Another Crash 2017?

88 Replies

Hi All,

I'm hearing from multiple sources that a potential economic downturn is likely to take place in the next term.  Everyone has a theory (China's recession, Brexit, cyclical nature of the market, etc.).

I figure this would be a good platform to get some interesting perspectives from a Real Estate Investor's standpoint. 

1. Do you think a potential downturn is likely to happen?  Why do you think so?

2. Are some regions more susceptible than others? Why?

3. What's your strategy?  Wait patiently? Or are there more active strategies to prepare for the downturn?

Thoughts?

Thanks!

Cheng

A down turn is defiantly coming. When is undetermined. The economy fluctuates, politics change etc.

Buy and hold for positive cash flow, If you are not selling who cares.

If your buying a crash is a good thing. Now may be a good time to build up cash reserves to take advantage of others.

If you've read or watched The Big Short, you'll notice that for most downturns the reasons aren't apparent until after the crash. That's been the case for pretty much every market crash of every kind throughout history: Things seem to be better than ever, then all of a sudden it blows up. 

I have a theory, but I don't have the data to back it up yet. I think that something will cause rents to fall, which will destroy the investors who have been leveraging as much as they can at 3% interest rates to get $100/month/unit. Imagine you have 100 units leveraged up that rent for $750/month and give you cash flow of $100/month. What if all of those rents fell to $650/month, or $550/month? Then imagine that you can't sell your 24 4-unit buildings because 1,000 other investors are trying to get rid of theirs because they're facing the same issue. BiggerPockets is a great community encouraging REI, but I think a lot of the new investors are overlooking the pressure of falling rents.

The final piece of the puzzle would be: some shock to cause rent to drop across the board, which would probably accelerate quickly. It could be millennials moving home to cut costs, adults sharing single family homes to cut costs, macroeconomic fright of some sort, etc. 

What do you think? 

Well the last market crash was in 2007ish so if I punch all the numbers in to my market cycle predictor.... the next crash will be... 2014!  Oh shoot this thing must be broken.  So it's safe to say it will prolly be in 2017... and if not 2017 then for sure 2018... and if not 2018... then.    Ok you get the point. 

Of course people are predicting a crash. We are way overdue so it is easy to make that prediction.  But the truth is the general market could just flatten out for a few years and then shoot up again. Or it could bottom out. Or it could go up and then stay flat. 

The point is to worry less about about market fluctuations. And do what @Thomas S. says. Buy GOOD deals and hold them.

Fixed interest rate is a good choice too as rates could possibly rise and kill a good deal. 

Just my thoughts

Comes down to jobs  no jobs real estate flattens  rents decrease or stop and the cycle starts.

there won't be a mortgage meltdown crash on new originations ( last 8 years) like there was during the GFC..

Also very much regionalized.. some region's have not come back and may never as populations change employment changed etc etc.. others are just steaming right ahead with job creation.

Build up as much cash as possible and become a very discriminating buyer. You'll be shocked at the deals you'll be able to get should a real estate recession occur.  You have to be patient though because the impact of any economic news takes months to actually filter into the mind of the populace. Remember, we pay attention to real estate every day but the average person only when they're in the market to buy or sell.

With that said though I'm not in the camp that believes a major downturn is imminent. My own opinion - for what it's worth - is the market is in flux due to the election with prices stabilizing and trending slightly downward in more of a 'correction' fashion than anything else. This is of course regional but I'm seeing evidence of this in the Midwest as well as parts of Connecticut and Florida.

Crashes are incredibly rare. Prices go up and they go down every market cycle, but actual crashes are incredibly rare. No one can predict them, even the people who made money during the last crash. The bears always look like geniuses during downturns, but it's just a statistical certainty that someone will make money from guessing right during a downturn. 

Instead of trying to be Nostradamus, build a business that survives both the good times and bad times. 

@Thomas S.   I tend to agree with your line of thinking about too highly leveraged and the thought that rent ALWAYS goes up... rents can go down We experienced that here in the Portland market in the early 2000s were rent was flat or went down a little.. ( reason every one was buying homes).

Statistics based on long term history tend to be relatively accurate. If we look at vacancy rates from 90-2010 they climbed to a high of around 11%. They are now at a rate similar to the 1985-1995 rates of around 7%. Although isolated areas did have major problems in the rental market it is not common across the board.

