Clues in the News – Market Peaks, Credit Scores, and Student Loans

This edition of Clues in the News is coming to you from Bozeman, Montana, where we just wrapped up an insightful weekend at the Red Pill Expo with thought-provoking author G. Edward Griffin and other amazing speakers.

Perhaps the mention of this conference provokes skepticism. Why attend, you ask?

We’ve learned that as real estate investors, it’s crucial to examine information from all sides instead of taking a single account at face value.

That’s why we found the expo so exciting. It’s also why we read the news every day … and then examine it with a critical eye to see what lies between the lines.

In this all-new edition of Clues in the News you’ll hear from:

  • Your at-the-helm host, Robert Helms
  • His (tired of being kicked in the side!) sidekick, Russell Gray

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The rise (and fall?) of short-term vacation rentals

We find it helpful to look at the real estate investing world from both a big-picture perspective and a smaller local perspective. Often, local news gives us helpful insight into currents running underneath the big waves that make national headlines.

That’s why we took a look a Bozeman’s local newspaper, the Bozeman Daily Chronicle, where we found an interesting article about short-term vacation rentals.

Short-term rentals are a craze that has been sweeping across the nation over the past couple years … and local governments have responded in various ways as these rentals have risen in popularity.

Although Bozeman isn’t a large town, many residents and businesses are concerned about this issue.

Why? Well, think about who’s threatened by rentals offered through companies like Airbnb. Hotels.

A pragmatic investor or businessperson is aware they may meet resistance to their business model … and that’s what’s happening in Bozeman.

Companies threatened by these smaller rentals are taking the issue to local politicians … who are backing them up.

Think about it … who has a bigger influence on local economics, and thus a bigger say in local politics? The one-property Airbnb owner, or the hotel operator?

Investing is more than just making deals. An important piece of being a successful investor is being aware of the local political environment, including tenant-landlord laws and local issues that may affect you.

The lesson? It’s great to be optimistic and hope for sunny skies, but always pack an umbrella in case you run into rain (or resistance).

Market peaks continue to soar higher

When we took a step back and zoomed out to see the nation as a whole, we noticed a trend we’ve been seeing for a while … escalating home prices across the board.

Although home prices continue to rise, there’s a lot of variation in different markets. A close look at the data in Harvard’s Annual Housing Report tells us that while home prices in the 10 most expensive metro areas have risen a whopping 63% since 2000, while prices in the 10 cheapest areas have grown by only 3%.

That’s a big difference!

We think it’s important to dig deeper and find the over-performers. Looking at information at the macro level is great … but it’s up to you to take that information and move toward the micro.

Look at the nation … then examine your specific town. You may find surprising disparities, even between different neighborhoods in one city!

We zoomed out even further to see if the housing boom was a U.S.-only trend and found an article from an Irish newspaper that stated the average cost of buying a house was €338,000 (about $384,000).

That amount is nine times the average Irish salary!

Big, overheated markets aren’t a problem specific to America. They’re a worldwide trend.

As this trend becomes more obvious, journalists are taking note and coming up with their own interpretations of the data to satisfy the curious public.

We find it helpful to remember news isn’t hard data, and it isn’t the answer … it’s really the question.

The news gives you a starting place to ask yourself: Does this topic affect me? And what does this article really mean? How can I dig deeper?

We went through this process with a CBS article that contained advice for home buyers in the current market.

Many of the article’s statements were simply the opinion of the journalist. And although the journalist offered some helpful advice, we often find professional journalists don’t have the buy-in to catch some of the most important dynamics active in the marketplace.

That’s why as an astute investor, YOU have to be prudent and pay attention.

Rising home prices may mean it’s time for you to take some chips off the table. Depending on trends in income versus rent prices and other numbers, they may mean something else.

Either way, it’s up to you to do the math!

The cost of renting versus buying

If you’re a landlord, you know it may not make sense to buy rental properties in areas where tenants can afford to buy homes.

We found this infographic eye-opening. Although it only cites average numbers, it’s obvious that today buying a home is more affordable compared to renting than it ever has been.

What does that mean for you? It means you have to watch your numbers.

Analyze your own tenant base. Ask yourself the following questions:

  • What is the income-to-price ratio?
  • How affordable is your housing for your tenants?
  • Do you have tenants with high credit scores who will be able to get easy loans?
  • Do you have a competitive advantage over other housing options?

The overall idea is to find tenants that have income durability, but won’t skip when they can buy a house. One option is to invest in rent-to-own properties.

Finding that balance can be tricky, but if you’re paying careful attention to your numbers, it’s doable.

Rising mortgage rates and plummeting credit scores

Credit rates affect new homebuyers’ abilities to get loans and buy houses. In a recent article, we read that for every increase in mortgage rates, credit scores go down.

As real estate investors, we always want to understand the ratios of mortgage rates and interest rates.

We have no control over these rates … but they definitely affect what we do as investors.

So what do these changing numbers mean? Is there any correlation? We don’t necessarily think so.

What we do know is when lenders lower barriers to entry by decreasing the credit score required to get a loan or nudging the required debt-to-income ratio, it can be a warning sign credit markets are starting to get desperate.

When you start to see lenders giving borrowers up to 50% of their income, that’s when you know something problematic is happening.

A dimming outlook for brick-and-mortar retail stores

We’ll look at this next issue with the assumption that with the rise of mega-sized online retailers (think Amazon), retail is not the greatest place to be right now.

With this dimming retail outlook comes a push for shorter leases.

When retail tenants consider their options, they ask themselves a basic question: Do I pick a longer lease for more stability, or a shorter lease I can get out of sooner?

The trade-off of choosing a longer lease is that the landlord decides what the future 5-10 years will look like in terms of rate increases, even if those don’t match up to reality.

Retail tenants also have to consider how the location they choose will drive traffic.

If big-box stores pull out, can smaller retailers expect the same regular traffic? Uncertain about the future of these stores, more smaller retailers are pushing for shorter lease terms.

If you’re not in the retail business, you may be wondering how this affects your residential properties. Ask yourself, How many of my residents work at these stores? What will happen when local retailers shut down and my residents are out of work?

Big sea changes for retailers can also mean big changes for you. Retailers typically choose to close stores in places that are weak for core drivers. If you have a tenant demographic similar to the store’s shopper demographic, it may be insightful to look at where stores are shutting down, and why.

As an outsider, you’re not privy to why the big dogs do what they do, but you can observe what they’re doing and come to your own conclusions.

New options for homebuyers with student debt

We all know student debt is increasingly becoming a bigger issue amongst millennials.

This younger generation often forgoes buying homes due to high amounts of student debt.

An article in the Wall Street Journal reported on a new option backed by Fannie Mae that allows homebuyers with student debt to refinance and convert their student loan debt to housing debt.

This program gives younger buyers collateral … and may make them more likely to choose to buy a home.

The program could also drive home pricing in your area, depending on the makeup of the local population.

If you don’t have student debt, this program may not seem relevant … until you stop to consider the bigger picture.

That’s it for now until next week, when we talk about a major disruption in real estate markets!


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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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