Leverage Is Through the Roof!

174 Replies

Lenders are getting more and more aggressive in their underwriting  - read this...

I am researching a project and reached out to a friend who is working for a big lender.  He confirmed - they are approving stuff that makes no sense anymore.

This bubble has more room to run, but when it bursts, it'll hurt - unless real incomes jump very significantly!

Thoughts?

If you're able to purchase with less money down and the numbers when you analyze still make sense (you're making money) they why would people care if the bubble bursts?  

If you finance with at least a 7 or 10 year chances are you'll ride out the possibility of a crash just fine and be in a position to refi when the market turns around.  

Just my $.02.

@Darren Sager  - you care because most commercial paper re-sets interest rate in 5 years or sooner; even paper that is amortized for longer.

I also care because as a syndicator I have to plan on getting my investors out on a specific time-table in order to drive the IRR.

I also care because CapEx comes on in waves, and I don't want to own property past a certain time-fram as it will require additional expenditures which will drive down IRR.

Having time is priceless in this business, and it's getting to be very dicey to underwrite...

Yes @Ben Leybovich our primary focus is different. You're playing with time tables more so than the typical buy and hold investor. A typical buy and hold investor will not be concerned about CapEx coming in waves, etc. It's not their goal to get out in a certain time frame. It's about creating long term income.

Your model is not short term but more moderate term and hence these factors weigh in much more significantly upon your business model and I can understand why. 

Call me naive but wont another crash not be  great time for those with strong cash reserves to make some great purchases assuming they will not require financing?

@Darren Sager - typical investor is dumb! Don't you think CapEx will DRASTICALLY impact their "income"? haha

How many typical investors do you know who set aside replacement costs as they should?!

We are seeing Fanne/Freddie compete big time with each other right now.

We recently closed a 200-unit deal with an 80% LTV, sub 4% 12 year fixed loan with Fannie. And it came with 4 years I/O.

Originally posted by @Darren Sager :

If you're able to purchase with less money down and the numbers when you analyze still make sense (you're making money) they why would people care if the bubble bursts?  

 I assume that you have never had a property where the gross income dropped by more than 30% before...  Those people do care.   :)

@Jeff G. is alluding to those who are still borrowing heavily BEFORE the expected crash. A good approach for investors now might be to look at possible deals as though the next crash is imminent, and so should not apologise for putting in maximum offers of, say 45% current FMV (not ARV), rather than 70%. Cheers...

I don't think this bubble will burst the same way as the last one.  Last time the economy had a total meltdown in conjunction.  This time, I believe that money will drift away from RE driving the cap rates up.  The incomes will probably not be hurt as bad.

But if we start seeing inflation, that will be good for values. 

The future is blurry like always...

Ben - yes - we are riding a bubble.  But let me turn the question around to you:

When the bubble bursts, what will happen to gross rents for most SFR investors. We know it will drop, but will it drop by 2% or 40%? And in that spirit, what happened to gross rents during the most recent crash (I am hearing ~10% in gross rents was normal).

@Jeremiah B. The bigger problem is that as far as the banks will be concerned, most SFR Investors will have borrowed more than the newly crashed values of their investments, so will be likely to call in those loans EVEN IF THE LOANS ARE STILL BEING SERVICED! Cheers (while you can)...

Updated over 3 years ago

Er, sorry for the scaremongering. I have heard of such cases happening, and when made public, the banks defence was they THOUGHT that defaulting would happen. Hopefully, stopped.

@Ben Leybovich   I agree with you that the typical investor does not put the proper capital aside for repairs and capital expenditures.  The reason for this in my opinion is not that they're dumb, it's because they're not taking it as seriously as they should.   It's more like a hobby to them and they need to wise up.  A hefty repair bill is usually what it takes to make them think twice. 

@Steve Olafson  No I have not had a property's income drop significantly ever thank God.  I think the reason for that is that I will not invest in an area that you can add to inventory easily and there's a long term high demand to live in that area.  

This post has been removed.

Originally posted by @Darren Sager:

@Steve Olafson No I have not had a property's income drop significantly ever thank God.  I think the reason for that is that I will not invest in an area that you can add to inventory easily and there's a long term high demand to live in that area.  

 My point was that it is not always easy to ride out a bursting bubble.  If you are immune to this issue then great.  But, **** happens even to the best investors.

@Ben Leybovich  at the beginning of the week, I was talking with a lender and they too indicated that a micro bubble burst will probably happen sometime this year.  The rates look attractive for the 5 year, but going out to 10 is my preference to bridge the gap of downturns.  Over the last few months I have seen larger portfolio's coming on the market - properties that were purchased in 2012.  No these are not hedge funds liquidating - even though I have seen some of them too... these are personal portfolios worth millions.   

