As a long-term Real Estate investor, I am always trying to determine where the money is to be made in Real Estate. I personally like passive income generated through being a landlord. It’s not as passive as some would like, but it is passive in terms of the IRS.
I write about the non-passive nature of self-managed rental property and some of the adventures on my personal blog.
If you are a short term investor, a ‘flipper’, you are somewhat insulated by the long term direction of Real Estate. If you only hold for three or four months, your window of risk is short.
If you are a long term investor, which many homeowners are, the direction of RE could make or break you. Many people are relying on their home to enhance their retirement life style.
If you are a landlord, you are expecting rents to go up, property appreciation to happen, and an eventual mortgage payoff. The fruits of your labor at some point will allow you to enjoy sipping margaritas on the beach. RE has been the ticket to wealth in the past; will it continue to do so?
There are a lot of unknowns in the game of RE investment. Tax rates, property values, inflation, projected rent increases, vacancy rates and a lot of other factors feed into your financial picture when you own real estate. If you had a crystal ball, all would be easy. Here are some thoughts that I think about what the future in RE will bring.
What Drives Housing Prices?
People segregate themselves in various neighborhoods based on the economic status of the neighborhood.
That is what the term “location, Location, location” is all about. All the homes in the neighborhood are roughly the same price, if you have the largest most expensive home on a block, you probably paid too much. The reverse is true of a smaller home. That is RE 101. Never own the most expensive piece of property on the block. That said, most of the people living on that block make similar incomes, hence they can afford it.
They would likely not be able to move into a more expensive neighborhood, nor would they want to move to a less expensive area. If they did, they would already be there. Doctors and Lawyers do not move into low income areas, and low income people do not live in beach houses.
When people choose where to live, it is in a neighborhood with similar people with similar economic backgrounds and ability to pay. If that neighborhood gets priced too high, there is no one available to replace them. There is an limit to how high prices can go.
It’s Not the Price, It’s The Price Per Month
Housing is a function of a monthly payment.
That is, no one except a cash buyer buys a property on the total value; they buy a monthly mortgage payment. That payment includes principal, interest, taxes, insurance, MIP and even HOA dues. All of these affect the amount someone can qualify for.
If any one of the expenses goes up, the amount to put towards principal must go down in order to keep the same payment. When the amount allotted for principal goes down, the total value of a mortgage drops, and the value of the home drops. It’s that simple. Prices of any goods or services cannot go up beyond people’s ability or desire to pay for it.
As long as wages rise faster than the inputs to a mortgage, and the other expenses a typical household has, there is generally not an issue. People make more, they can spend more. The market will slowly trend up with the availability of money chasing the goods.
Increasing expenses will put pressure on RE prices to move down.
What we have right now, is historically low interest rates.
With a lower rate, people could own two homes very easily. The increased demand increased prices. Odds are, interest rates will not fall further, and there is not much room to fall even if they did. There are no competing investment alternatives, but if rates rise, there will be. If rates rise, there is less to put towards principal on a monthly payment.
Increasing interest rates will put pressure on RE prices to move down.
In all but the elite in society, wages are not rising.
If you look at the trend in real wages, it is headed down. Some would argue that workers have increased benefits, so the total package is worth more, but an employer paying more for healthcare does nothing to add to a workers ability to pay more for a mortgage.
There are many available jobs, but they are not paying a solid enough scale to purchase RE. Manufacturing jobs are almost non-existent, compared to even twenty years ago.
Lower wages will put pressure on RE prices to move down.
Taxes and Higher Prices
Taxes to fund schools and infrastructure are rising.
Whether it is a gas tax, a school levy, property taxes, or even the cost of a Big Mac going up, all these things take away from a purchaser’s ability to pay a monthly payment. Factors that are directly related to a mortgage are the big detractors, but all of them eventually factor in. If the price of gas went to $10 per gallon overnight, you would see the amount of foreclosures increase.
Increasing taxes and prices will put pressure on RE prices to move down.
Much has been written about property availability.
In 2008 through 2012, inventory was plentiful. Short sales and other distressed properties made up the bulk of the sales. Once those dried up, few owners who wanted to sell could walk away from a closing table without writing a check. As prices begin to increase, more supply will come on the market. People become solvent in their mortgage, and more supply comes on the market. This will produce a damper on prices.
Increasing inventory will put pressure on RE prices to move down.
When there is increased demand for any product, the price generally increases.
When the population increases, but it cannot afford the product, it may not. Virtually every demographic study of the future trends of the population shows changing demographics. Unless the future demographic model is significantly changed in terms of economic distribution from the current one, future populations are more likely to be lower skilled and lower paid.
Unless we raise the minimum wage, and recognize that being a fast food worker can be a lifetime career, housing prices for the masses will remain too high.
Demographic trends will put pressure on RE prices to move down.
Owning a home is not the American Dream anymore.
As employers have given up on creating jobs for employees that last them their entire life, younger people have given up on the housing market. They would rather rent, and not get tied down to a mortgage. If things get bad, they can move to another area of the city or even country. Home ownership is falling, and will continue to do so.
Less desire for home ownership will put pressure on RE prices to move down.
Apartments and Multifamily Housing Will Rule
With the majority of the upcoming populations being renters, multifamily will be the place to be. Renting a single family home will be second best. There is less profit and cash flow in a single family if you do not get price appreciation.
More and more apartments will be built, and Government will begin to provide more and more housing to the less fortunate. Some of that will be in the form of vouchers for the private market, some will be Government housing. More regulations swill be put in place to ensure safe housing, so if you are a landlord, make sure you maintain your property.
A renter society will put pressure on rent prices to move up.
What Will Save Housing?
Higher Wages. Higher wages and employment stability are the number one things that will propel the housing market forward. Whether that is in the form of increased minimum wages, more manufacturing in the US, or more government jobs, employment stability will be crucial. With a higher minimum wage, more people can afford homes.
Smaller Payments. If mortgages go to a 50 year model, monthly prices will be lower. Lower prices mean more demand. Perhaps a gradual mortgage forgiveness program if you hold your own home over 10 years.
Easier Qualifications. If it was easier to qualify for a mortgage, more people would be able to be a purchaser and increase demand. In the ‘old days’, banks made money on a foreclosure due to the quickly rising property values. In today’s market, they have to make money on the mortgage. Banks only loan to people that can pay the mortgage back. Perhaps waiving the MIP requirements for lower income borrowers would make homes more affordable and increase demand.
Less Expensive Construction. There is a move to build ‘Tiny Houses’. While that is the extreme, if the square footage decreases, so will the price.
More People Living In the same Place. As families take on extra roommates or additional generations of the family, there is more income to support a housing payment. When you have four earners, instead of two, you should have more for a housing payment.
Will housing prices go up, or down? No one knows for sure, but in 10 years we can look back and said “We should have seen it coming”. What do you think?
Be sure to leave your comments below!