October 31, 2018
Real Estate Market Numbers
By Glen Bell (510) 333-4460
Here are some highlights for the 38 East Bay Cities that I track:
Affordability, rising interest rates, increasing inventory, reduced sales, considerations of moving out of the Bay Area, are all topics of interest in a market in transition. Properties are staying on the market longer, we’re seeing fewer offers than before, more price reductions and some incentives now being offered, in effect, all favoring buyers. Yet indecision has many buyers on the fence with a wait and see attitude despite having more choices.
- Here’s where we stand as of the end of October 2018 . There’s 63% more inventory now as compared to last year at this time. However, despite that increase, we’re seeing fewer go into contract. There’s 16.7% less pendings compared to last year. This creates a pending ratio of .68, the lowest we’ve seen since March of 2009. This is also the 7th straight month this ratio has dropped, but more importantly the fourth month in a row that it falls under 1.00. The pending/active ratio has been a benchmark that we’ve used as a measure of supply and demand to determine whether we’re in a buyer’s or a seller’s market. Typically, a number well above 1, (more inventory with fewer pendings) favors sellers as has been the case now for quite some time. A number below 1 favors buyers. This is the case throughout the East bay with 95% of the cities that I track now having a ratio of below 1.00. In short, we have been moving from a strong seller’s market since the beginning of summer towards a more normal and balanced market, and in many cases, now favoring buyers.
- Some of the articles below further support this. Some key statements made;
- Sales in the nine-county region dropped sharply to 5,970. That was down 22.1 percent from August and down 18.9 percent year over year. That was almost twice the normal drop between August and September and the lowest sales count for the month of September since 2007.
- “Sales have slowed quite a bit and inventory has increased,” said CoreLogic analyst Andrew LePage. “Some potential buyers are sitting this out and a significant number have been priced out.”
- Of all San Francisco Bay Area residents using Redfin, 22 percent were searching for homes in another metro. In the Bay Area, the poor are moving out, the wealthy are moving in and gentrification is picking up steam.
- The runaway market has slowed, with median prices for existing homes down to $850,00 in September from a peak of $935,000 in May. (That’s about a 9% price drop).
- Many economists are still predicting a recession in 2019 or 2020 and although the Real Estate Market will not be the trigger as it was in our last recession, it will be a factor. For many buyer’s there may be some opportunities to be realized, but keep in mind that for whatever modest corrections we may see, much of it may be offset by rising interest rates.
- As anticipated, we repeated the dramatic drop off in inventory at year end, following our normal pattern for December, typically our low point. We’ve increased our available housing inventory by a whopping 388% since the beginning of the year, now 63% higher than where we were last year at this time.
- Our monthly supply is now 48 days. Last year, our months’ supply, at this time, was 30 days. As a reminder of what we mean by “months’ supply;” If no more homes come onto the market, and homes continue to sell at the same pace as they have been over the last 12 months, then the “months’ supply,” (in this case 48 days), tells us that’s how many days it would take to sell the remaining number of homes we currently have available for sale in any given market. September is typically our high point over the year in terms of inventory.
- It’s hard to predict how much tax reform will play into this but see the article, “Is California facing a tax exodus? Thanks to Trump’s tax law, more may start to flee.” We are seeing interest rates starting to go up. Prices have continued to rise and are only now beginning to flatten out. More and more, affordability, the high cost of living and our traffic woes are coming into play for those, especially in the “middle class,” who may now be considering leaving the Bay Area.
- The number of pendings, (homes that are in contract), decreased again. The pending active ratio decreased to .68, now at the lowest point we’ve seen since March of 2009. This compares to last year at the same time of 1.33. This supply and demand ratio signals whether we’re in a sellers’ or buyers’ market. Typically, a number well above 1, (more inventory with less pending) favors sellers. A number below 1 favors buyers.