Rental rates on the other hand, although they did drop by about 2.5% following the 2008 crash they have climbed steadily. If 2008 could be considered a serious crash then rental rates should hold through future down turns.

It is very doubtful, aside from isolated areas, based on what happened after 2008 that a real estate crash would have much effect on rental income investors in for the long term.  Those with zero cash flow dependant on equity pay down alone will always be at risk. The greater the equity held in a property the greater the chance of loss. If equity is your retirement plan you may wish to rethink that strategy. 

Interesting point to bring up @Thomas S.

The housing bubble is why vacancy rates were at 11% from 2000 - 2010. When the Clinton Administration altered the Community Reinvestment Act, demand for homes increased and the demand for rent decreased significantly.

This change laid the foundation for banks to make loans to just about anyone which is something that absolutely fueled the housing bubble. So now you have unqualified home buyers (aka should-be renters) purchasing homes with no money down and the demand for rent takes a hit. 

So... If the rental market can take something as drastic as the false demand for housing, we can say that is a resilient financial instrument. Please observe the chart below:

@Jay Hinrichs

I posted the chart above for you too. I think @Thomas S. has a strong point. I.e., If rent decreases by 15% in your area, and you have enough padding in your cash flow to finance the rent deterioration, then in theory, you should be able to weather the storm.

But if you're in crazy market like PHX or Vegas, then getting wiped out is certainly possible. I would go ahead and say that cities like Phoenix or Vegas aren't statistically significant in assessing the housing bubble. They were the rare events that were far removed from the average events. 

Could be wrong here...   But it looks like on average, vacancy was never > 11% in the U.S. 

@Cary Ferguson Jr   here are the markets that got hammered in the GFC both price and rents

1 Vegas

2 PHX

3. many parts of FLA

4. Atlanta

5. Inland empire of CA

6 Central valley of CA from Sac to Fresno

Along with epic price melt downs in Detroit  and other inner city old rust belt metro plexs'

@Cary Ferguson Jr , you mention having enough reserves to pad the rent deterioration. How long would you consider it to last? Is a year or two of reserves (covering the 15%ish drop in rents) enough? 

As per a recent GreenStreet report, homeownership is still weak, currently at 63.5% nationwide and 58.4% between 35-44. Below 35, it's at 35.2%. 

For every 1% change in homeownership, there's 1,000,000 renters added or taken from the market. GS is forecasting a bottoming of homeownership of 62% in 2018, which means 1.5 million renters added to the market in 12-18 months. 

Developers are primarily building luxury rental and for sale units because land and labor costs are higher. 

The GFC was caused by massive speculation and a lack of risk management. 

What will happen when rates rise? How will corporate earnings slow? How will the labor market fare? Corporate America is highly leveraged, will companies not be able to pay debt service when they need to refi?  When rates rise, prices decrease... but how much will they correct downwards?

Hi @Luke Mike

I wasn't referring to reserves financing a rent deterioration. I was talking about cash flow/profit from the property financing it.

For example, consider the following example:

  1. Say you have 1 unit being rented for $1,000/month
  2. Now say that you have $200/month profit from that unit. 
  3. Now say that a recession hits and your rent drops 20%, or $200/month
  4. Now you're operating with $0/month profit BUT you're not paying out of pocket or using cash reserves to keep the property

This is oversimplified but you should get what I'm trying to say. Make sure you have enough cash flow coming in from every unit, whether you're in a recession or not. If there's a large recession but you're still breaking even, then you won't have to use your own money to keep your portfolio afloat.

All that being said, you should have cash reserves saved up in case a really bad recession hits and then lasts a long time. To figure out how much cash you need requires a bit a number crunching.

Calculate your negative cash flow per month across properties that are losing money. Then consider what you have in reserves and you can find how many months you can make it before your cash is tapped. 

Bigger issue in my mind is all the home owners that will be facing 6, 7, 8% mortgage rates. Many home owners have over bought and most live pay check to pay check. This will create more renters but primarily flood the market with properties not generally suitable as rentals....high priced SFHs.

Originally posted by @Thomas S. :

Bigger issue in my mind is all the home owners that will be facing 6, 7, 8% mortgage rates. Many home owners have over bought and most live pay check to pay check. This will create more renters but primarily flood the market with properties not generally suitable as rentals....high priced SFHs.

 true. 

