{"id":119936,"date":"2019-12-03T14:30:53","date_gmt":"2019-12-03T21:30:53","guid":{"rendered":"https:\/\/www.biggerpockets.com\/blog\/?p=119936"},"modified":"2021-03-16T14:57:11","modified_gmt":"2021-03-16T20:57:11","slug":"is-housing-in-a-dangerous-bubble","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/is-housing-in-a-dangerous-bubble","title":{"rendered":"Recession Watch: Are We Overbuilding in the U.S.?"},"content":{"rendered":"

This blog is meant purely for educational discussion of finance. It contains only general information about financial matters. It is not financial advice and should not be treated as such.<\/em><\/p><\/blockquote>\n

The U.S. economy has been growing for 11 years, making the current expansion the longest in its history. So, when is the expansion going to end?<\/em><\/p>\n

This is the question on everyone\u2019s mind. Although we can\u2019t predict when the recession is going to start, we can assess the market risk intellectually using statistics and then prepare for it strategically.<\/p>\n

With that, let’s discuss the current status of the housing market and how to minimize risk and not lose money.<\/p>\n

The Housing Market<\/h2>\n

Median Historical Housing Price<\/h3>\n

\"\"<\/a><\/p>\n

Figure 1. Median Single Family Home Price in America 1953-2019<\/strong><\/p>\n

Based on the graph above, our inflation-adjusted home price in the beginning of this year just reached the pre-recession high. One might think that we\u2019re in a bubble, and it\u2019s time to sell. On the contrary, I think home values still have room for growth, since they typically increase in the long-term, and we just spent the last decade recovering!<\/p>\n

\u201cMedian housing price just reached pre-recession high\u201d is a scary fact, but let\u2019s look at this from a different perspective. Our current S&P 500 stock price is 3150; the previous peak was 1550 in 2007. It\u2019s double what it used to be!<\/p>\n

Even though the S&P 500 price doesn\u2019t account for inflation, the difference is still much greater than that of housing. If the current housing market were in a bubble, then the stock market is in a way worse situation. Not to mention the Nasdaq Composite is currently triple of the previous peak.<\/p>\n

Are We Overbuilding?<\/h3>\n

The short answer is NO! We\u2019re actually not building enough. Here\u2019s why!<\/p>\n

\"\"<\/p>\n

Figure 2. Housing Units Completed Analysis (1970-2018)<\/strong><\/p>\n

The number of housing units we built in 2018 was 1,185,000, compared to 1,979,000 in 2006. We are currently building at 60 percent of the pre-recession rate\u2014not to mention that we now have a higher population.<\/p>\n

By adjusting for the population size, the number of housing units completed in 2018 was only 0.36 percent of the population, compared to 0.66 percent in 2006\u2014a drastic decline in the building rate per capita.<\/p>\n

Related: <\/em><\/strong>8 Ways to Identify the Best Places to Buy Rental Property<\/a><\/em><\/p>\n

The economy has been doing well and our interest rate is at a record low, so why are we building at a slower pace?<\/p>\n

Although our interest rates are at a historical low, the more conservative underwriting by banks, such as debt coverage (DCR) and loan to value ratio (LTV), combined with our cautious mindsets, have limited the pace of growth.<\/p>\n

Conclusion<\/h3>\n

Since housing prices have more room for growth, and we haven\u2019t saturated the housing market by overbuilding, I\u2019d argue that housing in the U.S. is still at a healthy state. However, this doesn\u2019t mean that we won\u2019t have a recession. There are still other factors that can cause our economy to decline, which will inevitably impact real estate.<\/p>\n

How Can Real Estate Investors Reduce Risk<\/h2>\n

Warren Buffett\u2019s No.1 rule: \u201cNever lose money.\u201d<\/p>\n

Here are some very important tips that you should follow, especially at this stage of economy.<\/p>\n

Local Absorption Rate<\/h3>\n

Although we concluded that U.S. housing in general is not overbuilt, that doesn\u2019t mean this is the case in every city. Some cities are more overheated than others, so try applying the two methods I presented earlier (in Figure 1 and Figure 2) to the cities that you\u2019re interested in.<\/p>\n