- The percentage of homes “sitting” has increased to 48% of the homes listed now remaining active for 30 days or longer, while 22% have stayed on the market for 60 days or longer. This is higher than last year at this time with 42% of the homes listed remained active for 30 days or longer, while 22% stayed on the market for 60 days or longer.
- The “distressed” market, (foreclosures and short sales) are no longer a factor representing less than .05% of the market.
- The month’s supply for the combined 39 city area is 48 days. Historically, a 2 to 3 months’ supply is considered normal in the San Francisco East Bay Area. As you can see from the graph above, this is normally a repetitive pattern over the past four years. We are higher when compared to last year at this time, of 30 days.
- Our inventory for the East Bay (the 39 cities tracked) is now at 3,369 homes actively for sale. This is higher than last year, at this time, of 2,065 or (63% higher). The last time we’ve seen inventory this high was in July of 2014. We’re used to seeing between 3,000 and 6,000 homes in a “normal” market in the San Francisco East Bay Area. Pending sales decreased to 2,289, less than what we saw last year at this time of 2,749, or 16.7% lower.
- Our Pending/Active Ratio is .68, now at the lowest level since March of 2009. Last year at this time it was 1.33.
- Sales over the last 3 months, on average, are 3.3% over the asking price for this area, lower to what we saw last year at this time, 4.0%.
Kathleen Pender , SF Chronicle, Oct. 31, 2018
Signaling a market in transition amid a surge in new listings, the median price paid for a new or existing Bay Area home or condo last month was $815,000, down 1.8 percent from August but up 9.3 percent from September 2017, research firm CoreLogic said in a report Wednesday.
While still robust, that 9.3 percent gain was the smallest year-over-year increase for any month since June 2017, when it rose 9.2 percent. Last September, the median price was up 13.7 percent year compared with the previous September.
Sales in the nine-county region dropped sharply to 5,970. That was down 22.1 percent from August and down 18.9 percent year over year. That was almost twice the normal drop between August and September and the lowest sales count for the month of September since 2007.
These numbers are for sales that closed last month. They don’t fully reflect how buyers and sellers are responding to a recent spurt in inventory, because it typically takes a month or so for accepted offers to close.
“There is still a gap between sellers who are trying to extrapolate out what they have seen in the past three or four years in price increases and buyers who have more options to choose from. I think that still has several months to play out,” said Jordan Levine, senior economist with the California Association of Realtors.
Throughout the Bay Area, new listings, active listings and price reductions all surged last month year over year, said Patrick Carlisle, chief market analyst with the Compass real estate brokerage.
The change was most striking in Santa Clara County, which had been one of the nation’s hottest markets for most of this year. There, new listings of existing, single-family homes were up 83 percent year over year in September, active listings were up 120 percent and the number of homes with price reductions was up 308 percent, Carlisle said.
In San Francisco, the comparable numbers were 28, 8 and 32 percent.
If you compared September 2018 to September 2016, the increases were much less dramatic. That’s because the Bay Area market was “ferociously hot” from 2017 through this spring, Carlisle noted.
Last week, the California Association of Realtors reported that the number of existing, single-family homes on the market in the Bay Area was 44 percent higher in September than in September of last year. Statewide, active listings rose only 20 percent, the sixth consecutive month of increases following 33 straight months of declines.
Levine said the market is transitioning from a strong seller’s market to more equilibrium.
“The market is less competitive, with a lot more listings for buyers to choose from. That, taken together within higher interest rates and higher prices, has cooled demand. You are seeing time on market come up a little bit, premiums are coming down to list (price) or a little lower.” There are “more active listings that haven’t sold yet that have price reductions,” he said.
“We are still forecasting that prices are going to go up, but at a slower pace than what they had been for most of the past year,” Levine said.
Garrett Frakes, managing partner with brokerage firm Polaris Pacific, said, “We are shifting to a more balanced marketplace where buyers are being more judicious, more careful and more thoughtful and willing to step away from a deal if it doesn’t meet what they want.”
