How Do You Predict The Next Real Estate Crash? Mine is...

30 Replies

Mine is foreclosure filings and REO sales.

Let me explain.

In 2007, I was working on 20 shortsales and a business partner of mine was working on about 40 shortsale cases. None of the shortsales were accepted. This was unusual. In 2005-06, we made a lot of money on shortsales and we were able to get banks to approve a big percentage of them.

We worked on some cases for 1 year. When we asked the banks why they are so slow in approving these shortsales, they said they are working on too many foreclosures. At that time, home prices were still rising.

IN 2008, the real estate market crashed.

A foreclosure filing is defined as someone who is behind 3 months or more on their mortgage and they have received a Lis Pendens or Summons to Foreclosure. Of course, there are instances where someone in foreclosure can catch up or do a loan modification and now he is no longer in foreclosure. However, more often than not, someone who is behind on their mortgage is unlikely to get caught up. Eventually, the house gets foreclosed on and becomes banked owned or REO.

My hypothesis is that if the rate of foreclosure filings is higher than REO sales, then the number of REOs will rise to a critical level that it will push prices downwards.

If you're selling your house and you have 3 or more neighbors which are REOs too, there's a good chance you will be forced to sell at a discount. It becomes a vicious cycle: the bank sells their REOs at a discount, pushing the market downwards forcing the banks to sell even lower.

Foreclosure filings is NOT the only indicator. If the banks are able to sell their REOs quickly at a good price (just like what's happening now) and they are ahead of new foreclosure filings, the critical mass of foreclosures won't be reached and the real estate market will continue to rise or remains stable.

So, I track both FORECLOSURE FILINGS and REO Sales.

What about you? What metrics do you track to predict real estate price movements?

I always love your posts, and having been in banking at the time of the last crash, I agree with your analysis this is one key indicator. 

My problem is I'm in Texas, a non-judicial foreclosure state. Anyone have any ideal how I can reliably track foreclosure rates in Texas?

I think you are right on the money in looking at that as a key indicator of where things are going.

Out of curiosity what are your feelings on where we are going?  You made one minor comment about how banks are selling the inventory fast at a good price right now.  That comment makes me think you aren't saying we are heading to an imminent crash soon, but wondering if you feel we are trending more towards that.

Around my parts I am seeing BIG time increasing in foreclosure activity.  Petitions have been up 15 straight months compared to the same month the previous year (Data though May) with most of those months being 100%+ increases, so not little blips.

We ain't a fast place to foreclose so most of those year old petitions are just really getting cleared up now and the last 3 months have seen foreclosure deeds increase by >50%, >50% and >80%.

In the last crash we were well ahead of the curve.  Sh*t got real here by late 2005.  I actually bought a bunch of stuff in 2007 thinking we had to be near the bottom at that point.  I was pretty green then but the places I was getting were a good 25-30% less than the people that got foreclosed on had paid just 2-3 years previous, at OUR regional peak.

(Good news is they are almost worth what I paid for them again! #Winning(Almost)) 

I don't see things being as bad as back then since that was an epic disaster with the whole economy tanking (Of course the economy isn't very good since it is ONLY being propped up by low interest rates) and the mortgage meltdown.  At least not many people that overpaid for a place are looking at negative amortization ARMs with 0% equity, so that kind of stuff that sank people last time won't be a factor.

Anyway I can see some reals signs of bubbling in my area, and given the patterns of a decade ago it might be wise to pay attention if you hear about the Boston area real estate market having issues.  Might be foreshadowing of what might happen on a national level in another year or 2.

Originally posted by @Hattie Dizmond :

I always love your posts, and having been in banking at the time of the last crash, I agree with your analysis this is one key indicator. 

My problem is I'm in Texas, a non-judicial foreclosure state. Anyone have any ideal how I can reliably track foreclosure rates in Texas?

@Jay Hinrichs beat me to it. You can track NOD or Notice of Defaults.

Watch out if the NOD's double in a short period....

That will be interesting to play again.  People retract, fear consumes the average people and opportunities are created.  

Frank

Originally posted by @Shaun Reilly :

I think you are right on the money in looking at that as a key indicator of where things are going.

