Are we heading for a 'bubble' in Orlando Real Estate?
Orlando, FL · Member since 2014 · 93 posts · 35 votes
In reviewing the latest Orlando Real Estate statistics, there is a concern that house prices are rising so fast that they are becoming out of reach for the average citizen. If this continues, banks' loan business will eventually falter and there will be pressure on them (and the government) to ease lending criteria further (they have already dropped credit score requirements to 580 in some cases).
Does this sound familiar (2005/2006/2007)?
What do the voices of BP think?
@Chris Romanythanks for bringing up an important topic. I'd like to expand it a bit further and point out housing prices across the nation being high (see case shiller inflation adjusted home index and compare current level to historic norm). But my post pertains to Orlando as well.
I'm new to BP but I'm not new to macro econ or real estate investing and I must say, after reading a lot of posts on BP, I'm astonished by 2 things... A. How well many real estate investors study the impact of micro econ and B. How most real estate investors totally ignore macro econ. And ironically, there's a very strong argument for the macro playing a much bigger roll in price appreciation or depreciation.
As you point out, lets look at the last crash. At a very basic level what caused it? homeowners not being able to make their payments. If homeowners would've continued to make their payments we wouldn't of had the defaults that caused the domino affect we all remember well.
So then the question becomes "why were homeowners unable to continue making their payments"? because everyone lost their jobs? No...that was a result not an initial cause. The answer is because interest rates had been artificially low for several years and when interest rates started to rise the loans adjusted, increasing the mortgage payments, making those payments unaffordable for a large amount of borrowers, regardless of whether or not they were subprime, granted subprime was a huge part of the problem. (if you have an adjustable rate loan right now just run the math on what would happen to your monthly payment if interest rates normalized and increased by 5%. Many properties owned by investors far from "subprime" would become cash flow negative). Now, if you recall, the theory was if you couldn't afford your monthly payment anymore you could just sell and no one's hurt. The reason that didn't work is because demand evaporated overnight and prices plummeted locking the homeowner/investor into a position where they couldn't sell or make their mortgage payment. Why did demand vanish? Because when you keep interest rates artificially low it pulls demand from the future into the present. In 2007 much of the demand from the future (2008,2009,2010,2011) was pulled into the present/past (2003,2004,2005,2006). Combine that with the fact that monthly payments increased, therefore the price of home that people could afford decreased (if you can afford a $950 a month payment you can afford a $200,000 loan at 4% interest and only a $160,000 loan at 6% interest), and you've got no demand.
As we all know the fed just started a tightening cycle (whether they continue to tighten remains to be seen), the same thing they did in 2007 that pricked the bubble. So what's different now? 1. Interest rates were far lower for far longer from 2008-2016 compared to 2003-2007... 2. As a result far more demand was pulled from the future than before and malinvestment was enabled for much longer... 3. Labor force participation is much lower (lowest level in decades) and wages have been stagnant, adjusted for inflation, so fewer people working at the same rate of pay, reducing aggregate purchasing power... 5. If we go into another recession (many economic indicators show we're already recession) the fed is out of ammo. Interest rates are basically zero already. This means that we have exhausted all traditional methods of softening a blow of recession. Just think what would've happened in 2007/08 if interest rates were already at zero...we most likely would've gone into a massive depression... 6. Hedge funds now own a significant amount of homes, many just like the rentals us small investors buy. Whats my point? What happens to the supply/demand balance if they have to liquidate their real estate portfolios?... 7. "Lending standards aren't as low." That myopic view may be misleading. Look at auto subprime, student debt subprime, oil subprime. Remember the only reason subprime housing debt was a big deal was because it was colateralized and sold and made the banks freeze when it went bad. People may think that bad housing debt affects only housing and bad car debt would affect only car sales. Not true. The type of debt is irrelevant if it causes banks to freeze up. Subprime car debt could crush the housing credit/demand just like housing subprime crushed car credit/demand. I could go on but hopefully that shows the importance of the macro environment on housing.
My goal is not to promote a bearish narrative. I actually currently like US rental properties as an investment. But only under certain conditions and only if you factor macro as well as micro into your decision making process. An ignorant investment that makes money is still an ignorant investment and over the long term ignorant investors lose.
Taking the macro into consideration here's my current strategy in the US. This applies to Orlando as well as any other market you know well and are comfortable with the micro conditions.