As an example, Frakes said he recently received a postcard from a Realtor about a home in Burlingame, an “undersupplied” market where prices “have run up dramatically in the last two or three years.”
The home was listed at $2.5 million and a year ago it probably would have sold for $2.6 million, he said. One of the new condo developments Polaris is marketing is the Alexandria, which is nearing completion in San Francisco’s Richmond District. With only six units left, Polaris cut prices on a couple of them. A one-bedroom plus den unit with 1,098 square feet listed at $1,219,000 on Sept. 1 is now listed at $1,150,000. Frakes said it’s not unusual to lower prices on the last few units of a development and that response to other new condos is strong.
“This time it sold for $2.4 million in 18 days.” It likely had one offer from a buyer who was willing to close in 18 days but not willing to pay more than asking price. “The seller probably had a good agent who said this is where the market is, if you don’t take this deal, the likelihood is it’s not going to get much better.”
SF-area “outflow” on real estate site jumps four percent
By Adam Brinklow, Curbed SF, Oct 24, 2018
Real estate site Redfin once again puts its eye on what its own users are eyeing and come to the conclusion that more and more Bay Area residents are shopping for homes in other cities, typically in more affordable metros.
This has been the consistent trend every time Redfin has released one of its quarterly “migration reports” like the one released today covering the third quarter of 2018.
According to Redfin analyst Tim Ellis:
In the third quarter of 2018 people continued to move away from high-cost coastal markets like San Francisco, New York, Los Angeles and Washington, D.C., in increasing numbers. Meanwhile, more affordable areas like Sacramento, Atlanta and Phoenix continued to draw thousands of potential new residents.
[…] Of all San Francisco Bay Area residents using Redfin, 22 percent were searching for homes in another metro, up from 18 percent during the same time period a year earlier.
For SF the “outflow” rate—i.e., the number of locals shopping for homes in other cities via Redfin greater than the number of people from elsewhere looking at SF-area homes—was 28,143 for the quarter. (Note: When Redfin says “San Francisco,” they actually mean the Bay Area as a whole.)
A series of caveats must accompany these Redfin figures:
- This only tells us what Redfin users are doing, which may or may not reflect on the general population. And since Redfin doesn’t handle rentals, this also restricts the data to would-be homeowners.
- Redfin can only tell us what site users are looking at, not how many of them actually buy a home in Sacramento and make a move. However, Redfin spokesperson Jon Whitely tells Curbed SF that, in order to count as outflow, at least 20 percent of a user’s site activity must be spent browsing another city, so casual window shoppers aren’t included in the statistic.
- Though Redfin has ranked San Francisco as the top outflow city in the U.S. consistently since starting these reports, the city’s actual population continues to grow, largely thanks to still being a destination for immigration.
- The U.S. Census Longitudinal Employer-Household Dynamics are a far more conclusive measure of how many people are moving into or out of SF; however, those numbers don’t update often enough to give us an idea of contemporary trends.
- In short, Redfin’s reports don’t necessarily mean that anybody is actually leaving SF.
- However, it’s hard to interpret the fact that so many more SF-based site users are increasingly devoting their page traffic to other locales as anything but a sign of regional discontent, and the spike of more than 10,000 people is surely not an insignificant one.
- For the curious, the median home price in Sacramento (per the California Association of Realtors) in September was around $372,000. In SF it was more than $1.5 million.
By LOUIS HANSEN, Bay Area News Group, October 31, 2018
Bay Area home buyers facing ever-escalating prices are adopting a new strategy — watching and waiting.
The median price for an existing home in the nine-county region jumped 9.7 percent in September from the previous year, but more buyers are sitting on the sidelines and fewer homes are being sold, according to a report released Wednesday by real estate data firm CoreLogic.
Bay Area sales volume in September dropped nearly 20 percent, scraping lows not seen in the month for more than a decade. Interest rates on standard 30-year mortgages have also risen about 1 percent in the last year, driving up home costs and helping drive down sales.