However, if the mortgage rates slowly increase over time (say .5%-.7%/y), this might not happen. inventory would get tighter (less incentive to sell if new mortgage is more expensive), which would keep driving prices up  

Let me get out my trusty crystal ball and tell you when the next crash will be.... *rummaging around*

Ah, here it is. Let's give it a shake and see what we have... *shake*  *shake*

OK, I see it. It is getting clearer... Dang it. I just says Merry Christmas.

If you have rentals and you can't afford to keep them vacant, you can't afford to keep them. If you expect a crash and your cash flow is tight, the market is good NOW so sell them and take your profit. You never watch the news story about the guy who sold just before the peak and made a nice profit. No, just the complainers crying about how the bank, yes the bank screwed them.

If you have good cash flow, but think you can get better deals after a crash, again sell them. I will argue that you will need significant discounts in order to replace your existing inventory. I will further argue that if you think financing is difficult now, it will be non-existent for you as an investor later. Now would be a great time to build strong relations with a bank. Although, those business lines of credit may likely dry up if real estate drops 20, 30% or more.

Personally, I have been using the last few years to shore up financing, eliminate crappy rentals and replace them with B+ or better properties. Good houses in good school districts will always be in demand. 

If you're sitting on the sidelines thinking you're going to load up on properties "at the bottom" it most likely won't work out how you are planning. Get in the game and make some money today. Regardless of the market, there is ALWAYS somebody looking to stop renting, move out of mom's and starting a family and wanting.. needing to buy a house. I was rehabbing and flipping homes before the bust and all the way through it. Some of my best deals were houses I bought in 2007, 2008 and 2009, rehabbed and flipped to owner occupants.

From my point of view, it is always a great time to be in real estate.

Originally posted by @Cheng Bin Zhang :

Hi All,

I'm hearing from multiple sources that a potential economic downturn is likely to take place in the next term.  Everyone has a theory (China's recession, Brexit, cyclical nature of the market, etc.).

I figure this would be a good platform to get some interesting perspectives from a Real Estate Investor's standpoint. 

1. Do you think a potential downturn is likely to happen?  Why do you think so?

2. Are some regions more susceptible than others? Why?

3. What's your strategy?  Wait patiently? Or are there more active strategies to prepare for the downturn?

Thoughts?

Thanks!

Cheng

Forget about bubbles and crashes!  These are terms used by people who are completely clueless about real estate investing or those with little to no experience.

Just like the stock market, all real estate markets move through market cycles.  A full market cycle generally lasts 5-7 years, which is why most hold periods for MF deals are 5-7 years.  

Here's a breakdown of the phases of the real estate market cycle:

For your amusement, here are the emotions you can expect...

@Jon S. As someone who works in finance can appreciate that it's a cyclical area like any market. 

However saying that bubbles or crashes don't exist is ignoring forced circumstances that wouldn't normally occur in the cycle....such as aggressive sub-prime lending......

I think saying those words are for people who are clueless is a little bit of an arrogant assertion to make on a forum filled with MANY successful real estate professionals. 

I've been doing a fair bit of research lately and I've seen a lot of economists breaking down the reasons for a predicted downturn. It seems the GFC has many people thinking we're in for another similar event, but many others are simply implying we're headed towards a weakening US dollar which can have some overlap with a housing crash, but it's really a separate type of event in some ways. It probably is a good time to look at investing overseas, but that's a separate topic alltogether. 

Originally posted by @Natalie Kolodij :

@Jon S. As someone who works in finance can appreciate that it's a cyclical area like any market. 

However saying that bubbles or crashes don't exist is ignoring forced circumstances that wouldn't normally occur in the cycle....such as aggressive sub-prime lending......

I think saying those words are for people who are clueless is a little bit of an arrogant assertion to make on a forum filled with MANY successful real estate professionals. 

Sorry, I respectfully disagree with you.  Of course my comments are based on my 13+ years of investing in 5+ markets nationwide and working with many different RE professionals and investors.

Market cycles are impacted by many variables (ex. Interest rates, international buyers, tech trends etc), but cycles will continue forever.  Variables may impact cycle making them more stretched (peaks lower, bottoms higher) or narrowed (more volatile/peaks higher, bottom lower).

@Jon S. #11-12-13 for the top 50 US areas, that's not good.

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