Leverage Is Through the Roof!
Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
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?
I am with @Serge S. on this one. I am little annoyed at how everyone claims to be so smart but they aren't doing deals. I'm not that smart and I've purchased over 3,000 units the past three years on behalf of the fund I work for and every single one of my deals has been a strong performer. Granted, I look at deals in several markets which helps, but please don't tell me it's not possible.
The last slowdown has scarred many people, for good reason. But most "slowdowns" don't look like that. I feel that those sitting on the sidelines and waiting for "massive discounts" may be waiting for a long time. When overbuilding takes effect, obviously there may be some price relief and sure a little better pricing, but with demographic trends the way they are these days, don't expect to see bargain basement pricing on multifamily any time soon.
I work for a fund that is continually buying, buying, buying. Let me see if I can explain the rational.
We offer a 7% preferred return to our investors, as well splits above that amount. Our president is the largest investor in our fund, so we have more skin in the game that any other investor. We believe rents will continue to grow modestly the next couple of years, most likely. @Ben Leybovich you are a smart guy, you understand the delta between cap rate and interest rate is where the money is made. If we buying at 6+ cap rates (and that was usually 7+ the past few years) and financing at 3.5/4% or lower, we are making a lot of money.
Will their be a slowdown? 100% YES. That is a certainty. But, if we are buying deals with 10%+ cash on cash returns in stable secondary and tertiary markets, short of 2007/8 happening again, what's the likely outcome? Things slow down in a couple of years and instead of paying our investors amazing 15% returns, we are then paying a more modest 7-9%. Still keeps people happy and we still are able to raise money. And so we don't make as much as a company. But we've been making money hand over fist since 2011.
We put 10 years loans on most properties. We are getting 2-4 years of interest only with incredible rates on nonrecourse loans.
@Ben Leybovich as an example, I put together a deal in your next of the woods last year. Bought 204 units built in 2004 out of foreclosure just north of Dayton for about 40% less than replacement cost. Put a bank loan on it, stabilized operations and refi'd end of 2014. Appraisal was $2 million higher than purchase price 11 months later. We put a long term loan on the deal and expect 11-12% annual cash on cash returns for the foreseeable future.
Are there risks out there? Of course. And as @Steve Olafson said, it's very metro specific. I totally understand why he's not buying in Phoenix right now. He also doesn't need to buy. He's doing quite well.
If you want to keep growing today, you need to be opening to expanding your target markets a bit, or yes, you might be sitting on the sidelines.
Maybe we will be famously wrong. That is a possibility. But our model has worked for 23 years, built incredible wealth for our founder and he has NEVER missed a mortgage payment on any deal in 23 years. That includes 2007 - 2009 when the world imploded.
My $0.02. But remember, I'm not as smart as most of you.
I forgot to add this yesterday. There is an interesting study that was just released by McKinsey that essentially states that leveraging has increased at exponential rates in almost every country since the Great Recession. However, the US is only one of 4 countries to have de-leveraged, granted this is at the household level, and not at corporate level.
"Household debt is reaching new peaks. Only in the core crisis countries—Ireland, Spain, the United Kingdom, and the United States—have households deleveraged. In many others, household debt-to-income ratios have continued to rise. They exceed the peak levels in the crisis countries before 2008 in some cases, including such advanced economies as Australia, Canada, Denmark, Sweden, and the Netherlands, as well as Malaysia, South Korea, and Thailand. These countries want to avoid property-related debt crises like those of 2008."
Ben Leybovich just curious as to where you are getting your stats on the Toronto condo market? Yes there are a lot of units and towers being built. However the toronto downtown vac rate is at 1.1%.
For what it's worth, I sit in my chair here in Cleveland and simply cannot understand why the market would allow for a Manhattan closet condo to sell for more than an entire city block here.
Um, I think the answer is supply & demand.
And in an efficient market, arbitrage will lower the spread. Instead of prices approaching the mean, we are seeing a reversal of the expected trend. It's this kind of behavior in the marketplace that is signaling to me that the market is inefficient and irrational. Since many will argue until they're blue in the face about how there's no place like Manhattan, let's instead use the housing market of Secaucus, NJ as an example. There are no mines or oil wells or unique geographical features driving the growth of the greater NYC metro -- just people. Long-run expectations call for a reversion to the mean.