“Sales have slowed quite a bit and inventory has increased,” said CoreLogic analyst Andrew LePage. “Some potential buyers are sitting this out and a significant number have been priced out.”
The runaway market has slowed, with median prices for existing homes down to $850,00 in September from a peak of $935,000 in May. But year-over-year prices continued to surge last month, according to CoreLogic data from Bay Area counties: median sale prices for resale homes jumped 11.6 percent to $1.2 million in Santa Clara, 20 percent to $1.5 million in San Mateo, 8.4 percent to $607,000 in Contra Costa, 8.8 percent to $865,000 in Alameda, and 13.4 percent to $1.4 million in San Francisco.
Since January, year-over-year price gains have averaged 13 percent. Median sale prices have risen every month, compared to the previous year, since April 2012.
Sales volume tumbled 18 percent across the region. Sales in Santa Clara County, home to Apple and Alphabet headquarters, dropped 25 percent as prices rocketed out of reach for many buyers. San Francisco and Alameda counties both saw declines of about 14 percent.
In San Francisco County, home to 884,000 residents, fewer than 400 homes changed hands. Santa Clara County, with more than 1.9 million people, had 1,350 home and condo sales.
The Bay Area mirrors a statewide trend: CoreLogic data shows sales volume dipped across California last month by 17 percent, LePage said. “What we need is more affordable inventory,” he said.
Bay Area real estate agents are feeling the cooling trend. Homes are sitting on the market longer, and all-cash, as-is offers for properties in hot neighborhoods are less common, some say.
Homes in San Mateo and Santa Clara counties took an average of 13 days to sell, a few days longer than last September, according to Sunnyvale-based real estate analytics firm Aculist. Meanwhile, the inventory of homes on the market increased 74 percent in Santa Clara and 29 percent in San Mateo during the last 12 months.
San Jose agent Gustavo Gonzalez said demand remains strong, but the lack of affordable inventory is taking a toll. Starter homes move quickly, but more expensive properties are sitting longer, he said.
“I’ve seen a pause in the market,” said Gonzalez, who sells in the East Foothills. “Some of that is seasonal, some of that is interest rates going up, some of it is buyers just burned out.”
Matt Rubenstein of Compass Real Estate in Contra Costa County, said buyers are snapping up starter homes in the $500,000-range. Young couples without children and older, empty-nesters have been active in Concord, he said.
“We’re seeing a peak. Markets go up and markets go down,” he said. “Be prepared to ride it out.”
The search remains agonizing for many, involving intense planning and financial sacrifices to buy a piece of the Bay Area. Despite slowing sales, competition remains tight for homes near tech headquarters in San Mateo and Santa Clara counties. Bargain-hunters in the East Bay are watching record prices approach $1 million for the typical home.
Samantha Tomaszewski, 31, moved back into her parents’ house in Clayton for a year to save for a down payment. She endured a 3 hour daily commute by car and train to get to work as an administrative assistant in San Francisco.
By Blanca Torres – San Francisco Business Times, Nov 1, 2018
California leads the nation in many categories from population to venture capital funding. Add lack of housing supply to the list.
The Golden State is under supplied by 3.4 million homes to meet its current housing needs, according to a report on housing underproduction from Up for Growth California, a nonprofit research and advocacy group. The national shortfall is 7.3 million homes, which means California makes up about half of that total.
Not only does the state not have sufficient housing, but the housing that does exist is expensive, out-of-reach to people making median household incomes, said Mike Wilkerson of Econorthwest, an economic consulting firm, who co-authored the report.
Up for Growth released the report Wednesday at a forum that included California State Assemblymember David Chiu, Bay Area Council President and CEO Jim Wunderman, Denise Pinkston of development firm TMG Partners, and Carol Galante, head of the Terner Center for Housing Innovation at the University of California, Berkeley.
The Bay Area serves as a microcosm of the broader problem, Wilkerson said. From 1980 to 2010, the market had the highest price appreciation of anywhere in the country. Meanwhile, the amount of new housing added per resident was among the lowest in the country.
