Are We Causing the next Bust?
Earlier today, on the way to work, I was listening to the BP Podcast #285 as per my usual routine (another great podcast by the way). But after hearing some of the guest's comments about building multi-family and renting units for $13/sq-ft in a small town in North Dakota and making a killing from it, which was much higher than what is expected in that market, it got me to thinking:
Are we contributing to the next economic bust?
By "we" I mean real estate investors, both small and large. While I only have one duplex under my belt, I have used the techniques on this community and through the books I've read (thanks @Brandon Turner) to buy a value-add property, rehab it, and raise the rents by ~$200/mo compared to what it was before. I don't plan on stopping the BRRRR process any time soon.
I started digging in to the statistics and I found some frightening numbers:
- over 11 million Americans are spending 50% or more of their paycheck on rent
- over 21 million are spending over 30% of their paycheck on rent
- over 60% of Americans have less than $1,000 in their savings account
- over 20% don't even have a savings!
- student loan debt is not slowing down at all - the average graduate now has $40,000 in debt (up 6% in one year!)
Now granted, most of the time I am an advocate believer in the capitalistic society and that every person is in control of their own situation and they wouldn't find themselves with this much debt if they had planned accordingly, etc etc etc..
What concerns me is the rate of debt (rent included) increasing at a faster pace than most Americans' income levels. I live in Detroit and have seen rents literally skyrocket over a short period of time. Units that used to rent for $1,100/mo in the Central Business District just 3-4 years ago are now fetching upwards of $1,750-$1,900/mo.
When I hear multi-family investors talk about how hard it is to find good deals today I can only imagine they are trying to squeeze every dollar they can out of their refurbished buildings to generate higher cap rates.
All of this leads me to wonder; will we eventually hit a "cap" and see rents start to relax in price, or will people start defaulting on other debt to afford their living situations thus starting a domino effect similar to the housing crisis (on a smaller scale).
Would love to hear everyone's thoughts!
Thanks,
Mike
@Account Closed I didn’t mention this earlier but I am lucky enough to know people who’s entire careers are to track this sort of stuff.
When way smarter people then myself say theses are the likely causes of the next recession and their whole career is to know that sort of thing, I take note
@Account Closed I don’t think anyone I’ve talked to is predicting something that bad. I’m thinking more on the line of 10-20 percent dip. I personally think middle of 2020 but If that doesn’t happen could go another couple years of bull market
I have an odd prediction with concern to the future. My belief is that the entire country will begin to experience the same issues as California in terms of real estate.
The result will be huge amounts of appreciation for those who own real estate. For that reason I want to own as much as possible. I don’t believe there will be a bust, but a move to a country where the majority rent, and real estate prices are out of reach to the middle class.
Originally posted by @Caleb Heimsoth:
@Account Closed I don’t think anyone I’ve talked to is predicting something that bad. I’m thinking more on the line of 10-20 percent dip. I personally think middle of 2020 but If that doesn’t happen could go another couple years of bull market
Didn't we already have a dip in the stock market when short vol went kaput in Feb? We've plateaued since, and things are not really looking that great at this point, but we do have to take a breather from that massive Trump boost that was experienced since the election night (funny enough, futures were tanking that night). Tech sheet is bound to correct sooner or later. Those valuations are simply insane. Once coders start losing their jobs in hordes, focal cities in CA will feel the pain. Will that be enough to start something? Possibly. Yield curve is another indicator that folks are watching currently, and it's also pointing to something brewing. Fed is trying to hike to be able to reduce when shtf, but this could potentially expedite shtf... Anyway, what I'm saying is - nobody knows. It's always 20/20 after the fact, so I'm grabbing my popcorn and enjoying the show.
Investors maybe! RE investors, likely not. To cause a recession we need something big, like a sovereign nation going bankrupt or a big bank or financial institution going bust because of a bad loan poro
We are always contributing to the next bust just like we contribute to the next boom.