@Christian Carson - Of course the market is inefficient - because investors are irrational! That's it brother; simple but complex :)
Most people that say this have NO IDEA WHAT THE MEAN is. Make your decisions on factual evidence.
Some info to consider;
Moodys predicted a banner 2015.
Many markets are still under their all time peaks almost 10 years later.
There are trillions more dollars in existance today than in the past run ups.
The buyers are more qualified today than in the past run ups.
The demand for multis exceeds the supply to buy and rent.
We are nearing full employment which usually indicates wage increases on the horizon.
The demand for multis is forecasted to increase in 2016 and 2017.
Lower energy costs can stimulate growth.
It is Ben's 40th and he is looking to party like it's 1999!
Exactly, when this $70,000,000 gem was available. http://www.socketsite.com/archives/2008/08/san_fra...
This actually sold thru foreclosure at $28,000,000. I looked at this property for valuation. It was bought as new construction for around $30,000,000. I think the purchaser thought the St. Regis brand would ad more value than it did. The space was mostly big. There were few high detail finishes and the view of the bay was nonexistent.
Most people that say this have NO IDEA WHAT THE MEAN is. Make your decisions on factual evidence.
Let's define what it means. Two comparable markets A and B have the same tangible goods selling at low price A' and high price B'. Arbitrageurs physically carry the goods from market A to market B, thus increasing supply at B and lowering B', and increasing demand at A, thus raising A'. Thus, the equilibrium price that we expect, is (A' + B')/2, or the mean of the two prices. Hence, the arbitrageurs have cause a reversion to the mean.
Real estate is a unique good since it cannot be moved. What can be moved are the warm bodies occupying residential units. The "price" of a piece of improved real estate can be re-characterized as the cost of attracting an owner, which takes into consideration all the neighborhood characteristics traditionally affecting the price of real estate. The potential owner-occupant of the house in the cheaper neighborhood thus actually becomes the "arbitrageur," and so does the corporation which seeks to significantly cut its overhead by relocation. The outsized gap in pricing between first and second-tier markets is historically high, and will not go unnoticed by cost-cutters.
As for "factual evidence," there's plenty of evidence that indicates that the upturn in the major markets is largely fueled by institutional speculation and the influx of foreign capital looking for a haven. The wealthy from places like China, Russia, Ukraine or any of the crisis-gripped EU nations are seeking to store their capital in sound investments, and it appears to them that a New York condo fits the bill. There's no need to tenant it, of course.
www.cbsnews.com/news/investor-driven-housing-recov...
http://www.naiop.org/en/Magazine/2014/Summer-2014/...
http://fivethirtyeight.com/datalab/why-the-chinese-are-snapping-up-real-estate-in-the-u-s/
For what it's worth, I sit in my chair here in Cleveland and simply cannot understand why the market would allow for a Manhattan closet condo to sell for more than an entire city block here. The laws are the same. The freight transportation network is the same. The language is the same. The skills base is the same. We even have a train system (which, by the way, lowers property values here). People are paying absolutely ludicrous markups simply for the opportunity to be Maury Povich's neighbor. This is what I call a bubble--one of misguided soul-seeking and misalignment of priorities. The Internet was supposed to make the world flat, but instead it has made it spiky. Why someone would pay $49 million for a penthouse with a decent view of the SF Bay is as puzzling to me as paying some guy $10 to make potato salad.
With all due respect, comparing Cleveland to Manhattan is apples to oranges.
For what it's worth, I sit in my chair here in Cleveland and simply cannot understand why the market would allow for a Manhattan closet condo to sell for more than an entire city block here. The laws are the same. The freight transportation network is the same. The language is the same. The skills base is the same. We even have a train system (which, by the way, lowers property values here). People are paying absolutely ludicrous markups simply for the opportunity to be Maury Povich's neighbor. This is what I call a bubble--one of misguided soul-seeking and misalignment of priorities. The Internet was supposed to make the world flat, but instead it has made it spiky. Why someone would pay $49 million for a penthouse with a decent view of the SF Bay is as puzzling to me as paying some guy $10 to make potato salad.
With all due respect, comparing Cleveland to Manhattan is apples to oranges.