1. Only buy something where you can add value and be all in for the LTV of a current cash out refi. As soon as the rehab is done take out your equity and lock it into a 30 year fixed. If the market goes up that's great and if it goes down your equity is protected and you'll have cash to buy after prices have fallen. You get paid (the positive cash flow) to hold cash and see how everything plays out AND you participate in the upside if the market continues to rise.
2. Only buy something with a 1.3+ R/V ratio. This will ensure you're cash flow positive and you have staying power regardless of which way the market goes.
I personally wouldn't buy anything unless I could fit it into that strategy because the risk/reward doesn't make sense when compared to cash.
Having said all that I could lay out a strong argument for US housing prices, including Orlando's, going higher. I'm happy to expand on that if anyone would like me to but this post is long enough;)
I hope that helps your decision making process Chris,
George
@Paul Gilo@Jay Hinrichsso my bullish case for real estate prices is as follows and Jay I'm really curious to see what you think about this...
Let's assume for a moment the fed takes rates negative. This could make money even cheaper, potentially almost free. Heaven forbid, but how many projects that won't cash flow or don't produce decent ROI at 4 or 5% will cash flow or produce sufficient ROI at .5 or 1% interest? Look at how far the cap rates have compressed due to lending rates being at 4-5% what happens to cap rates if interest rates go to .5%? DSCR are already down to 1.25 look at what that does to asset prices if lending rates go down further. Sovereign debt in Europe is negative, where is money going to find yield if US treasuries go negative? What do investors do if only given the choice of paying the bank negative interest and guaranteeing a loss or buying real estate at a price that's inflated?
Also the government has to have inflation to reduce it's debt load. If they can get the velocity of money to increase, producing price inflation, I think they'll understate the CPI so they don't have to raise interest rates. Although the real value of real estate may not go up the nominal value most likely would.
So my argument for higher prices isn't exactly comforting, but if negative rates go low enough it could produce a massive rotation of capital into real estate sending prices even higher.... or if velocity picks up, inflation could send the nominal value higher as well. Look at a dollar index chart going back to 1970. Dollar bull runs usually last about 2 or 3 years and crash down lower than the starting point. We're about a year into this dollar run so 2017 or 2018 it could start losing purchasing power putting upward pressure on nominal real estate prices.
A bull case and bear case (above post). I want to impress upon real estate investors that there are no certainties only probabilities and to assess the probabilities you have to consider the macro as well as the micro...investing without probabilities is gambling.
@Aditya Varlet me preface by saying what I would do isn't right for everyone and only take what I'm saying in any of these posts as food for thought.
It really depends on the value of your current home or the R/V ratio if you could rent it out. I'll assume you own your current house free and clear. You said prices are pretty high in your area so I'm guessing the R/V ratio's aren't great. What I'd consider doing is selling your current house and buying however many properties you can buy with the proceeds of the sale in a market where the R/V ratios are higher and is more linear in it's historic price action.
Once I did that I'd take the rental income and rent an expensive house in your current area. Why do this? Rent on a 400k house will most likely be less than the rental income on 4 100k rental props. You take your equity and put it in a market that has less ups and downs (shielding it from some downside risk) and pocket the positive cash flow spread on the difference between the rental income and what you're paying to rent. If you really want to own the house you live in you can take the equity out of the rentals for the down payment and you'll still be making more rent income then if you rented out your current home because of the difference in rents between 1 big house and 4 little houses.
If you're really concerned about the market going down you could just sell now and rent until you're more comfortable buying. Once you're comfortable with the market conditions employ the strategy above. The downside is if the market continues to go up you won't have the price appreciation in the linear market or any appreciation at all if you're in cash.
Again, it's all about analyzing probabilities and then executing a game plan that's right for you.
Hope that helps, let me know if I can clarify anything or you have further questions.
George
Thanks @george gammon for the detailed response. I have to re read that a couple of times to understand where you were going with that logic. :)
R/v values where we are at are pretty good on the smaller houses. I don't think that will change. We have built up equity in the current house but it is not paid out yet.
We were looking to move to a bigger house, but I am going through the dilemma phase right now considering new house pricing is around 135 per sft in this area.
Renting out the current house is not going to be an issue as I am confident about the cash flow.
Having said that, I have to look into what you suggested. Do you really think negative interest rates are likely here? Probabilities?
@Aditya Varyou're welcome....
quick tip: if you type in the @ symbol and start typing the name of the person you want to mention slowly their name will pop up. Click on it and that'll create the blue hyper link at mention you see everywhere.
