Monday, March 7, 2016

Is the Real Estate Market bound for a correction? Probably.

The Real Estate Market is somewhat overpriced right now and could be due for a correction.

One thing millennials like to whine about (and boy howdy do they like to whine about what a raw deal they got in their lives, as sent from their iPhone) is how expensive rent is, and how they likely will never be able to buy a home - as if owning a home is a great deal or some inalienable right.

I also am not sure why they feel entitled to own a home at age 25.   I mean, maybe out in the country where houses are still cheap, but in the city?  Come on, here.  Let's be realistic.

And I am not sure rents are so outrageously high just yet.  In the DC area (Alexandria Virginia) I own a condo which I rent out for $1100 a month which includes utilities.  It is also next to a Metro station and has off-street parking.   It sat unrented with no takers  for six months.

I lived in the same area in 1987 and paid $900 a month for a similar apartment.   Um, please tell me again about how "unaffordable" rents have become.  Because in nearly 30 years, we are looking at a $200 a month increase here.   I just don't get it.

The good news for millenials is that capitalism does work and pretty soon, they are going to find themselves in the proverbial catbird seat.   As the baby boomer generation lurches off to retirement, there will be a lot of new job openings out there.   No, you won't be making a hundred grand to start, but there will be opportunity which is the key.

Second, the market has responded to high rents and high home prices (in some areas) and I've seen a lot of apartments being built in places like Florida, as rentals are more attractive than condos these days.  As a result, we may have a glut of rental apartments on the market in short order, which will bring prices down, or at least stabilize them. 

Some folks are predicting that housing prices will remain flat, increase slightly, or even go down during 2016 - particularly in some overheated markets.    Of course, it depends on which "expert" you consult.  If you consult six "experts" from a home mortgage broker website, they all will say "Now is the time to buy!!!!"  I think they said the same thing in 2007.

But is housing overpriced?  I think so, across the board.   For example, my house, according to Zillo, is worth $384,369 which is less than we paid for it.  Since similar homes are selling in the high $300's, I think this is a realistic number.   Similar homes rent, full-time for $1700 to $2000 per month, although few are available for rent right now.   The overhead carrying costs (excluding utilities) for insurance, lot lease, fire fee, and whatnot, run about $450 a month, leaving $1250 to $1550 per month to service a mortgage, if you were to rent one out at a break-even point.  A 30-year mortgage, assuming 20% down payment (leaving a balance of about $300,000) would run about $1432 per month at 4% interest.

From this, we can divine that the price of the home is about right, perhaps a little on the high side depending on what kind of rents you can get and what the home would sell for.   This is, of course, not taking into account some pretty hefty expenses such as home repairs, vacancy and the like.   As a landlord, I would want to see a greater rate of return than that before buying and renting out such a home.

The condo in Virginia, which is supposedly a hot market is worth (according to Zillo)  $139,031, which again seems to be what they are selling for in the market from the listings I have seen.   The overall carrying cost - condo fee, insurance, and taxes, is about $844 a month.  It currently rents for $1100 a month, although if you stretched it, you might get $1250.  Some are asking more, but not getting it (six months' vacancy negates any increase rent in such schemes).  That leaves (assuming the higher rent of $1250) about $405 a month to service a mortgage.   Even if we put down over 40% to make the mortgage an even $100,000, the monthly payment at 4% would be about $477.   It's clearly cheaper to rent than it is to buy.

Throw in a couple of $10,000 assessments every five years or so, and you are coming out behind.  Toss in a month of vacancy every years and you lose even more money.  The market in Virginia is clearly ahead of itself.
Now to some folks, the idea of "supply and demand" in the housing market seems an anathema.   "You have to have a place to live!" they cry, "You don't have a choice!"  But indeed, you could make the same arguments about food or gasoline - things we need to get by (particularly food) but the laws of supply and demand kick in with them, all the time.

The thing is, even though you "need" a place to live, you do have choices.  You can rent a cheaper place, or get a roommate or chose not to live in a certain city if it seems too expensive.   Often companies will move out of some locations, when it becomes too expensive for the employees to live there.   A vast migration of tech companies occurred in the 1990's - seeking greener pastures in Colorado and Texas, where they could pay employees less but since the cost of living was far less, they would make more.

And even a small displacement in the difference between supply and demand can cause huge disparities in prices.   If there are 10 homes for sale in town, and nine buyers, well, someone is going to lower their price to lure away another buyer or convince a renter that it is time to buy.   Similarly, when there are 10 apartments for rent in town and 9 renters, someone will lower their rents - considerably - to attract someone else's tenant.

It doesn't take much to switch from a buyer's market to a seller's market - often overnight.   And in 2008, when the City of Ft. Lauderdale had dozens of new condominium high-rises "topping out" at the same time, dumping literally thousands of units on the market at once, well prices simply collapsed.  There were no buyers at any price.

Perhaps the same thing won't happen this time around.  Although in South Florida, it seems that new apartment complexes are going up like the condos were last time around.

The point is, prices cannot remain "unaffordable" for too long.   People will simply stop buying or buy less or commute further or live elsewhere or look for other alternatives.   Eventually the market reaches equilibrium.  And we can go from boom to bust in a matter of months.

After all, it was only about five years ago that you could not give away a house in many parts of the country, right?   How soon before something like that happens again?