Ok so let’s say @Caleb Heimsoth is correct and there will be a correction mid 2020. You buy a house now at 300k with 75k down 20 year commercial loan at 5.5%. The house appreciates 3% a year. Mid 2020 the house is now valued at 318k and the mortgage a at 212k. Now let’s say it drops 15% over a 3 year period of time. The value is now at 270k and the loan is now at 189k. The drop in value is a total of 30k. The principle paydown is 36k. You are still ahead 6k. Now when the house goes back up in value over the next 7 years at an appreciation of 3% a year for 7 years you are at a value of 332k with 120k on the mortgage.
Now let’s say that you were able to know exactly when the bottom of the market was and you bought it in 2023 at 270k with 67,500 down, you’re mortgage would be about 155k left after 7 years and the house value would be about 332k (this example is a comparison of the rates being the same at 5.5% the whole time for both loans). The monthly payments on the first example would be about $1550 where as the payments in the second example would be about $1400. So a difference of about $12,600 over a 7 year period of time.
So it looks like there is still greater increase in net worth buying now verses waiting until the bottom of the down turn if it were to be in 5 years if the market were to adjust down by 15%. I know that this doesn’t account for more possible repair that may have come up in 5 years but it also doesn’t account for the tax savings through depreciation for holding it over the 5 years either, so I’m considering them a wash.
I however am more in agreement with @Anthony Gayden in that I don’t think that there will be a down turn in the upcoming few years because house prices are just getting back up to or a little above their peak of 2007 and 2008 now and there has been a lot of inflation over the past 10 years so I think there is still plenty of room to go up and I think those who own real estate will benefit a lot from appreciation over the next 4 years or so.
So I am still buying now and hedging my bets by using the lease option model.
@Shiloh Lundahl to be clear I’m still putting my money where my mouth is and still buyIng. I’ve seen about 20k in appreciation across my properties in a year (I’m dealing with 40-80k type stuff) so I can tell you first hand I’m not done buying.
I believe in dollar cost averaging my purchases. If I buy the same amount every year, it won’t mstter if the market is up down or sideways because it’ll all average out.
That being said the numbers don’t lie and they indicate a recession within a couple years. Hard to know what that will look like. Just want to be clear I’m not a naysayer who says to stop buying.
That being said the numbers don’t lie and they indicate a recession within a couple years.
Which numbers, Caleb?
Lot's of over priced properties will recycle at lower values on the next down turn when the owners can no longer hold on. I saw it last down cycle in 2007 to 2009.
I do not invest in SFR but I am seeing things sell at insane values that are not sustainable long term. I remember the (never again) articles from lenders doing loans yet people tend to have a short memory.
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Originally posted by @Anthony Gayden:
I have an odd prediction with concern to the future. My belief is that the entire country will begin to experience the same issues as California in terms of real estate.
The result will be huge amounts of appreciation for those who own real estate. For that reason I want to own as much as possible. I don’t believe there will be a bust, but a move to a country where the majority rent, and real estate prices are out of reach to the middle class.
we were predicting this in the 70s when I first got into real estate !!!
Originally posted by @Marc Winter:
The way I see it, not investors, not spendthrifts, not credit card or student loan debt, high rents--none of that will break the backs; it's government policy and interference. Remember, the last real estate 'bust' 2007 on, was in fact, not a real estate bust, it was a financing crisis. It was caused by political philosophy gone way bad; EVERYONE should own their own home.
Sorry, not everyone should own their own home, imho. Responsible, working individuals that have enough income and savings to purchase and have a reasonable chance of actually repaying the loan--THOSE people should own, if they want.
The government FORCED banks/lenders to give out mortgages to people that actually had NO CHANCE of repaying. You all remember--package up those doo-doo loans, call them grade A, and sell them as securities. Banks and Wall Street did the dirty work, but they were following their own philosophy--government mandates we make these garbage loans. OK, we'll figure out a way to profit from it. They did, at all our expense!
As the business cycle progresses, eventually you can expect another downturn or even a crash--that is the normal cycle of things. Don't be afraid of it; embrace it. Trust and follow your gut, only buy bargain, make-sense investments, keep some of your powder dry (don't overleverage), and take time to rest, recover and take a view from 30,000 feet to get a feel of what's the major, over-arching trend.
Simple, but not easy.
Good luck, keep investing.
