With a new administration coming into office in 2017, it might be useful to examine what potential policies will be enacted that may have an impact on housing. The market responded to the election results as if it were a Black Swan event. Most of the comments preceding the election almost assumed it was a foregone conclusion that Hillary Clinton was going to be the next President. Clearly that was not the case. The bond markets had an immediate sizable reaction. We still don’t have the full details on how things will change but there are some changes planned that may have an impact on housing. It is hard to see how rental Armageddon changes because of this.
You would think that with all the surefire bets in housing that people would be dialing up their realtors and heading out every weekend to make those lustful multiple offers presented in PowerPoint format on properties. Yet the overall market data shows a different story. The house horniest of them all, investors, are clearly pulling out of markets including sunny and inflated California. Apparently home prices do matter when making investment decisions. Cash strapped hormonal buyers will keep on buying but housing prices are set on the margin. That margin is becoming razor thin on current volume. I find it interesting that the biggest housing supporter of them all, the National Association of Realtors is also somewhat tepid on this recovery. Why? Because home sales volume is pathetic. Keep in mind they make money on selling and buying. Volume is key. Their model doesn’t work so well with banks holding onto properties like Gollum holding onto the ring and the foreclosure process being dragged out like the forever college student enjoying year 10 at Santa Monica City College. You see this overarching trend occurring in many metro areas across the country. Investors have been propping up the market since 2008. They are now slowly pulling back. You are also starting to see a convergence of analysts putting out their predictions on how overvalued housing is and backing it up with mountains of data. The other side of the argument points to prices. Sure, they’ve gone up but value is created by actual price and that is sort of the point. The answer as always isn’t so simple but using your thinking cap it is important to understand that housing is not a “no brainer” decision in this market.
If a foreclosure happens in the wilderness, does it make a sound? It seems like people have conveniently forgotten that since the housing crisis hit we have witnessed more than 7,000,000+ foreclosures. Do you think these people believe the Fed is almighty and can stop a speeding train or turn water into wine? Apparently some people forget that the Fed failed to prevent the tech bust or the housing bust in the first place. Now, the Fed is somehow the cult leader and the leader will not let housing values fall. The nation still has 9.1 million seriously underwater homeowners on top of the more than 7 million that have gone through foreclosure. It is abundantly clear that the mindless drivel of “buying is always a good decision” is just that. Investors are starting to pull back in expensive states because value is harder to find. I see the lemmings at open houses and you can see the drool at the side of their mouths hoping for a morsel of real estate.
The big motivation for large real estate investors was the yield they could potentially receive from purchasing real estate in depressed markets. Early adopters entered the market in 2008 and 2009 and by 2010 the market was flood by big money investors. Today we are seeing a saturation in terms of investors and yields are not worth the time for many large funds. For example, rents in Arizona and Nevada are down from where they were in 2010 in spite of the rapid rise in housing values. It could be because there is a saturation of rentals in these markets or simply because incomes are weak in these areas. One thing is certain and some investors are losing their appetite for rental real estate. Another interesting trend involves higher inventory and subsequently and ease in the volume of bidding wars. What are some of the trends in the current housing market?
The whispers about private equity exiting the rental market are now out in the open. A few reports are highlighting that some private equity investors are testing the waters for an exit via IPOs. Some have asked why it is necessary for these investors to hold onto properties for a few years before exiting. One of the main reasons is for valuation purposes given that it takes a few years to gather enough workable data on say a block of 1,000 homes and their overall vacancy rates, rental rates, and expense ratios. This would be important if this pool of homes were to be converted into an income stream for investors. Yet many are now looking to exit given how hot the stock market is. You want to sell into momentum. A few other key points include rents falling in places like Las Vegas where investor demand has been incredibly high. Is the hot money planning an exit?
The data coming out on home prices is rather clear. Home prices are moving up steadily in the last year now increasing at a rate last seen in 2006. Of course, little of this is coming from wage growth but more from easy access to debt, investor demand, and historically low supply. One thing that people fail to remember is that during the last housing bubble, people were supplementing a lack of income growth with easy access to debt to add fuel to the housing market. This time, the easy money is being supplied to banks and hedge funds that are simply chasing higher yields. Anyone that has a hand in the housing business, especially in the grind it out rental business understands that it is no hands off endeavor. This is why it is surprising to see how much money is now being funneled into the market by brand new small time investors, especially in places like California. You know things are getting frothy when new money is willing to chase the rental business.
Since 2009 all cash buyers have purchased roughly one third of all Southern California home sales. This is a significant number and unlike the early 2000s, many of these buyers are looking to hold onto properties as rentals. A good portion of buying has come from larger hedge funds and an increase of foreign money has caused competition on an already low selection of homes to become more pronounced. The latest inventory report for California is telling in many ways. Many of the larger metro areas in California are seeing annual inventory drops of 50 to 70 percent. Those looking to buy are facing added competition from a variety of unlikely sources. Last year in February we set a record with the number of homes sold to absentee buyers (29.9 percent). Where is all the inventory going in California?