Out of curiosity what are your feelings on where we are going?  You made one minor comment about how banks are selling the inventory fast at a good price right now.  That comment makes me think you aren't saying we are heading to an imminent crash soon, but wondering if you feel we are trending more towards that.

Around my parts I am seeing BIG time increasing in foreclosure activity.  Petitions have been up 15 straight months compared to the same month the previous year (Data though May) with most of those months being 100%+ increases, so not little blips.

We ain't a fast place to foreclose so most of those year old petitions are just really getting cleared up now and the last 3 months have seen foreclosure deeds increase by >50%, >50% and >80%.

In the last crash we were well ahead of the curve.  Sh*t got real here by late 2005.  I actually bought a bunch of stuff in 2007 thinking we had to be near the bottom at that point.  I was pretty green then but the places I was getting were a good 25-30% less than the people that got foreclosed on had paid just 2-3 years previous, at OUR regional peak.

(Good news is they are almost worth what I paid for them again! #Winning(Almost)) 

I don't see things being as bad as back then since that was an epic disaster with the whole economy tanking (Of course the economy isn't very good since it is ONLY being propped up by low interest rates) and the mortgage meltdown.  At least not many people that overpaid for a place are looking at negative amortization ARMs with 0% equity, so that kind of stuff that sank people last time won't be a factor.

Anyway I can see some reals signs of bubbling in my area, and given the patterns of a decade ago it might be wise to pay attention if you hear about the Boston area real estate market having issues.  Might be foreshadowing of what might happen on a national level in another year or 2.

 Shaun,

Foreclosure filings is just one indicator. Your REO sales is the other indicator. You have to subtract REO sales from foreclosure filings. If you get a positive number that means your market is in trouble or due for a price correction. If you get zero or negative, then your market will continue to go up.

The basic theory is: if there are too many foreclosures that the market cannot absorb, the price will go down.

In your market, since foreclosure filings is increasing, I will tread carefully and watch your REO sales like a hawk. If you get 6 months of REO sales being way lower than foreclosure filings, I will not do any fix-n-flips or any acquisition for that matter. You wait until the price goes down :-)

Texas is a non-judicial foreclosure state, and NOD's don't have to be filed with the court. They are sent directly to the homeowner. The first glimpse I can find is when the auction notice is posted at 30 to 60 (21 days is all that is required by law) days prior to the intended sale. Those are images, bundled in a PDF file for a specific auction date. (Technically, in Texas, a foreclosure could happen in as few as 42-days from first notice to actual auction.)

You have to scoll through the pages of the PDF to even find the owner names. Sometimes property addresses are included, but many times it's only a legal description of the property.  I thought I may be missing something, so I asked Jerry Puckett, when we were planning our new campaign. He confirmed it isn't available via the courts in an accessible manner. 

I was hoping maybe someone had a secret!!

Originally posted by @Hattie Dizmond :

Texas is a non-judicial foreclosure state, and NOD's don't have to be filed with the court. They are sent directly to the homeowner. The first glimpse I can find is when the auction notice is posted at 30 to 60 (21 days is all that is required by law) days prior to the intended sale. Those are images, bundled in a PDF file for a specific auction date. (Technically, in Texas, a foreclosure could happen in as few as 42-days from first notice to actual auction.)

You have to scoll through the pages of the PDF to even find the owner names. Sometimes property addresses are included, but many times it's only a legal description of the property.  I thought I may be missing something, so I asked Jerry Puckett, when we were planning our new campaign. He confirmed it isn't available via the courts in an accessible manner. 

I was hoping maybe someone had a secret!!

Contact a list broker. NODs in non judicial states may not be filed with the courts but I am sure the list is compiled by reputable list brokers.

This post has been removed.

Originally posted by Account Closed:
Originally posted by @Shaun Reilly:

I think you are right on the money in looking at that as a key indicator of where things are going.

Out of curiosity what are your feelings on where we are going?  You made one minor comment about how banks are selling the inventory fast at a good price right now.  That comment makes me think you aren't saying we are heading to an imminent crash soon, but wondering if you feel we are trending more towards that.

Around my parts I am seeing BIG time increasing in foreclosure activity.  Petitions have been up 15 straight months compared to the same month the previous year (Data though May) with most of those months being 100%+ increases, so not little blips.