“The less you expand (housing inventory), the more your housing costs,” Wilkerson said.
Addressing housing need is a complex issue, but in general, more new homes would help alleviate the problem, he said. The question is how do that, especially in places that want to avoid urban sprawl.
“Is there way to grow our amount of housing without growing our footprint?” Wilkerson said. “The answer is density.”
The report recommends that the state and local governments implement policies to encourage multifamily housing near transit stations that allow residents to reduce car trips.
Another strategy is to increase the number of homes in single-family neighborhoods by permitting duplexes, triplexes, and accessory dwelling units, which are separate homes attached or detached to a single-family house.
Already 50 percent of the housing built in California since 2010 is in a multifamily development of five homes or more, Wilkerson said.
Still, in high-cost cities like San Francisco, housing developers are spending $800,000 to $900,000 per home — costs that are unsustainable, Galante said.
“The demand (for housing) is in the middle-income and lower-income levels and that’s where it’s going to continue to grow,” she said. “Not only do we need to build 3 and a half million more places for people to live, but we’ve got to get the price points down to a place that middle income people can afford.”
Meanwhile, the challenges to building more housing abound in California: The state’s strict environmental laws and review process require developers to spend years moving projects through the approval process.
Many cities maintain zoning that doesn’t allow for high-density housing or even small multifamily housing in single-family neighborhoods, Pinkston said.
Zoning policies essentially block developers from building duplexes and fourplexes which cost much less to build than, say, a high-rise residential tower.
Neighborhood opposition to apartment buildings or high-rise residential towers routinely kills proposals when they reach city planning commission or councils.
Earlier this year, the state Legislature enacted a bill to make it easier to develop surface parking lots at BART stations into housing.
“It was certainly a fight all the way through the entire process of being opposed by dozens of elected officials, particularly in the East Bay, who were very invested in the current status quo of the character of how they perceive their cities despite the fact that everyone talks about a housing crisis and homelessness crisis that we need to address,” Chiu said.
The way to mitigate those challenges is to streamline the approval process, zone for higher densities and invest in mass transit, Wilkerson said.
“The more-of-the-same approach is not financially sustainable,” he said. “In the long run, affordability requires sustained production of housing.”
Other key findings from the report:
- 41 percent of Californians spend more than 30 percent of their take home pay on housing, which means they are considered cost-burdened for housing.
- Statewide, California added 4.4 new jobs for every new home from 2010 to 2015.
- In the Bay Area, the imbalance is worse. San Francisco added 11.4 new jobs per new home and San Mateo County added 13.2 new jobs per new home.
By JEFF COLLINS, Orange County Register, November 2, 2018
A Realtor economist said Friday, Nov. 2, not to believe those “scary headlines” about “plunging” home sales and stock prices.
Pushing back against claims of a housing market bubble, Lawrence Yun, chief economist for the National Association of Realtors, said home sales and prices merely are undergoing a “mild adjustment in the data.”
Yun’s forecast in a nutshell: No price plunge. No bubble. No unsustainable mortgage debt.
“The housing market is on very firm ground,” Yun said during NAR’s annual conference in Boston. “We should not be worried about price declines.”
Yun’s comments came days after CoreLogic released figures showing homes sales down about 18 percent in Southern California and the Bay area during the year ending in September.
Yun conceded that luxury homes in Southern California and throughout the state could face price drops in 2019. But prices should hold up at the lower end of the market in the Golden State.
As for the Bay Area, all bets are off. Prices could keep going up, Yun said. Or they could be more volatile and go down.
“It’s in its own world,” he said of the Bay Area.
But in the nation as a whole, expect nothing more than a slight market shift. There will be slower home sales. And price gains will be smaller. But no crash.
For example, Yun projected U.S. home sales will be down 3 percent to 5.3 million transactions this year. Then, sales should bounce back, rising 1 percent next year and 2.8 percent more in 2020.
