Is Housing Crash Coming?

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The “in” thing lately for everyone seems to be calling for the next housing market crash.

Almost everyone missed calling the last recession and nobody wants to seem stupid this time around by apparently being the only one not to predict the next one.

So now everyone is walking around yelling about the impending, massive, gigantic housing market crash that’s inevitably coming in 2018 that will be just like 2008.

But is a housing market CRASH really coming soon?

I’ve been thinking about this a lot lately and so should you.

My business revolves around 2 main strategies:  accumulating higher-end rentals and building spec houses to sell to retail buyers.

A real estate downturn would affect each part of my business differently:

My rental portfolio would likely benefit in the event of a housing crash as rental demand typically goes up when housing sales decline.

The house flips and new construction, on the other hand, would naturally suffer.

But is the big housing market crash that so many people seem to be predicting really coming?

I am no economist and I have my doubts that we’ll see a big real estate market crash anytime soon.

A downturn, or a slowdown?  Very likely real estate market predictions.

But a housing market crash like 2008?  Not happening anytime soon in my opinion.

Let’s talk purely in terms of real estate first (then we’ll talk about some outside forces that may mess things up long term):

Certainly every market is different and there are some Tier 1 markets that may be overheated (Miami, NY, etc)

But overall here’s why I don’t think we are NOT anywhere in the same situation as 2008:

[1] Inventory:

There is a massive lack of inventory almost in every market, especially in affordable product.

This applies both to retail sales AND rentals.

Rate of new retail construction hasn’t been anywhere near pre-2008 levels.

Many homes that fell into foreclosure in 2008 have been bought up by investors and turned into rentals.

And existing homeowners aren’t selling because there’s a lack of options to move to.

All this spells a lack of inventory and an ongoing high demand for houses, especially in the affordable category.

On the rental side, even with the high amount of new apartment construction concentrated in the Class A category and tier 1 and tier 2 markets, there haven’t been enough housing units created vs. new jobs being added.

Here’s a very interesting article that illustrates this and may speak directly about your market.  According to this report, from 2005 to 2015, new housing permits in many core markets have not kept up with job growth.

I quote: “The problem is particularly acute in many of the nation’s largest cities, including San Francisco, Boston and New York. As the most desirable jobs cluster in these metros, restrictive zoning and bureaucratic hurdles slow the pace of new construction. With supply failing to increase in line with demand, rents have been increasing to levels that are only affordable to those with the highest-paying jobs.”

[2] Levels of sub-prime lending over last 5-7 years

 A huge factor in the 2008 mortgage crisis and housing market crash was a giant spike in ARM resets, especially sub-prime ARM resets.

Homeowners bought houses with low teaser rates and when their payments reset, they could no longer afford the house payments.  A large # of these happening at the same time drove up defaults and contributed to a massive foreclosure crisis.

We are not quiet in the same boat right now though.

For one, amount of ARM resets coming down the pike over next few years is much lower.  See this helpful chart.   It’s not the easiest chart to interpret but just compare 2008 mortgage resets to what’s forecasted for the next few years.

Secondly interest rates are still low (much lower than in 2007-2008) and in my view won’t jump much higher over next few years.  So those loans that DO reset will reset into a lower rate than back in 2008.

Non-real-estate issues:

Even though the real estate market itself to me doesn’t seem like it will collapse anytime soon, there are broader considerations happening in our economy that could contribute to a financial crisis in the near future.  And a general financial crisis will no doubt then negatively impact the real estate market around the country.

Just a few points of concern:

Student Loan Bubble:  Future household formation will be done by millenials and the generation after them – the kids coming out of college. But they’re so burdened by student debt, which they can’t discharge via bankruptcy, that fewer and fewer of them can afford even entry level housing.  This will significantly affect the housing market over coming years on and will put a ceiling on appreciation.

Margin Debt:  Margin debt is when owners of stocks or stock portfolios borrow against those stocks.  They then use that debt to either buy more investments or spend that money elsewhere: consumer goods, vacations, etc.  With the stock market run-up, margin debt has climbed to all-time high levels.   This is leverage and works just like any other leverage:  in good times it’s fine, but as the stock market shifts back down, those with high margin debt will get wiped out.  Very simply put, the higher the margin debt out there, the broader the implications of a stock market crash or downturn will be on stockholders and the overall economy.

Car Loan Market:  Another market where there is a serious binge on debt over last few years.

Soaring National Debt:  I don’t even need to explain this one at this point. You know what’s up.

Other Countries’ Real Estate Bubbles:  Also, even though we may not be in a bubble, other markets are:  Canada and China.  And as their housing markets crash, the rest of the world’s economies will be impacted.

So what does this all mean for you? 

First of all, let’s all stay calm and not give into fear mongering.  As I said, I don’t think we’ll see a housing market crash like 2008 happen but we need to structure our businesses to be prepared for anything.

My real estate market predictions and takeaways for my own business are as follows:

[1] I will continue to accumulate high quality rentals into my portfolio. Current demand is strong and if the retail sales side crashes, demand will only go up.   Long term, owning good quality rentals at a reasonable cost basis and leverage is a no-brainer to me.  Mailbox money.  All day long.

Key being:  reasonable leverage.  The biggest mistake everyone seems to be making in this market is leveraging their rental portfolios to the tilt to keep buying more real estate.  Those who don’t watch their leverage will get crushed in the downturn instead of benefitting from it.

I am also looking into building “workforce housing” – something cheaper than Class A but geared for working people making between 60-100% of average median area income.   There’s a huge need in most markets for this as most new apartment construction has focused on Class A luxury rentals.

[2] On the flips, my main objective is not to get overextended. I will keep building 3-4 houses at a time that all fall into the “affordable” category under $400k or so.  If the market slows down, I won’t be stuck with a huge inventory.

I think we easily have a 12-24 month runway of selling affordable houses like hotcakes to people.  If you can rehab or build affordable retail product, you’ll do well in most markets.

Now you have to figure out your own takeaways and how you will structure your business to both maximize profits and make sure you’re protected if the downturn or housing market crash does come!

Look at your downside.  If you’re holding rentals, look at your leverage and de-lever if necessary.  Don’t cash-out refi everything you can just to grow.  Raise private capital that won’t have calls built-in.  Form joint ventures where your capital is patient.

As I said, holding affordable, high-quality rentals long-term is a no-brainer to me.  But you have to have great management systems and a debt structure that won’t collapse with the market!

If you have loans with community banks with calls or resets coming up in the next 2 years, re-negotiate those loans now and extend them out further.

Pay off debt, stockpile some cash so that when the market dips you can take advantage  and pounce!

If you are holding inventory of houses to rehab/flip, I would work that inventory down to a level that you can live with if the music stops.  We may not crash, but a slowdown and pullback is absolutely inevitable!   Be ready for it.

Happy investing!

Daniil Kleyman

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