We ain't a fast place to foreclose so most of those year old petitions are just really getting cleared up now and the last 3 months have seen foreclosure deeds increase by >50%, >50% and >80%.

In the last crash we were well ahead of the curve.  Sh*t got real here by late 2005.  I actually bought a bunch of stuff in 2007 thinking we had to be near the bottom at that point.  I was pretty green then but the places I was getting were a good 25-30% less than the people that got foreclosed on had paid just 2-3 years previous, at OUR regional peak.

(Good news is they are almost worth what I paid for them again! #Winning(Almost)) 

I don't see things being as bad as back then since that was an epic disaster with the whole economy tanking (Of course the economy isn't very good since it is ONLY being propped up by low interest rates) and the mortgage meltdown.  At least not many people that overpaid for a place are looking at negative amortization ARMs with 0% equity, so that kind of stuff that sank people last time won't be a factor.

Anyway I can see some reals signs of bubbling in my area, and given the patterns of a decade ago it might be wise to pay attention if you hear about the Boston area real estate market having issues.  Might be foreshadowing of what might happen on a national level in another year or 2.

 Shaun,

Foreclosure filings is just one indicator. Your REO sales is the other indicator. You have to subtract REO sales from foreclosure filings. If you get a positive number that means your market is in trouble or due for a price correction. If you get zero or negative, then your market will continue to go up.

The basic theory is: if there are too many foreclosures that the market cannot absorb, the price will go down.

In your market, since foreclosure filings is increasing, I will tread carefully and watch your REO sales like a hawk. If you get 6 months of REO sales being way lower than foreclosure filings, I will not do any fix-n-flips or any acquisition for that matter. You wait until the price goes down :-)

Not sure of any easy way to track actual REO sales. Might be able to pull it off MLS if they put that it is bank owned in the proper field. They definitely don't always do that right though.

In terms of completed foreclosures (So inventory that will need to be liquidated in some manner) I can say that ratio is HORRIBLE.

Year to date (data through May) we have had 4,430 petitions issued and only 1,623 foreclosure deeds filed.  Compared to last year petitions are up 59.6% so far and deeds are only up 18.1%.

As I said a year to foreclose is actually pretty fast here so NONE of the increases in petitions are reflected in the increase in deeds so far.  In reality probably very few of those deeds even reflect many of those Jan-May 2014 petitions (Which incorporates the first few months of the 15 month year over year petition spikes) so I only expect more and more places to get taken back.

I expect to see REOs continue to increase every month for a while since we are now at the point that this LONG period of big petition increases will get to the point where final auctions will take place.

I should also point out that I also look at the local price trends in a lot of communities as I have been putting a lot of market reports on my website and I see lots of price stagnation and even lots of regression.  These are only snapshots in time looking at the changes year over year in the current month (So right now doing reports on the market in June 2014 vs. June 2015) and I am putting these on a lead generation site so I am cherry picking places that don't look so hot, but I have usually do 3 each week and I have ZERO issues finding places I want to work that have their prices down noticeably.

There is still plenty of irrational exuberance at the retail level (and the new "Investor" segment) but that seems to be driven more by hype and legacy than actual numbers in most places around here now. 

When the IMF stopped short of covering the needed funding

for Greece, (short $50 Billion) they told the world the collateral being held

by Greece's central bank and all the other Europe central bank is not

enough value to cover the loans needed. So really, the jig is up. Experts

are saying the debt, which is really 85% held by the country, not in private

hands, should be written down as much as 70%. Sad, but the rest of the

nations and the USA are in worse shape, as our dollar is eroded by the

new regional (Asia) banking centers and the Petro Dollar is being killed.

Next Dominos  They call FIGS   France, Italy, Greece, Spain  Puerto 

Rico was a surprise to me, also the fact that Washington DC and the 

IRS are both incorporated there.   Hum...not sure what that means yet. 

In addition to tracking NOD'S and REO sales I would also track inventory levels. If inventory levels are rising then supply is greater than the current demand. This too will push prices down. How many months supply does your market have? Inventory levels can rise because of REOs etc but it can also rise for other reasons as well such as low buyer confidence, hedge funds selling off portfolios, prices no longer being affordable for the local economy, if prices rise faster than rental rates and buy and hold investors are no longer buying due to low cap rates or negative cash flow this will also hit demand.