1. Sorry it's a little tough to follow. Basically multiple small homes usually provide more total rent than one big home.
2. If R/V ratios are good in your area then I'd say it's wise to have the rental props there so you can keep an eye on them.
3. Have you done any flips? Maybe you could buy a house to live in and remodel it to add some value? That added equity could give you some wiggle room... The big problem I'd be trying to solve, if I was in your shoes, is how do I protect the equity I currently have (in any home) against housing prices going down. That's why I talk about linear markets, adding value to homes, and extracting equity via cash out rifi's.
4. That's great if your current home would cash flow nicely as a rental. Again, my concern is protecting your current equity regardless of whether it's in your current home or a new home.
5. If you're referring to the fed funds rate...yes. I'd give it 65%. It wouldn't be the end of the world it's just something we as investors need to think through and means test our portfolios for that type of environment.
*If you're a little leery of the current market you can always sell your current home, rent a new place and sit on the cash until you feel more comfortable.
@George Gammon thanks for the tip. Great info as always. Now, to get the equity out of my house before prices go south! :) And look out for low priced rentals.
Have not tried a flip yet. Would like to try a small one first to see if it is something I like.
@George Gammon thanks for the tip. Great info as always. Now, to get the equity out of my house before prices go south! :) And look out for low priced rentals.
Have not tried a flip yet. Would like to try a small one first to see if it is something I like.
Remember prices may go north too Aditya (please see my bullish case for housing prices above) it's all about each person analyzing the probabilities thoroughly and executing a game plan, based on those probabilities, that's right for them.
Good luck
@George GammonThank you for your great insight. And yes, that is the most difficult - guessing where it would go between now and the time we buy - up / down / nowhere and by how much.
@George Gammon - you are the man! a bit above my head, but thats the great thing about it... room to learn. I like your market analysis and your thinking. there arent many other contributors that think at that level. Will be looking out for your posts in the future. thanks again. :)
George, is your 1.3 R/V calculation 1.3% rent yield (annual net rent / home price?
George, is your 1.3 R/V calculation 1.3% rent yield (annual net rent / home price?
monthly rent/value (or price paid) for property. 100k prop getting $1300 a month for rent would have a monthly R/V ratio of 1.3...I think some people may use annual rents, I've always used monthly rents.
JOB GROWTH AND RE PRICE APPRECIATION IN ORLANDO MSA
As you can see for the last two and a half decades, job growth and loss has had a strong correlation with home price appreciation. As job growth accelerates, real estate price appreciation accelerates. And now we see both job growth and RE prices decelerating in your area. So I would expect appreciation to decelerate in the area going forward. Remember, these are not DECLINES in jobs or prices. It is DECELERATION - jobs and RE Prices are growing less quickly. Unlike most geographic areas, the relationship seemed to break down in the 90's.
ADDING ECONOMIC CONDITIONS - ALSO DECELERATING
Note that the home transaction price in right axis has different scale..
Fortunately, the leading index for the state is still holding up, and hasn't showed that downward trends that foreshadowed the last decline as early as 2005!!!
@Curtis Yoder, I agree!
@George Gammon, you hit the nail on the head!! Preach it!!! You sound like me! lol
The Fed usually saves us with about 500bp drop in rates. Financing is not as loose in credit quality, but our safety net is smaller also..
JOB GROWTH AND RE PRICE APPRECIATION IN ORLANDO MSA
As you can see for the last two and a half decades, job growth and loss has had a strong correlation with home price appreciation. As job growth accelerates, real estate price appreciation accelerates. And now we see both job growth and RE prices decelerating in your area. So I would expect appreciation to decelerate in the area going forward. Remember, these are not DECLINES in jobs or prices. It is DECELERATION - jobs and RE Prices are growing less quickly. Unlike most geographic areas, the relationship seemed to break down in the 90's.
ADDING ECONOMIC CONDITIONS - ALSO DECELERATING
Note that the home transaction price in right axis has different scale..
Fortunately, the leading index for the state is still holding up, and hasn't showed that downward trends that foreshadowed the last decline as early as 2005!!!
@Curtis Yoder, I agree!
@George Gammon, you hit the nail on the head!! Preach it!!! You sound like me! lol
The Fed usually saves us with about 500bp drop in rates. Financing is not as loose in credit quality, but our safety net is smaller also..