In additional to that, you should look at the local absorption rate for both single family and multifamily<\/a>. If you notice that local housing is overbuilt, then start underwriting more conservatively by using more stress tests.<\/p>\n

Single Family<\/strong><\/p>\n

For single family, it\u2019s a red flag if you see absorption rate lower than 15 percent. That means less than 15 percent of the single family supply was sold in the last 30 days.<\/p>\n

For example, in a market where there are 100,000 houses available for sale, only about 15,000 houses were sold in the last month. This is a 15 percent absorption rate<\/p>\n

When the rate is lower than 15 percent<\/strong>, the local supply is much higher than the local demand. This is now a buyer\u2019s market, which means the selling price is usually below the listed price. The local housing economy is starting to cool off.<\/p>\n

\"hand<\/p>\n

Multifamily<\/strong><\/p>\n

The metric for multifamily is a bit different, because you are not selling commercial properties<\/a> on a daily basis. Instead of looking at how fast the commercial properties are selling, you want to understand how fast the rental units are being leased out.<\/p>\n

For multifamily, use the absorption period, which is defined as the amount of time it takes to lease out the current vacant supply. If the absorption period is more than three years<\/strong>, then it\u2019s a sign of oversupply.<\/p>\n

For example, Los Angeles currently has 21,000 lease-up vacancies, and the average annual absorption is 10,000 units, which means the absorption period is about two years.<\/p>\n

Reducing rent is another sign of oversupply. When the apartments are not leasing out fast enough, rents will naturally decrease to retain or attract tenants<\/a>. Declining rent is not a good sign for the housing economy.<\/p>\n

Related: <\/em><\/strong>5 Ways to Reduce Risk When Investing in Multifamily Real Estate<\/a><\/em><\/p>\n

Buy for Cash Flow<\/h3>\n

One of the common ways to lose money in real estate is selling the property while the market is down. Obviously, nobody wants to sell at a loss, but there aren\u2019t many other choices when a house is losing money or when the property needs to be refinanced.<\/p>\n

To reduce the risk of this from happening, you want to make sure that your property\u2019s debt coverage ratio (NOI divided by debt service) is still above 1.4 after several different stress tests. The stress test could be lower economic occupancy, higher interest rate, or lower rental growth.<\/p>\n

You also want to avoid using cash flow for renovations. If you\u2019re renovating a house or an apartment complex, make sure you raise equity for this, and add an additional 15 percent contingency into your budget.<\/p>\n

To avoid having to refinance your property, talk to your loan officer, and try to secure a permanent loan as soon as you can.<\/p>\n

So\u2026 Should You Keep Investing?<\/h2>\n

The best strategy is to make good investments consistently overtime. It\u2019s very difficult to predict the next recession or to quickly adjust your real estate portfolio.<\/p>\n

The bottom line is: even though the next recession will hurt your property\u2019s value, it\u2019ll eventually recover. Stress test and make sure you have enough cash flow to cover the expenses and loan payment\u2014even during a market downturn!<\/p>\n

This blog is meant purely for educational discussion of finance. It contains only general information about financial matters. It is not financial advice, and should not be treated as such.<\/em><\/p>\n

\"\"<\/a><\/p>\n

What do you think about the current state of the economy? Are you still investing or sitting on the sideline?<\/em><\/p>\n

Please share your thoughts below!<\/strong><\/p>\n","protected":false},"excerpt":{"rendered":"

Data show our inflation adjusted home price in the beginning of this year just reached the pre-recession high. One might think that we\u2019re in a bubble, and it\u2019s time to sell. Others disagree. Here are the facts. <\/p>\n","protected":false},"author":286556,"featured_media":113945,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[5528],"tags":[],"class_list":["post-119936","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-real-estate-news"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/119936","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/286556"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=119936"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/119936\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/113945"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=119936"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=119936"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=119936"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}