If you're not a fan of my comparison, feel free to use Philadelphia and Richmond or Boston and Pittsburgh as your city pairs. What I'm suggesting only sounds absurd because so many people are in love with Manhattan for its intangibles.
Most people that say this have NO IDEA WHAT THE MEAN is. Make your decisions on factual evidence.
Let's define what it means. Two comparable markets A and B have the same tangible goods selling at low price A' and high price B'. Arbitrageurs physically carry the goods from market A to market B, thus increasing supply at B and lowering B', and increasing demand at A, thus raising A'. Thus, the equilibrium price that we expect, is (A' + B')/2, or the mean of the two prices. Hence, the arbitrageurs have cause a reversion to the mean.
Real estate is a unique good since it cannot be moved. What can be moved are the warm bodies occupying residential units. The "price" of a piece of improved real estate can be re-characterized as the cost of attracting an owner, which takes into consideration all the neighborhood characteristics traditionally affecting the price of real estate. The potential owner-occupant of the house in the cheaper neighborhood thus actually becomes the "arbitrageur," and so does the corporation which seeks to significantly cut its overhead by relocation. The outsized gap in pricing between first and second-tier markets is historically high, and will not go unnoticed by cost-cutters.
As for "factual evidence," there's plenty of evidence that indicates that the upturn in the major markets is largely fueled by institutional speculation and the influx of foreign capital looking for a haven. The wealthy from places like China, Russia, Ukraine or any of the crisis-gripped EU nations are seeking to store their capital in sound investments, and it appears to them that a New York condo fits the bill. There's no need to tenant it, of course.
www.cbsnews.com/news/investor-driven-housing-recov...
http://www.naiop.org/en/Magazine/2014/Summer-2014/...
http://fivethirtyeight.com/datalab/why-the-chinese-are-snapping-up-real-estate-in-the-u-s/
I think you are mixing up some terms. like principle of substitution, elasticity of demand and reversion to the mean. Please identify what mean you are referring to that you see will revert.
Also kids, Real estate was not just invented. Foreign investors have been around since ancient times like the 80's. I was there when the Japanese were buying up Kahala estates from the back of their limo's. http://en.wikipedia.org/wiki/Pebble_Beach,_Califor...
Most people that say this have NO IDEA WHAT THE MEAN is. Make your decisions on factual evidence.
Let's define what it means. Two comparable markets A and B have the same tangible goods selling at low price A' and high price B'. Arbitrageurs physically carry the goods from market A to market B, thus increasing supply at B and lowering B', and increasing demand at A, thus raising A'. Thus, the equilibrium price that we expect, is (A' + B')/2, or the mean of the two prices. Hence, the arbitrageurs have cause a reversion to the mean.
Real estate is a unique good since it cannot be moved. What can be moved are the warm bodies occupying residential units. The "price" of a piece of improved real estate can be re-characterized as the cost of attracting an owner, which takes into consideration all the neighborhood characteristics traditionally affecting the price of real estate. The potential owner-occupant of the house in the cheaper neighborhood thus actually becomes the "arbitrageur," and so does the corporation which seeks to significantly cut its overhead by relocation. The outsized gap in pricing between first and second-tier markets is historically high, and will not go unnoticed by cost-cutters.
As for "factual evidence," there's plenty of evidence that indicates that the upturn in the major markets is largely fueled by institutional speculation and the influx of foreign capital looking for a haven. The wealthy from places like China, Russia, Ukraine or any of the crisis-gripped EU nations are seeking to store their capital in sound investments, and it appears to them that a New York condo fits the bill. There's no need to tenant it, of course.
www.cbsnews.com/news/investor-driven-housing-recov...
http://www.naiop.org/en/Magazine/2014/Summer-2014/...
http://fivethirtyeight.com/datalab/why-the-chinese-are-snapping-up-real-estate-in-the-u-s/
I think you are mixing up some terms. like principle of substitution, elasticity of demand and reversion to the mean. Please identify what mean you are referring to that you see will revert.
Also kids, Real estate was not just invented. Foreign investors have been around since ancient times like the 80's. I was there when the Japanese were buying up Kahala estates from the back of their limo's. http://en.wikipedia.org/wiki/Pebble_Beach,_Califor...