How did the government FORCE banks to give home loans to people who didn't qualify?
Government policy certainly encouraged homeownership by most/all, but it's actually lack of government oversight that allowed banks and financial institutions to create and sell CDOs made up of C-grade CMBS debt and call it an A tranche offering. Chasing the immediate paydays of the debt offerings is what led to more and more relaxed lending standards. That recession really was a great example of capitalism going bad and showed why some government regulation is necessary.
@Sean Cole, if you remember, the policy was written that if the lenders did not give loans to certain classes of applicants, then the government would step in and fine the lender. Or they could keep the lender from expanding their banking operations. Or they would FORCE a lender to make a 'donation' to an organization like ACORN, to make up for the bank's lack of filling their 'quota'.
If you don't care for the word 'forced' call it something else, but the way I see it, the government pushed these loans by the policies they promulgated and selectively enforced. Do we need government regulation? Of course. But not to the detriment of the taxpayers. Those of us who were FORCED to bail out the banks when the whole scheme unraveled. Bankers and legislators--totally in bed with each other--it's all fun and games until somebody gets hurt--that's you and me.
Is there any way to know :
The average down payment as a percent of purchase price made on residential properties by Area (state, region, county ideally) and how is that trending on owner occupied vs investment properties say over the last 36 months.
The average loan to value ratio across the US residential market (by state, region, county). And what is the trend on that over the last 36 months for owner occupied vs investment properties
Also is there a way to know what percent of mortgage payments are late (by state, region, county) and how that is trending over the past 36 months on owner occupied vs investment properties.
Investors can only kill the market if they are investing beyond their means. The answer lies in data. Where is the data :) ??
Victor S. When corporate junk debt hit its peak that’s usually a 3 year indicator recession. It peaked Last summer
Originally posted by @Marc Winter:
@Sean Cole, if you remember, the policy was written that if the lenders did not give loans to certain classes of applicants, then the government would step in and fine the lender. Or they could keep the lender from expanding their banking operations. Or they would FORCE a lender to make a 'donation' to an organization like ACORN, to make up for the bank's lack of filling their 'quota'.
If you don't care for the word 'forced' call it something else, but the way I see it, the government pushed these loans by the policies they promulgated and selectively enforced. Do we need government regulation? Of course. But not to the detriment of the taxpayers. Those of us who were FORCED to bail out the banks when the whole scheme unraveled. Bankers and legislators--totally in bed with each other--it's all fun and games until somebody gets hurt--that's you and me.
Yikes! I think there's a giant misunderstanding at play there... CRA (Community Reinvestment Act) is about a lot more than providing home loans to people. At it's core, it's about ensuring that banking services are provided to low income communities - specifically areas that banks "redlined" when no government intervention was involved. It's absurd to claim that banks were forced to give loans to people who couldn't repay them simply because those people were low to moderate income. Lending standards related to DTI and ability to repay still apply to those loans. I used to manage a bank branch in a CRA neighborhood for US Bank, and I assure you that our lending standards were identical there as they were in wealthier areas.
In short, banks were (and are) required to offer banking services, including loans and deposits, in low to moderate income areas, but no bank has ever been forced to make a loan to someone who they knew could not repay. Claiming otherwise is outright dishonest. The foreclosure crisis didn't happen in low to moderate income areas - it happened in medium to high income areas where everyone went and bought way more house than they could afford or bought 3 houses on negative am. loans.
I hope that you just misunderstood what CRA is and didn't intentionally try to mislead people about what it is.
@Marc Winter without much searching: https://www.fdic.gov/regulations/resources/directo...
