Are We at the Top of the Market??

Question

What is going on in Southern Maine? Over the last 12-18 months, feel like valuations have gone hyperbolic. Looking at cap rates on some 2-4 units and there is actually stuff with a 3-handle on it! Most seem to be ~4.0-4.5%. And this isn't just in Old Port / Munjoy Hill / etc. It's all of Portland and even South Portland (not even stuff close to the water...)

I know inventory is tight tight tight down there, and that price appreciation is strong right now, but these are asks that are implying you wouldn't even get your cash  back via NOI (assuming rent/expenses are steady state) for 20-30 years...

I personally think we are closer to a downturn in terms of broader macroeconomic trends than we are to an upswing...not expecting anything dramatic but we've been going on nine years running at this point. Makes it risky to buy something at 4% cap. And assuming we don't go into downturn, builders are eventually going to build more entry-level single-family product (which is what that market needs)...that's just supply and demand.

What sort of price appreciation forecasts are people penciling in to make these deals work on the buyer side? Or are people just playing hot potato right now? Anyone else scratching their heads?

John Bapst · Answer

@Russell Brazil @Omar Khan

Nowhere in my post did I call for a price decline. Just noted that price appreciation has gone hyperbolic. Also, wouldn't make the argument "prices have only gone down twice before, it can't happen!" That's exactly what we heard back in 2003-2006...but hey, at least I know where sentiment is. And I'm not even addressing the entire national market - this is expressly about Portland, Maine.

You want to talk national trends I would be happy to point out that first time buyers as a % of mortgage applicants is around 45% versus 15% two years ago, that there is a lot of overdevelopment going on in multiple markets (D.C. comes to mind as a great example, and the public apartment REITs results there back this up), that birth rates for 25-35 year old women have started picking up, etc. that all support my viewpoint that entry-level single-family product is what people want and that on the balance, the market is not as supportive of rent increases as it was three years ago. Talking of putting my money where my mouth is, I own entry-level homebuilder stocks - LEN, TMHC, NVR.

The yield hunting thing is not anything new - has been the case for last 8 years at this point. I bring that up because cap rates were not as unattractive in Portland, say, 3 years ago. Or 5 years ago. Etc. And I would argue that the people searching for yield - institutional investors - are not buying du/tri/quadplexes. Institutional size properties, yes, but not something on this small of a scale. Mom + pop investors such as ourselves may on the margin be more inclined to buy something like that to get yield, but I would argue with the 10-year Treasury at 3%, and blue chip stocks like CAT yielding 2.5%, they headaches that come with being a landlord are not worth the extra 100 basis points - anyone who has been around this game long enough would agree with me on that, I hope.

This notion of "staying on the sidelines" being looked down upon is also not something I particularly care for...asset valuations (and life in general) is not black and white. Just because you aren't buying FB stock today doesn't mean you should be shorting it.

Omar Khan · Answer

@John Bapst If there is a downturn, your (or my) property portfolio will be the least of our worries. You are correct that prices have been rising across the country but that is (A) sign of solid economy and (B) investor hunt for yield with rock-bottom interest rates.

Honestly, the litmus test is putting your money where your mouth is. Buy put options on real estate companies OR if you feel bullish buy real estate. Staying on the sidelines is easy but doesn't make you any cash (unless you have cash and financing lined up in bad times).

Katie Magoun · Answer

Portland investor here. My thoughts: We won't know the top until we're past it. I don't think we're there, personally.

I will say that it's hard to forecast the market here in Portland as the activity we've seen lately doesn't fit into historical models. Buyers simply aren't behaving as rationally as they have in the past. This is due to combination of factors, but essentially boils down to demand FAR outstrips supply, so some (many?!) buyers are willing to do whatever it takes, even if they're buying well above market. The deals we've done this year, we were always one of many offers and our offer was never the highest (not by a long shot!). People are just acting irrationally; there's no other way to explain it. I also think we've seen a sharp uptick in the number of cash buyers (often investors from away hoping to "park" their money in what they estimate to be a reasonable bet, appreciation-wise). Those buyers often care less about the specifics of that property, as long as the property doesn't lose money (an easy bar to clear with a cash purchase).

Speaking of appreciation, I'm not a fan of factoring that into the purchase equation because it's ultimately all speculation. I subscribe to the notion that, over the long term, prices will go up... eventually. Since we're buy and hold investors, I don't care much about what the property is worth in 5 years. I plan to hold it far longer than that. So as long as the property cash flows in the short term, we are still trying to buy.

Russell Brazil · Answer

Prices have gone down twice nationally since WW2.  Why do you think this will be only the third time for that to happen? (The first time was year over year 1990 to 1991 with a $3,900 drop)

Account Closed · Answer

No foreseeable decline in Phoenix. In migration is high, job growth is high and taxes are low.

Vinay H. · Answer

A bubble happens when there is an unrealistic rise in asset prices based on unfounded assumptions and the expectation that somebody will pay a higher price for it when sold. A crash happens when the bubble is financed by leverage and the assumptions turn out to be unrealistic.

Eg if people think that the median houses in cities with median prices close to 1M will keep going up 10% they are creating a bubble. If they borrow more than they can afford to finance those properties, then they risk creating a crash.

Now ponder this headline today in the Wall Street Journal

House Money: Wall Street Is Raising More Cash Than Ever for its Rental-Home Gambit

Investors wager that high prices, higher mortgage rates and skimpy inventory are making homeownership harder for individuals and families

So I would say that the signs are pointing to a bubble. We may not be at top, there may even be a dip followed by a rally (just like stock market in February) but it is looking bubblicious in certain segments/markets.

Omar Khan · Answer

@John Bapst The point wasn't to belittle you. Mom-and-pops are feeling the same squeeze that institutional buyers are facing (at a way smaller level). It all boils down to 2 questions:

• How much conviction do you have in your forecasts?
• What are your investment options?

I worked in asset management on the sell and buy-side. Waiting on the sidelines is an option ONLY if you go balls-to-the-walls when a price correction occurs. If you don't, then you wasted (A) valuable buying opportunity and (B) are a tire-kicker (again, this is not to belittle you personally).

If you don't believe a price correction is imminent than by logic you are saying that the run-up in prices is due to fundamental factors (or rather more fundamental than speculative factors) i.e. this isn't a speculative orgy.

Also, real estate is a regional market. There is no national real estate market. Portland/Maine might have factors that are local. Alternatively, your market could be in the midst of a massive speculativve frenzy.

You can take an active decision to stay on the sidelines ONLY if you aggressively move into the market when the downturn happens. If the downturn isn't happening, then why not buy now in anticipation of increased future prices? :)

Kyle R Neagle · Answer

1 year later...Portland is still behaving the same...

Are We at the Top of the Market??

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