@Kathryn Marchetti   history does repeat itself and I have seen our market do it three times now and each with different severity.   I think this time it will be different as the Fed has printed so much money that something bigger is on the brink of happening; the housing market maybe the first domino to fall.   

If the dollar resets - my guess that the next recovery will go deeper and take much longer to recover.  No the "Sky is not falling!"  I am suggesting to stay financially fit and don't be tempted to over leverage!

Originally posted by @Brent Coombs :

@Jeremiah B. The bigger problem is that as far as the banks will be concerned, most SFR Investors will have borrowed more than the newly crashed values of their investments, so will be likely to call in those loans EVEN IF THE LOANS ARE STILL BEING SERVICED! Cheers (while you can)...

Brent  - I'm not sure I follow.  If I owe 80K on a 100K house, I have 20K equity and all is well.  If that house value is cut in half to 50K, I will owe 80K on a 50K house.  That's a big paper loss, but does not mean that the loan will be called due.  Either way, I can still keep making my monthly payments at <5% and ride out the bubbles and bursts.

My view is that if I am cashflow positive on the house, I should keep it - regardless of whether I'm underwater 30K or have 20K in equity.  So, for properties I already hold in my long-term, buy-and-hold portfolio, I'm far far far more concerned about gross rents than property value.-

The "bubble" is a artificial market event created by a lack of inventory and very low interest rates. The rise in prices has still kept many homeowners out of the market. As mentioned above those who are holding large inventory plus the hedge funds are slowly releasing their inventory in a controlled manner to maximize gains  to prevent a price collapse As interest rates rise prices will come down but it is a more normalized market then 2007-08

I can agree with @Steven Picker

The market in 2008 was like the Wild West compared to our present market. Be careful not to compare Apples to Oranges. Yes, both are fruit. But, that doesn't make them the same. Low int rates, excess paper, less inventory and much, MUCH more regulation are all factors that weren't necessarily present 7 yrs ago. History showed us what happens with no regulation (bank runs and economy collapse during Great Depression brought on the FDIC just as the RE and bank crisis in 2008 brought stricter lending standards) and how we learned from our mistakes.

That said, coming from a commissioned sales position from my last 8 working years, sales people get greedy and being to get "creative". I can only hope that rules aren't starting to bend again in lending specifically. Bad loans are a problem for all of us. Economically speaking.

Sorry for my ramble. Reminds me of old class discussions in college.

Ps - for "buy & hold" 'ers out there - a bursting bubble is always a good thing if you're liquid. In the Little Book of Value Investing, Author Christopher H Browne notes we should buy stocks like steaks...on sale.

If we started seeing insane price growth due to the lending practices, then I'd think "bubble". Right now I'm still thinking "recovery". 

Although, I may have blinders on. I live in Tulsa, where we've always seen modest, healthy growth and never really experienced huge, unsustainable jumps in real estate values. 

Originally posted by @Jeremiah B. :
Originally posted by @Brent Coombs:

@Jeremiah B. The bigger problem is that as far as the banks will be concerned, most SFR Investors will have borrowed more than the newly crashed values of their investments, so will be likely to call in those loans EVEN IF THE LOANS ARE STILL BEING SERVICED! Cheers (while you can)...

Brent  - I'm not sure I follow.  If I owe 80K on a 100K house, I have 20K equity and all is well.  If that house value is cut in half to 50K, I will owe 80K on a 50K house.  That's a big paper loss, but does not mean that the loan will be called due.  Either way, I can still keep making my monthly payments at <5% and ride out the bubbles and bursts.

My view is that if I am cashflow positive on the house, I should keep it - regardless of whether I'm underwater 30K or have 20K in equity.  So, for properties I already hold in my long-term, buy-and-hold portfolio, I'm far far far more concerned about gross rents than property value.-

 @Jeremiah B. Yes, I am with you there, and have updated my previous post. Cheers...

@Ben Leybovich  Yet another risk factor in the commercial market. 

  • Historically low cap rates
  • Historically high occupancy rates
  • Historically high numbers of young people expressing no desire to own
  • Historically low interest rates

All things return to the mean. Perfect storm coming?

Don't know about your areas @Ben Leybovich  but here in Portland, Oregon there was an article talking about the tipping point where buying is cheaper than renting and predictions that rents will increase for the next 2 years, and that renting will become less affordable, forcing renters who can, to buy.

I remember when renters started buying and money was easy. My rentals started becoming vacant and stayed vacant until my rents came down or I sold them. That is when owning SFR becomes the better play.

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