On a side note it is good to read your posts again @Shaun Reilly. It has been a while as I have been focused in my other market Las Vegas for the past year. I look forward to reading more about the MA and RI market now that I have more time to spend on the east coast markets. I will be back east from July 8th to the 19th. Do you know of any meet ups within that time? (Sorry to go off topic).

Originally posted by @Robert Adams :

In addition to tracking NOD'S and REO sales I would also track inventory levels. If inventory levels are rising then supply is greater than the current demand. This too will push prices down. How many months supply does your market have? Inventory levels can rise because of REOs etc but it can also rise for other reasons as well such as low buyer confidence, hedge funds selling off portfolios, prices no longer being affordable for the local economy, if prices rise faster than rental rates and buy and hold investors are no longer buying due to low cap rates or negative cash flow this will also hit demand.

On a side note it is good to read your posts again @Shaun Reilly. It has been a while as I have been focused in my other market Las Vegas for the past year. I look forward to reading more about the MA and RI market now that I have more time to spend on the east coast markets. I will be back east from July 8th to the 19th. Do you know of any meet ups within that time? (Sorry to go off topic).

Good points Robert.

Now around here at least there was never a huge amount of Hedge Fund activity so they can't prop up or crash the market in the same way they could in many other areas.

Also even in the trough you never had big time cash flow investors here.  Finding a <1% property that would have have low/no cash flow was still the norm then, now it rarely works to make much of anything in non-commercial sized rentals unless you are house hacking and include the savings in living expenses in the numbers.

Of course with the big time recent run up I will guess that must savvy equity investors (Which is what you predominately have here) are moving towards the sidelines or will start to sell as they might have seen 20-100% gains in the last 2-3 years.

Buyer confidence is high right now.  But it feels a little like 2004-05 where people wanted to get it because things are hot so the common man pays ABOVE retail at the peak and then gets slammed.

As for meetups you aren't actually here for a great week that I know of.  Best bet is the Boston AREIA in Medford that Thursday.  I like a meeting on Wed up in Nashua NH but I am probably the only person that goes that would do anything remotely close to Bristol County MA.

@Shaun Reilly what you have described is completely different than out here in Vegas. The hedge funds have bought up thousands of properties over the passed few years and are in a holding pattern now. If they choose to dump all their inventory at once (which I don't predict but is possible) it could have a major impact on Vegas market.

It boggles my mind why anyone would want to buy and hold in MA if there is no positive cash flow and appreciation rates are so low. Then add on the tenant friendly laws regarding evictions etc in MA and it makes the MA market very unappealing to buy and hold investors when they know they can go to other markets. In Vegas we still get about 6% CAP rates after all expenses, repairs, and vacancies considered. Appreciation is still around 10% down from 30% in the hay days of 2012 to 2013.

I agree that in both markets it seems to being driven by the first time home buyers and the mom and pop investors that are new to the game and jumping on the bandwagon after hearing success  stories from other investors around them over recent years.

Oh @Robert Adams this is a great area for appreciation.  I was just saying that with the short term run up I would not buy looking for big gains in the medium term.

I would buy here regardless of what things were doing right now if you have a long term time frame, like 10+ years or if you are doing fix and flips in the ~4-8 month time frame.

The former will pretty much wait out any short term decline and in the later as long as you buy with a realistic cushion and based on real numbers, not assuming the place will be worth 1-2% more than you paid just by owning it a few months, you will be fine.

The people that think they will buy a place now at retail and live in it then sell or refi in 1-3 years are the ones that could get burned badly.

For example I have some friends that were moving a couple times during the run up last time. They made close to $100K on the first home they had. Moved to another one then was going to be moving out of state for her work right around 2 years in the house. Actually in their MLS listing they specifically said they needed to close after that 2 year date so they could avoid the Cap Gain since it was a primary. Well they did get an offer that fell apart with the inspection then got another one that was so "insulting" their Realtor said to not even counter. Well the 2 years came and went and no other offers came and they had to move as the market was falling more and more every month. Turned it into a cash flow negative rental for the better part of a decade and sold a few months ago once it was paid down a bit and recovered enough to not be underwater for like $60K less than the insulting offer. They did at least get rid of it ahead of the divorce so they avoided that hassle...