Median house prices, or prices at the midpoint of all sales, will be up 4.7 percent by the end of 2018, rising to $247,200 (less than half the California median of nearly $579,000 as of September). U.S. home price gains will shrink to 3.1 percent next year and 2.7 percent in 2020, according to the Realtor forecast.
“We are in no danger of a price plunge,” Yun said. “All indications are that prices will move higher.”
Yun said the housing market doesn’t have any of the triggers that caused past market drops, such as the risky lending and rising foreclosures that tanked the housing market in 2007.
But there are potential challenges ahead.
Negative housing news could affect consumer behavior, causing a “self-fulfilling prophecy.”
“If people view the housing market as (having) peaked and prices are going to go lower, people will postpone their decision (to buy),” Yun said. “That could affect demand.”
Rising mortgage rates also will be negative for the housing market, he said, but rising employment likely will counter that.
Lastly, tariffs could be another concern. If the trade war with China “gets out of hand,” that could harm the housing market, boosting homebuilding costs at a time when construction is far below demand.
“My personal opinion is tariffs are (an) unforced error on policy,” Yun said.
2018 Migration Trends accelerate as more people look to leave Denver, San Francisco, and Los Angeles
Tim Ellison, Redfin, October 24, 2018
As mortgage rates climb, affordability in the most expensive markets has suffered, driving more people to affordable, low-tax inland job centers in states like Florida, Texas and Tennessee.
In the third quarter of 2018 people continued to move away from high-cost coastal markets like San Francisco, New York, Los Angeles and Washington, D.C., in increasing numbers. Meanwhile, more affordable areas like Sacramento, Atlanta and Phoenix continued to draw thousands of potential new residents. The latest migration analysis is based on a sample of more than 1 million Redfin.com users who searched for homes across 80 metro areas from July through September.
Nationally, 25 percent of Redfin.com home searchers looked to move to another metro area in the third quarter, compared to 22 percent during the same period last year. Affordability continues to be a driving factor causing people to move away from the coasts.
“Rising mortgage rates are exacerbating affordability issues that have been driving people out of expensive coastal metros for the past few years,” said Redfin chief economist Daryl Fairweather. “With rates no longer near historic lows, buyers are increasingly cost-conscious, seeking more affordable homes in low-tax states in the South and middle of the country.”
Moving Out – Metros with the Highest Net Outflow of Redfin Users
San Francisco, New York, Los Angeles, Washington, D.C. and Denver posted the highest net outflows in the third quarter. Net outflow is defined as the number of people looking to leave the metro minus the number of people looking to move to the metro. A net outflow means there are more people looking to leave than people looking to move in, while a net inflow means more people are looking to move in than leave.
Of all San Francisco Bay Area residents using Redfin, 22 percent were searching for homes in another metro, up from 18 percent during the same time period a year earlier. Of New Yorkers, 34 percent looked to leave, about the same as last year. Of Los Angelenos, 16 percent looked to leave, compared to 15 percent last year.
Moving In – Metros with the Highest Net Inflow of Redfin Users
The places attracting the most people are mostly the same regions that have been growing throughout the past year, including Sacramento, Atlanta, Phoenix and Portland. The metro areas seeing the biggest inflows of new residents are the big cities where home prices are still relatively affordable and job markets are strong. Median prices in the metro areas seeing the largest net inflow average around $150,000 below prices in the metro areas with the largest net outflow.
“We talk with a lot of people moving to Atlanta from areas experiencing more of a slowdown, and they seem to think Atlanta is too good to be true,” said Atlanta Redfin agent Ashley Ward. “Benefits of Atlanta that keep drawing people here include top-notch public education, affordable housing, an appreciating market and more job opportunities.”