And from Wikipedia (go read the citations. I'm only including this because it puts the sources in 1 easy to access spot): The Financial Crisis Inquiry Commission formed by the US Congress in 2009 to investigate the causes of the 2008 financial crisis, concluded "the CRA was not a significant factor in subprime lending or the crisis".[124]Ben Bernanke, then Chairman of the Federal Reserve, wrote that experience and research contradict "the charge that CRA was at the root of, or otherwise contributed in any substantive way to, the current mortgage difficulties."[125] Government economists and officials, including Janet Yellen, then President and CEO of the Federal Reserve Bank of San Francisco,[126] FDIC Chair Sheila Bair,[127] Comptroller of the Currency John C. Dugan,[128] and Federal Reserve Governor Randall Kroszner,[129] also hold that the CRA did not significantly contribute to the subprime crisis. According to Yellen, former Chair of the Federal Reserve, independent mortgage companies made risky "higher-priced" loans at more than twice the rate of the banks and thrifts; most CRA loans were responsibly made, and were not the "higher-priced" loans that have contributed to the current crisis.[126][130][131] During a 2008 House Committee on Oversight and Government Reform hearing on the role of Fannie Mae and Freddie Mac in the financial crisis, including in relation to the Community Reinvestment Act, when asked if the CRA provided the "fuel" for increasing subprime loans, former Fannie Mae CEO Franklin Raines said it might have been a catalyst encouraging bad behavior, but it was difficult to know. Raines also cited information that only a small percentage of risky loans originated as a result of the CRA.[132]
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"I don’t believe there will be a bust, but a move to a country where the majority rent"
The underlying problem is that the world trade wars that have been kicked off will result in high job loss, primarily in the US, and will have a negative impact down the line for landlords/investors. If the war continues it will result in about 10 years of adjustment that will be paid for primarily by the working class.
Over the term I am hopeful that Canada will move away from reliance on the US for manufacturing and ultimatly strengthen our own economy....but it will be a long haul.
Originally posted by @Josane Cumandala:
Causing? Not at all. Will we be impacted by it? Yes.
Federal reserve policy causes asset bubbles. Lowering interest rates distorts the decision-making process between debt and thrift. When money is cheap it's more expedient to borrow money for things rather than save it up yourself and buy it. The problem with this is that it leads to malinvestment and business practices that rely too heavily upon low interest rates to be sustainable in a higher rate environment. Cough cough Leman Brothers cough cough sub-prime mortgages.
It's easy to blame investors or even Wall Street and the financial sector but asset bubbles like that would not be possible without the Federal Reserve empowered to artificially suppress interest rates whenever they feel like it. The malinvestment portion of it is easy to succumb to and some people on this forum will get burned if rates go up too much. I blame the system itself more than the individual actors because if mortgages were based on the rationale of say the private or hard money lenders that we investors often deal with, then realistically they would be much higher in order to protect the lender unless the borrower was extremely qualified and/or brings a lot of business. It's only when the lender knows they are covered and there's so much helicopter money from the Fed to go around that they lend to people with no proven income or credit history.
Yep. When politics are involved in money decisions like this it's hard to keep it consistent and rationale. Instead of worrying about the 'what if', I'm focusing on conservative cashflowing #s so I can ride out any storm.
OP's question is whether RE investors are causing the next recession. The easy answer to that is no, or at least not really. Buying property, enhancing it, and charging higher rent to reflect its greater value is not sleight of hand, it's creating something of tangible quality that market actors will pay a fair price for.
The 08 crash was the product of a number of sources: originators willing to lend to anyone and re-sell terrible debt; I-bankers who repackaged that debt into CDOs that masked the worthlessness of the underlying debt instruments; financiers whose models relied on fundamental misunderstandings (independence of default) and mispredictions ("housing has never gone down so it never will!"); and yes the good old state, both by failing to regulate and by feeding the frenzy with its own massive contribution to the secondary mortgage market via FNMA and FHLMC.
Have those problems been remedied? To some extent. Mortgage standards tightened for a bit, but every time I hear a "Rocket Mortgage" ad it reminds me of 2006. The CFPB put in place some reasonable constraints but politics has gotten in the way of that agency making much of an impact. And even if bad debt is being originated, we'd also have to know whether it's being packaged into mortgage-backed securities (with related insane instruments like CDOs squared and synthetic CDOs) to know if we're looking at a repeat of 2008.
This is all to say that no, I don't think that investors are the primary driver of any forthcoming recession. They may facilitate supply and drive up demand, but recessions occur regularly and cyclically, while massive ones like the Great Recession are the product of much greater private and public forces than folks who are rehabbing duplexes to earn some side income.