I will comment on two points related to the market crash issue:

1) Predicting when it is likely to occur. As people stated, tracking NODs is usually the easiest approach I know of. Our source is one of the title companies. What you are looking for is not an absolute number. What you are looking for is the changes in the rate of NOD's. In general, in Las Vegas, NOD's proceed foreclosures by about 6 months and they are likely to hit the market about one year later.

2) What's going to happen to your buy and hold properties during a market crash? Since we have access to actual data (we are Realtors in Las Vegas) we recently decided to look at the rental rates vs. $/SqFt rates from 2008 through 2014. Remember that the crash was severe in Las Vegas, and that most properties went down by 50% or more (many have since recovered to pre-crash values). When we started the study we discovered that the metro area data we could obtain from news sources was virtually worthless because there was no granularity; they averaged the entire metro area and even different property types together in some cases. We choose to base our research on one of the prime rental areas, which is shown in the map below. The property profile we selected is: 3 bedrooms 2 car garage, 1,200 to 1,500 SqFt. 

Using actual sales data from the MLS we looked at property prices ($/SqFt) and below is a chart showing the monthly average $/SqFt sale price between 2008 and 2014.

As you can see, prior to the crash in 2008, conforming properties in the selected area were selling for an average price of approximately $120/SqFt. By 2012 the average price fell to approximately $70/SqFt. What happened to rental rates during the same period? Below is a chart showing $/SqFt rental rates for conforming properties in the same area for the same time period as the above.

As the above shows, rental rates were virtually unaffected by the 2008 real estate market crash. So, if you purchased an investment property in late 2007 at the market peak and the property was generating an 8% return, it continued to generate an 8% return, even though the market value of the property went down 50%. However, this is not true of all areas and even all rent ranges in Las Vegas. Lower end rental properties that were primarily leased by construction workers and such (who really got hurt) fared much worse. I think this shows the importance of selecting the right location and properties that will rent to a stable tenant population. 

In summary, watch for changes in NOD patterns and select properties in locations and rent ranges that are likely to be stable even during a market crash.

Originally posted by @Julio Contreras :

Really good information,

Forgive me for the newbie question but where could I track NOD's in the Los Angeles area?

 Ask a reputable list broker in your city. These lists are valuable to investors, bankruptcy attorneys, shortsale specialists so these are being compiled throughout the US.

Thanks @Eric Fernwood for sharing the details of what you've learned in your market. The rate of NODs make sense. If it's increasing, then that is a cause for alarm. Question for you:

How many months of increasing NOD filing will you be able to say that the market is headed for a price correction?

One of the big indicators is seeing building of massive apartments and other structures and a roaring demand for housing and skyrocketing prices, and of course, then it slows down, demand slows down, prices start to go down. The best of the appreciation from the crash is behind us, and inflation is at nearly zero. Rental rates stay almost the same when the economy turns down though so if you're a buy and hold kind of person for the long run it's fine. Always keep cash on hand, when the market does crash, it's like a clearance sale on a store going out of business. No one can know when it's going to crash again, we just know it will, more likely than not, sometime in the next 2-5 years based on everything I've heard from financial sources

Hello @Wendell De Guzman ,

No one knows the answer to that question because each time the cause seems to be different. And, I believe that tracking NODs may tell you what has already happened as opposed to what is going to happen. Perhaps this metaphor will help explain my view. If you contract measles, you will likely have a red rash. However, by the time the red rash appears, you already have the virus and your options for preventing the virus are nonexistent. The rash is the same as NODs. By the time NODs ramp up, the economy is already well into the crash. In Las Vegas during the 2008 crash, the time between the month the first payment is missed until the NOD is filed is between 6 months to 3 years. So, instead of predicting the timing of a crash, a much better approach is to prepare for a crash (at least from buy and hold point of view).

Preparing for a Market Crash

In my opinion, the best way to prepare for a crash is careful selection of your investment properties. This includes both the location and the type and rent range. Here is a link to a post on selecting the right location so I will not repeat it here. What I will cover here is the effects of rent range on rental income stability during times of economic stress.