I think it's pretty well settled that residential real estate has fairly high price elasticity of demand, with some stickiness downward (since people don't like to sell at a loss). It's because generally people will negotiate this purchase since it will be their largest. You're right to intimate that the elasticity of supply is low, but what I'm trying to point out is that the consumer is now much more able to move to where the supply is high than ever before.
The substitution effect doesn't appear to be influencing consumers with respect to these high-end real estate purchases--instead we're seeing something closer to the income effect, where a consumer increases their demand quantity as their income rises. Maybe if your annual income is $500,000 or more, then Cleveland real estate becomes an inferior good. It's safe to say that the majority of Americans would prefer to live only in the largest coastal cities, were money no object. I don't believe that that's what is happening here.
The problem I have with what's going on is that the money simply isn't there. The average New York household only makes $52,000 per year (which is only $2,000 more than my own city, Cleveland Heights) yet their median gross rent is fifty percent higher. So, the average New Yorker isn't making any more money, but they're paying out the nose anyway. I'd imagine that for this "average" New Yorker, buying a residence is absolutely out of the question. I don't buy that this is a sustainable trend.
Pebble Beach is a very nice area, and I've spent time there. Remember though that the CCC is blocking new water taps, though, which prevents new development altogether.
Completely unrelated, but in the Pebble Beach Wikipedia link that @Account Closed posted lists Pete Incaviglia as a "famous resident" of Pebble Beach.
I don't know very much, but Pete Incaviglia has to be on the (low-end) periphery of "famous", no?
(Yes, I grew up in the 80's...the mitt I still use has Dwight Gooden's signature on the palm.)
Everyone knows - the FED knows, and everyone plays the game, aside for you and me, it seems like...
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?
I would think so.
I know - I sound wise... That's cause I turned 40 today! That's a wise age...I think :)
Thank you for the advice. Happy birthday!
@Ben Leybovich While I appreciate the compliment on the size of my balls, I should remind everyone that I'm only risking a very small amount of my own cash when allowed to invest in our deals and in most cases I'm not an investor in the deals. My job is simply to find them, underwrite them, and get them financed and close. No easy task and certainly takes a certain level of expertise and deal making ability, but I'm not taking the same risk as my boss who invests millions of his own dollars in the deals.
One other thing to note. People in this thread have been talking about the 5-year risk when loans expire. I wanted to make it clear to everyone that we are putting 10-year and in some cases 12-year FIXED NON-RECOURSE loans on our deals. So no matter what happens, we aren't faced with the need to refi or sell for another decade. Our thought is if we buy right we can with stand a slowdown/drop in rents and just keep holding.
Also, I have no idea what @Christian Carson is talking about in most of his posts. His grasp of economics is way over my head :)
One more thing. A down cycle (which is a natural part of any real estate cycle) does not necessarily mean a crash. It did in 2007, but values of MF don't always plummet. In many cycles, it's more of a slowdown. I think that's what we are going to see...a slowdown, not necessarily another epic crash. Although I seem to be in the minority with this opinion.
We're seeing the same thing here in Cleveland. New apartments are going up right alongside those old duplexes and are renting for twice the $/SF. There's a waiting list. The good news is that it's creating comparables that are shattering landlord expectations here. Most landlords haven't raised their rents because they're just not aware that they can.
The way people are profligate about spending money on housing these days is really offensive to me. I'm frugal about personal expenses--that's why I have a distaste for living in NY. I had a great time in the stints I've spent there, but the place always managed to empty my wallet. I've turned down job offers, because I would be trading away my financial future. It wasn't a sacrifice I was willing to make.
@Christian Carson I think a few financial numbers that have been thrown around should be clarified and hopefully they will shed some light on the arguments.
NYC total personal income is 32,537% greater than that of Cleveland Heights. Additionally, on a per capita basis, NYC residents enjoy an 83% pay bump over your Cleveland Heights neighbors. When you look at the numbers that way, it becomes somewhat obvious as to the disparity in real estate prices, would you agree?
