I’m a big believer in trying to understand the risks in any investment I make. There are always going to be unforeseen risks — like a war, a terrorist attack or a crazy natural disaster — but the more risks you can plan ahead for, the better off you are going to be.
Here are the biggest risks I see for single-family home prices:
The 4 Biggest Risks that Threaten Single-Family Home Prices
1. Tightening Lending Standards
I am generally for the tightening of lending standards as prices increase and the loosening of standards as prices decline.
The lending community has been doing it the opposite way for a while now. When prices are dropping, it means that homes should hypothetically be more affordable — and vice-versa when home prices are increasing. Obviously it depends largely on wages, but that is a separate topic. My point is that tightening lending standards pose a real risk for current single-family home prices.
In many areas housing prices have been buoyed by “all-cash” buyers or investor types. This is true of markets like Atlanta, Phoenix, Vegas and Florida. These people are somewhat indifferent to lending standards — or at least were for the past few years.
At some point home prices will reach a point where it no longer makes sense for investors. The new buyers are going to have to get loans. If lending standards are tightened, then this could have an adverse effect on prices.
2. The Failure of the Buy-to-Rent Funds
I have dealt with a lot of large funds that bought thousands of homes with the intention of fixing them up and then renting them out. The jury is still out as to whether this strategy will work in a sustainable way. Operations for many of these companies still need a lot of work, and it is much more difficult to operate 1,000 homes over a wider geographic area than it is to operate 1,000 apartment units in a few complexes.
The latest strategy by some of these funds has been to create a rental yield bond. In other words, they are packaging together a number of homes that are rented and selling investors the right to a fixed portion of the rental income. It may sound similar to what banks did with mortgage backed securities.
There simply isn’t enough data about single-family rental tenants to determine the risk profile for these bonds. Are tenants in Atlanta more like to default than those in the San Francisco Bay Area? At what price point do delinquencies become more prevalent? How are evictions and ongoing capital expenses paid for? And these are just some of the questions that need to be answered.
To the point, if these funds fail, then they are likely to start selling some homes. I know that large funds like Colony Capital and Waypoint Homes are already selling parts of their portfolios. Right now it is small, but if these companies are forced to sell much larger portions, it could flood the market with supply.
3. Student Debt
I have been seeing a lot of headlines about student debt lately. Notably, Mark Cuban commented on it in this article. The effect on the overall economy could be substantial, but the effect on the housing market could be even worse.
The US Census Bureau estimated that almost one million housing starts took place in 2013. A million homes. Who is going to buy them if young Americans are saddled with thousands of dollars of student loans?
It is possible that those people who have rented for a long time will end up buying a portion of them, but what does that do to the funds who are dependent on high rental prices? During the recession new construction essentially vanished, which put upward pressure on home prices and also rents.
The problem is that with more construction comes more supply. If students are unable or unwilling to get home loans because of student debt, it doesn’t take a genius to see what it will do to pricing.
4. The Fed Stops Dumping Cash from Helicopters
I won’t pretend to fully understand the machinations of the Federal Reserve. It is operated by people with IQs that are probably three times what mine is.
But isn’t that part of the problem – that no one can really explain exactly how the Fed works? OK, that point aside, one thing is clear: the Fed has been supporting the housing market by buying trillions of dollars of mortgage backed securities. What happens if they have to sell them all? Isn’t that a lot like what happened to AIG?
At some point, and I don’t know when it will happen, but I would imagine that the Fed would have to stop buying mortgage backed securities and/or sell them. This FAQ section from the Fed dated August 5th, 2014 only serves to confuse me more — but if there’s something that confuses me, then it is probably confusing other people, too.
I don’t like that something so important and integral to single-family home prices is confusing to me. It makes me scared, and I think it is potentially the biggest risk to prices.
I am still an advocate of purchasing real estate, but I would caution people on being too aggressive. Make sure you can afford the investment through good times and bad. Have ample cash reserves or partner with an investor. Go through multiple scenarios of underwriting.
Can you afford for a property to be vacant for two months? What happens if you need to pay for a big capital expense, like a new roof? Plan, plan — and plan some more, my friends. Also, make sure to learn as much as you can about the aforementioned risks!
Which of these risks do you think is most prevalent? What would you add to my list?
Join in on the conversation below!