Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to email@example.com.
Question. Chicken Little from Somewhere, USA writes: Hi Brian, Four years ago, at age 29, I bought and flipped my first house in a 10 month period of time. Since then, I’ve flipped one other house and I’ve used the profits from both to buy and now hold one rental house. I work a full time job and consider myself an investing novice, certainly not an expert. The slowdown in the seller’s market has me concerned. Should I continue investing in real estate or get out before the bubble bursts?
Answer. Hello Chicken Little. The sky isn’t falling but it is a time to be more prudent. This isn’t 2007 and 2008 when the housing bubble burst. Nor have the last few years been a build up to a bubble the way 2004 through 2006 was. However, one thing you should be conscious of is that investors played a very big role in building the huge bubble that burst in 2007. In those days, investors were leveraging everything and lenders were letting them. If $100 of equity could be shown for a property, a third mortgage was approved for anyone who could fog a mirror. Not so today nor for the last several years.
Investors and certainly lenders have been paying much more attention to fundamentals. Encouraging has been the strong wage and job growth. But you should have noticed that the 2nd half of 2018 saw an interest rate jump that immediately slowed lending markets. When rates came back down in 2019, the market again ticked upward. Homeowners who had been on the fence about selling took notice. Not being sure it would forever remain a seller’s market, they brought more inventory onto the market. This has been sustaining the market through 2019 but house value appreciation has slowed because of the affordability issue. All in all, the market has been operating in a reasonable and sustainable way for a few years.
There was a short time when unchecked value appreciation threatened to shrink the sales market out of existence for lack of affordability. The result – rents shy rocketed. During that period, high school and college grads, along with other housing market newbies trended towards multiple roommates or parents’ basements for affordability. The bottom line is that housing prices can never exceed affordability. That means investors should watch the key indicators of wages, employment, interest rates, and value appreciation for clues where the real estate market is heading.
The Catch-22 here is that these indicators don’t produce the same results under different economic conditions. As a novice investor working towards a higher level of understanding, it’s good to look at indicators upstream that will soon work downstream to influence wages, employment, interest rates, and value appreciation. At a first glance, you’d think that today’s market would be especially robust based on months and even years of strong key indicators (maybe with the brief exception of interest rates). And yet, we are clearly in a transitional period. Two of the upstream indicators have been less than expected growth in the GDP and a decline in consumer confidence. Global economic uncertainty has also played a role.
As Lawrence Yun, Chief Economist for the National Association of Realtors said at about midyear, “The housing market is doing fine, but it certainly can do better given what’s happening with job creation and the historically low mortgage rate that is currently in place.” At about the same time, Skylar Olsen, Director of Economic Research at Zillow came out with, “For the first time in a long time, we’re starting to see prices correct and the big thrust that's changing that narrative is the affordability challenge.”
So take the affordability issue with deadly seriousness as the market transitions. Take Seattle as a good example. After about two years of leading the nation in value appreciation, values have now been declining for several months. That doesn’t mean the demand has gone away. It means that people are finding more affordable substitutes. The situation in Seattle has meant more expansion into the suburbs in adjoining counties. Yes, the work commute to Seattle jobs is horrible but the houses miles and miles away are affordable. In fact, it was mostly predictable that while Seattle’s houses are declining in value, the values in outlying areas are increasing faster than ever. You may recall that it wasn’t too long ago that some employers in Silicon Valley began relocating to the Midwest because employees could no longer afford housing anywhere in the Bay area. Although San Francisco hasn’t seen declining values, the annual rate of appreciation has dropped from 10.9% down to 1.8%.
As an investor, understand that today’s market is mostly about affordability. The other thing about affordability to take notice of is that although interest rates are back to near historic lows, buyers didn’t flood back into the market. The current interest rate is sustaining the affordable sections of the market. It would be unwise to invest in property with the expectation that profits will come from unbridled value appreciation. That is the mentality that led to the real estate bust in 2007. A reasonable expectation is for appreciation to meet and slightly exceed inflation.
The best investment strategy to follow is the one that has always worked. Buy low and sell high or at least have a healthy cash flow from the property. Be prepared to hold the property for some time if necessary. This is not the time to buy high expecting to sell even higher. But all is not doom and gloom in the real estate market. The huge wave of Millennials are just now hitting their peak home-buying years. Demand for homeownership isn’t going away anytime soon.
What are your thoughts about the possibility of a real estate bubble bust? Please leave your comments.
Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to firstname.lastname@example.org.
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