David Greene, Forbes, October 30, 2018
In 2005, everyone was buying houses. It was common knowledge you were stupid to wait. House prices flourished and loans flowed like drinks at an open bar. Lots of people made money—until they didn’t. In 2009 the music had stopped and people were frantically looking for someone to pass the hot potato to. By 2010, those “smart” people were the ones looking stupid. Foreclosures dominated the market place and the great real estate boom of ‘05 looked more like a ghost town as the real estate downturn hit full effect.
Fast forward to 2018 and it’s starting to look a little familiar. In Northern California, we frequently see homes sell significantly over asking price, regardless of appraisals or the condition of the home. Demand is outpacing supply, and prices are rising again. In hot rental markets across the country, we continually see local investors totally puzzled by how much out of state folks are willing to pay for traditionally modest priced homes.
So what do you do? Is now the time to buy, or should we be waiting for the next crash? Are we in 2005 at the peak of the market, or are we in 2010, with plenty of room to run?
If you want to make the best decision, you have to consider all the facts. Before I make a black or white suggestion, let’s take a second to consider several market factors, strategies and possibilities. There just may be a way to invest now, and still be primed to take advantage if the market crashes later.
Are we in a bubble?
When we refer to a “bubble,” we are typically referring to an unrealistic, unsustainable value in an asset class that can’t reasonably be expected to continue. In 2005, home values weren’t based on affordability, they were based on horrible loans that allowed people to borrow much more than they could afford over the long term. When those loans reset, nobody could pay them, and the market was flooded with foreclosures. Supply increased while demand dropped and the market went south.
In today’s market, we see a much different scenario. I work as a real estate agent in the San Francisco Bay area, and I’ve yet to see any funky, clearly foolish loans from any of the buyers I’ve worked with. Rates are generally fixed over 30 years, do not adjust, and are absolutely reasonable based on the buyer’s income. It’s obvious that home prices are up, but what’s not often talked about is how wages are up, too. Let’s not forget that there have been 13 years of wage increases since 2006. That’s a pretty healthy number. Prices may be higher, but they’ve increased in proportion to wages as well. The danger of a massive wave of loan defaults hitting the market all at once isn’t all that high.
So are we in a bubble? In some areas, possibly. But remember, as long as people can afford their payments, it would take some external event to cause a housing problem—things like an overall recession, hit to the job market, etc. If that happens, many asset classes are going to take a hit, not just real estate values. The point is, don’t be lazy and assume just because home prices seem high that automatically means we are in a bubble or seeing a repeat of 2005. There are lots of other variables to consider.
What happens if I invest too early and the market crashes?
This seems to be every investors worst fear. It’s a bit of a catch-22. If you invest too early and the market crashes after, you missed the “opportunity of a lifetime.” If you wait for the market to crash, you could spend years not making any financial progress. Then, when it does crash, all you hear is how real estate will never recover and you end up too scared to pull the trigger. Either way, no matter the current market, it’s hard to take the plunge and jump in.
This question also assumes real estate markets are the same everywhere. A “crash” in one area doesn’t always mean there will be a crash in another. Some markets are driven by specific economic factors that aren’t affected by the rest of the country. Example? Texas. In 2009-2010, when many of the rest of the country (California, Arizona, Nevada, Florida, to name a few) were all getting hammered, Texas went by relatively unscathed. The same goes for parts of the midwest that tend to operate independently of coastal markets.
So what’s the solution? Should you buy now, or buy later? Finding a way to have your cake and eat it too isn’t as hard as you may think. The trick is understanding why it is you’re actually afraid to buy now and miss out later. It can be summed up in two words: opportunity cost.
Opportunity cost is an economic term that refers to the price you pay to miss out on one option when you commit to another. In this case, buying House A can be a problem if you miss out on House B. If House B ends up being better (as in, you bought it after the market crashed and paid less), your opportunity cost would be the money you lost that you could have made if you’d waited for House B.
This fear of the unknown holds a lot of investors back. So how do you beat it? With the secret wise investors have been using for years: the BRRRR method.
What is the BRRRR method?