I believe the goal of investment real estate is sustained profitability. Part of the necessary elements for achieving sustained profitability are:

• A population of tenants that are unlikely to lose their jobs during reasonable instability, like 2008 in Las Vegas. See my previous post in this thread on how rental properties performed during the 2008 to 2014 period.
• Good tenants - A good tenant as one who: pays all of the rent on schedule, takes care of the property, does not cause problems with neighbors, does not engage in illegal activities on the property and stays for multiple years. Please note that tenant quality does not necessarily correlate to rent rate. 

Rental Sweet Spot

Each market has what I call a rental sweet spot. This is the range of rents that has the largest population of potential tenants. I will explain this statement but first, I will make some generalizations that I will use later. Remember that generalizations will not work for specific cases but are usually more often right than wrong. The assumptions I will use are:

• A property that rents for $500/Mo. is generally less desirable than a property that rents for $1,000/Mo. to the average tenant.

• People would choose to live in a property that rents for $1,000 than a property that rents for $500, if money were no barrier.
• If a person can afford $1,000/Mo. rent, they are unlikely to want to rent a $500/Mo. property.
• Except in special cases, people are unlikely to spend more than 30% of their monthly income on rent.

If you plotted the number of tenants who wish to live in a property and can afford to live in that property, the number of prospective tenants by price would be something like the curve below. 

There is a relatively small number of renters who choose to live in undesirable areas or undesirable properties if they can afford better. And, there is a small number of tenants that can afford to pay a very high rent. In real life, the curve would be flatter, wider or skewed to the left or right but the concept does not change. The green rectangle below delineates what I call the rental sweet-spot. Properties that rent in this rent range have the largest population of potential tenants (resulting in higher rent and lower time-to-rent) and you are more likely to end up with the highest quality tenants. More about quality tenants later.

You could segment the curve by job/income level (The following is a silly segmentation but bear with me.) as shown below. 

Each of the potential tenants in each segment are subtable to different market challenges. For example, if your rental properties targeted the minimum wage class and as the minimum wage increases, the number of available jobs are reduced, you are going to have decreased rents and increased time to rent. The point is:

• Different price ranges (or segments) can and are affected by different market changes.
• To minimize the vulnerability to such market risk, you want to buy properties that fall into the rental-sweet spot because you will have the largest pool of potential tenants. If you do this, you are more likely to still be able to rent units out even in time of economic challenges.

Tenant Quality vs. Rent

I mentioned earlier what I consider to be the characteristics of a good tenant. Good tenants come from effective screening by the property manager, not from the rent range. So, if I targeted the "doctor/lawyer" segment (a property that is expensive to rent), I might have only one or two applicants to select from when I am trying to rent the property. If this is the case, the odds of selecting a good tenant are reduced. If I target the sweet spot I will have far more tenants to select from and the odds of selecting a good tenant are increased.

Summary

• It is very hard to predict a coming crash far enough in advance to take proactive action. All the "experts" missed the last one and they will likely miss the next one.
• Market crashes have and will occur in the future.
• The best way to protect yourself is to buy properties that will rent in the rental sweet-spot so you have the largest number of potential tenants.
• Only careful screening by the property manager of a significant number of applicants will increase your odds of getting a good tenant.

Wendell, this is a long answer to a short question but I hope this helps.

@Wendell De Guzman Do you see the market crashing in some areas and not in others? As everyone knows, this has been an uneven real estate recovery with markets like Boston, San Francisco, Seattle, and Austin not only fully recovering, but surpassing their previous highs. Meanwhile, I can tell you for a fact that Phoenix and Tucson are nowhere near their previous highs. Also my hometown of Kansas City still hasn't reached it's previous highs either. Phoenix has recovered better than Tucson by a great deal, but still isn't at 100%. 

In the case of Tucson, I can name quite a few areas where you are still literally paying half of the peak sales prices. 

We all know that there is a large influx of foreign money in some markets right now, especially money coming from China. With the recent market troubles in China, I could see the real estate spending spree coming to an end, with the result being suddenly having too many properties that cost too much.

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