assumed if the borrower was willing to risk their down payment and credit score, they probably had the means to repay…whether or not the tax returns proved it.

Of course, when real estate got “hot”…and everyone was rushing in and betting on never-ending price appreciation…borrowers and lenders got sloppy.  And we all know what happened.

So today, borrowers need to plan ahead.  That means preparing your income documentation…including your tax returns…TWO YEARS in advance of your purchase!

Obviously, it’s a REALLY good idea to work closely with your mortgage AND tax advisors.

Of course, if you decide to make the leap to commercial lending (more than 5 residential units or anything non-residential)…it’s the income of the PROPERTY that needs to qualify…and it’s your balance sheet…and not your income statement…that the lenders will be interested in.

There’s another group of people who are somewhat locked out from all the great cheap government subsidized loans.  Foreigners.   And foreigners have been very interested in buying up U.S. real estate.

Of course, where there’s demand, entrepreneurs (even lenders) will look for ways to create supply.  But as you  might imagine, those solutions don’t involve government programs.

Still…some leverage…even at higher interest rates…can be better than no leverage.

As we often say, “Do the math and the math will tell you what to do.”

Another question that came up has to do with Fixed Rate versus Adustable Rate…which is best?

The answer….as you might guess…is “IT DEPENDS!”

It’s hard to imagine interest rates falling too much farther.  So the probability is higher rates in the future.

With that said, asking the the lender to fix your rate for 30 years puts all that risk on them…which you might like…but it’s insurance you’ll pay a premium for.

So the decision to go fixed or adjustable can be largely based on YOUR plans for the property.  Do you plan to sell in 3-5 years?  Do you plan to hold for 30 years?

Also, if you decide to exit the property in a few years…will you buyer be able to get affordable financing?  You can’t always assume you can freely get out of the property…at least not at your price…because if rates are up…there will be less buyers and likely less appreciation.

We think it makes sense to look at the terms of your ARM…and if you can live with the WORST case scenario interest rates…and want to enjoy the low rates of adjustable in the meantime…and ARM could be a good choice.

On the other hand, if you’re squeezing into the property with thin cash flow based on a temporarily low interest rate…and you MUST get out in 3-5 years or you’ll go bust…an ARM can be a time bomb.

Be smart.

Just like picking your property carefully, it’s important to pick your financing carefully.  And your mortgage advisors can be VERY helpful in making good decisions.

For now, listen to our two expert guests and consider how you can be a smarter borrower.

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