BRRRR is an acronym that stands for Buy, Rehab, Rent, Refinance, Repeat. It is the order of which you conduct the various stages in the investment cycle when you buy a rental property. When you BRRRR correctly, you can end up buying an investment property with zero money down. This often ends up resulting in a cash-flowing property that’s been fully rehabbed and sometimes puts more cash in your pocket than you put in. When you recover 100% or more of your capital, opportunity cost ceases to be a factor to consider. It stops being about “House A or House B,” and instead becomes “House A, then House B.”
How is this possible? When you buy a house traditionally, you put a hefty down payment down, then include money for closing costs and the rehab. The total of that money you put down makes up your investment basis that is used to calculate your ROI. With the traditional model, there is always a heavy opportunity cost. If you put $35,000 down, pay $5,000 for closing costs, and have a $10,000 rehab, that’s $50,000 of your money you cannot invest anywhere else.
In this case, if the market crashes, you don’t have that $50,000 to invest in the down market, so your opportunity cost is high. This is the reasoning behind the “fear of missing out” that keeps investors from getting started investing in real estate. So how do you overcome this? My solution is to remove the opportunity cost. If you can buy a property and recover the capital you used to buy it, what stops you from buying the next one, too?
BRRRR’ing successfully is the way I accomplish this. In a hypothetical BRRRR deal, you would buy a fixer upper property for $60,000 that needs $40,000 of rehab work. Throw in the same $5,000 for closing costs and you end up with a total of $105,000, all in.
At a loan-to-value ratio of 75%, if the property appraises for $135,000 once it’s rehabbed and rented out, you can refinance and recover $101,250 of the money you put in. This means you only left $3,750 in the property, significantly less than the $50,000 you would have invested in the traditional model. The beauty of this is even though I pulled out almost all of my capital, I still added enough equity to the deal that I’m not over-leveraged. In this example you’d have about $30,000 in equity still left in the property, a healthy cushion.
It’s not too difficult to save another $3,750—and it’s significantly easier saving than $50,000. This means you’ll have all that money to put into the next house when the market crashes. If you do this effectively, you can pull out even more money than you put in (by buying great deals and rehabbing prudently), growing your capital and the ability to invest in future properties. No more opportunity cost.
How do I know which market to invest in?
While no one has a crystal ball and can tell where the market will crash and when, there are some pretty standard metrics you can use to hedge your bet against a crash.
Diversified Economy: You want to avoid any area that is dependent on one employer or economic driver. Detroit is a great example. When the auto industry failed, so did all the home values. With no one able to find work, all the rentals went vacant (and so did everything else). Other examples would be North Dakota (oil dependent), an area known only for tourism, or a coastal village in Alaska that is completely dependent on fishing.
C-class or better neighborhoods: Real estate investors tend to evaluate neighborhoods like school grades. A-class properties are the best spots in town, B-class is where the upper middle class lives, C-class is your average neighborhoods with lots of renters, and D-class properties are problematic with high-crime and high-vacancy rates.
You want to avoid anything less than a C-class neighborhood. By investing in nicer neighborhoods in economically diverse markets, you avoid the worst of the negative factors when a market turns and can ride out the storm. For more information on how a property is classified, ask a local top producing real estate agent or property manager.
Cash Flowing Properties: If your property cash flows (brings in more income than it costs to own), it doesn’t really matter what happens to the value. If prices drop, that doesn’t impact you unless you sell. Experienced investors buy properties that produce income and only experience price appreciation as icing on the cake.
Look for properties in areas that meet the “1%” rule. If a property will rent for 1% of the purchase price every month (a $100,000 that rents for around $1,000 a month), it is very likely to cash flow positively. If you focus on buying in areas like this, and avoid bad neighborhoods and non-diversified economies, it won’t matter what the market does. Your investment will be safe.
We can never know the future, but if you follow this advice, you’re much more likely to grow your wealth over time. Don’t wait to buy real estate, buy real estate and wait.