California home prices experienced a big surge in 2012. This might fly in the face of stagnant household incomes but the incredible push for lower interest rates and reliance on low down payment FHA insured loans has brought many people off the fence. In Southern California home sales are up by 14 percent over the last year and the median price is now up by 16 percent. The median price is largely being pushed by the mix of home sales. Distressed properties are making up a smaller pool of sales. With low inventory, you have regular home buyers competing also with house flippers, big Wall Street buyers, and foreign money with limited supply on the market. The result has been to push home prices much higher making it more difficult for middle class families to afford a home. As we approach the end of 2012, let us look at the data for Southern California.
The assumption that households are doing much better simply because the stock market is up is really a problematic understanding of how wealth is dispersed across the United States. I vividly remember a handful of parties back during the peak of the bubble where people would often quote how much their net worth went up courtesy of the housing bubble. “My home that I bought in the 1990s is now worth over $1 million.” As all of you know, until you sell the home those gains are largely on paper and many did not sell. In fact, many tapped out large portions of that equity and spent it. This is why even with home prices moderately recovering US households still have close to record low equity in their homes. It probably does not help that low down payment FHA insured loans are such a large part of the market encouraging Americans to make the biggest purchase of their lives with very little down. The Fed reported last week on net worth figures and it is worth digging deep into the data.
Desirable areas in Los Angeles County are finding bidding wars and many places are selling for prices last seen during the peak of the bubble. A fierce competition between flippers, foreign money, and households with healthy incomes leveraging low mortgage rates are pushing prices higher. A few readers were sending over some of the recent action taking place in Culver City. A few recounted their tales of open houses and the sense of urgency to purchase a property. The flood of easy money has certainly had an impact on mid-tier and prime locations. Only a two hour drive up north, in California City you can find homes selling for rock bottom prices. This is a trend bearing out in income statistics. It is becoming harder for the middle class to find affordable housing in California. Some have mentioned in zombie like fashion that some areas are becoming fortresses while other areas are left struggling. Let us take a look at some recent data.
Foreign money is flowing heavily into US real estate markets. Now some think that foreign money is going to prop up the entire market but this is simply not the case. The money flowing in from abroad is going specifically into targeted markets. This isn’t necessarily a US trend only. Canada is experiencing a massive housing bubble from money flowing in from China in particular. Here in Southern California many cities are seeing solid money flowing in from Asian countries. You have this occurring while big fund domestic investors are buying up low priced real estate cross the country as investments. What occurs then is the crowding out of your typical home buyer. I get e-mails from local families looking to buy saying they were outbid by $50,000 or $100,000 for properties that had nothing special. Even after the crash, why does it seem hard for domestic buyers to purchase a home?
It is easy to get swept into the momentum of the housing market. The Federal Reserve has managed to push interest rates to historically low levels creating additional buying power for US households. As we enter the slower fall and winter selling season, there is unlikely to be any major changes until 2013 as the election year concludes. We do face major challenges ahead. This current momentum in housing isn’t being caused by flush state budgets or solid wage growth. No, this is being caused by low inventory, big investors crowding out households, and a concerted effort to push mortgage rates lower. If you simply follow the herd, you would think that prices are now near peak levels again (or soon will be) and household incomes are hitting record levels. Let us examine where things stand today deep in 2012.
There is an interesting dynamic unfolding in the housing market. Real estate agents in places like California are arguing that there is a lack of inventory and are also generally against the government unloading blocks of properties to big investors. Why? There has been bulk selling and buying to the investor class and a large amount of crowding out has occurred. This brings about an interesting set of problems for your average buyer in the current market. They are competing with swaths of big investors but also local flippers trying to make a quick buck once again courtesy of low interest rates and another mania in some markets. SoCal is now in a mania again as you will see with some of the patterns occurring. This is also happening in many other states as well. A new feudal system has emerged. The banks were bailed out by the Fed, were allowed to circumvent accounting standards, and now deep pocket investors in the financial class are buying up these places either to increase prices on flips or to hike up rents. In the end, if you want to compete in today’s market you need to bow down to the Fed, put on a football helmet and go head-to-head with big investors, flippers, suckers, and take on a massive mortgage.
Another interesting trend courtesy of the low interest rate environment created by the Federal Reserve is the feverish chase for yield. In a previous article we discussed that a large part of the higher rental prices were coming from a segment that had lost their homes via foreclosure. Since the housing bubble popped millions of Americans have lost their homes. As the report also found, many of those stayed within the same area but likely shifted to a single-family rental or an apartment. What we did not discuss however is how investors are playing a role in pushing up rental yields as well. As bigger blocks of large investors purchase distressed properties, many add value to the property and try to push rental prices upwards. I saw a presentation a few months ago of some local investors in Southern California purchasing older apartment buildings (some built in the 1970s) and upgrading them to more modern standards. Once the upgrades were complete, these investors pushed rents up by 7 to 10 percent. What impact is the flood of investors having on the market?