**Sorry for the poor formatting, I always seem to have trouble making lists on BP forums.
NYC 2013 CAFR (using 2011 data because that's all that's currently available):
Cleveland Heights 2013 CAFR (notice the 2013 and 2011 numbers are the same indicating a reporting error or little to no growth):
2013
2011
City of Cleveland 2013 CAFR (can't link to it, sorry):
2013
2011
(using 2011 information to compare with Richmond):
Richmond 2013 CAFR (using 2011 information because that's all currently available)
@Account Closed @Ben Leybovich
@Brandon Hall - nice try :) I think you can agree that the Per Capita Income discrepancy of $30k to $55 hardly explains or justifies property valuation discrepancy in and of itself...
It's out of alignment no matter which way you look at it as it relates to incomes. Certainly people are making sacrifices in order to be in NY.
I wouldn't, but I understand others wanting to be there...
@Ben Leybovich Sure I agree that the earnings difference in and of itself does not explain price discrepancies, but it definitely plays a role.
NYC is one of the top ranked cities in the world by GDP. When you have a city that churns that much money, the demand curve shifts way right pushing up the equilibrium price. Depending on curve elasticity, you could see massive price increases.
I think NYC's GDP is 8% of the US total GDP or something like that.
@Brandon Hall - no argument. Besides, there are a lot of things that NY offers which only the NY City can offer. If those "intangibles" represent so much value to people that they are willing to very obviously sacrifice financially for them, who am I to argue. We live once, and if being around the corner from the Metropolitan Opera, NY Philharmonic, or the Broadway means so much to people - God bless!
I would, however, point out that in all likelihood, out of that 8% GDP the Wall Street is responsible for 7%+. While they can afford whatever housing they want, they constitute a sliver of population. Arguably, everyone is spending money that they cannot afford...
Thoughts?
Oh Shocker......What is every third blog post on Bigger Pockets? How I bought a apartment for no money down? I ask who is on the hook for this no money down property?
At the end of the day I built my portfolio on failed investors and the cycle has and always been rinse and repeat. Bigger Pockets the website has only contributed to this. Don't get me wrong tons of good stuff here but an equal dose of very bad advice.
@Christian Carson I think a few financial numbers that have been thrown around should be clarified and hopefully they will shed some light on the arguments.
NYC total personal income is 32,537% greater than that of Cleveland Heights. Additionally, on a per capita basis, NYC residents enjoy an 83% pay bump over your Cleveland Heights neighbors. When you look at the numbers that way, it becomes somewhat obvious as to the disparity in real estate prices, would you agree?
The main thrust of my original writing was intended to address home affordability, which necessitates examining household income (i.e., the aggregate wages contributing to per-unit rents). The median income also lessens the impact of ultra-high-wages residents (which you and I both know are far more common in NY than the city of Cleveland).
As an aside, I don't like using the city of Cleveland as a statistical marker. It is a place where people work, but do not live. I would wager that more than 80% of downtown office workers earning in excess of $60,000 per year do not reside in the city of Cleveland, but instead in one of the nearby suburbs which are less than a 5-mile drive, train or bus ride away. Nearly all the housing projects of the 2+ million metro area are located within its borders, thus skewing net incomes downward. We are trying to talk about people here who are actually in the market for a house, not people earning SSI and living in housing projects. Unfortunately, getting comparable metro data is more difficult than municipal information.
But let's try.
The mortgage and taxes alone in the New York metro area come close to the debt-to-income underwriting limits. This doesn't account or allow for any other debts like student loans, car payments or loans for investment purposes. Add to that the cost-of-living adjustment and the difference in lifestyle (which, in my opinion, basically demands more events of spending) and you're getting to the point where your savings rate has to be zero or negative.
Don't get me wrong - it's fine to live in New York if you can afford it. If you're wealthy, by all means buy that waterfront house. But the averages here are telling me that something is very wrong. Clearly income disparity is off the charts in New York -- and there's going to be a reckoning with real estate prices at some point or another.
Housing prices at 5.7 times household income is about where the Canadian average is these days (skewed heavily by Toronto, Calgary, Vancouver). If you want to see some scary ratios, Toronto is >7.1 and Vancouver proper is >11.
While the gap between income and housing continues to widen, the part to which almost no one seems to be paying attention is the fact the rate of divergence is increasing. At some point this non-sustainable relationship will breakdown.
@Roy N. - I think you just put a bow on this conversation - "rate of divergence is increasing"...This is some scary stuff with lots of opportunity coming :)