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Updated about 3 years ago on . Most recent reply

User Stats

38
Posts
15
Votes
Jake Moran
  • Rental Property Investor
  • Tallahassee, FL
15
Votes |
38
Posts

Are We in a Bubble?

Jake Moran
  • Rental Property Investor
  • Tallahassee, FL
Posted

Hi my name is Jake, and I'm a realaholic. 

I've been completely obsessed with real estate for a while now. After several years of education, preparation, and researching countless markets and strategies, my wife and I finally turned all the theory into reality and bought our first rental property in 2020. We also completed a fix-and-flip in 2021, and we're currently putting the finishing touches on a new vacation rental as well as trying to get under contract on another rehab here in Tallahassee.

I'll save the juicy details about those investments for another time, but let me tell you -- finally taking action has only fueled my passion and desire for more.

Having as much fun as we are, and watching our wealth grow more quickly than I even imagined, I can't help but share our success with others and hopefully open anyone's eyes (for those whose aren't already opened) to the incredible potential that real estate investing holds. I want to help anyone interested in real estate to figure out their own journey and how to get started.

I'd love to discuss my long-term plans for syndication, but there is a more pressing topic I need to start with. Because, you see, some of you are skeptical.

Some of you see home prices reaching new heights every day, and you're convinced that there's nowhere to go but down. I hear people saying the same thing about once a week, whether it’s my contractor, my in-laws, my cashier, my dog: "Well, when the bubble finally bursts...."

That’s not actually true – we don’t have a dog. But it's no wonder everyone else assumes we’re in a bubble, given that the carnage of 2008 is still pretty fresh in our minds.

But the truth is, aside from prices continually hitting new record highs, 2022 has almost nothing in common with the circumstances that brought about the Great Recession. I can think of five very good reasons to believe the housing market is not in a bubble.

1. The M2 Money Supply

The M what? Exactly. Somehow this almost never gets discussed in mainstream media, yet it's the single greatest argument for why we're not in a bubble. (I'll spend more time on this first point, but the rest should be shorter.)

The M2 is simply a measure of how much cash (and other short-term deposits) is in circulation in the U.S. This supply has consistently risen, slow and steady, for the last 40+ years... until COVID.

Check out the incredible graph below. When COVID hit in March 2020, both Congress and the Fed began taking drastic measures to keep the economy from tanking (for example, the $167 that gets deposited into my bank account from the IRS every month, I'm not even sure how or why). Those measures resulted in an immediate spike in the M2:

M2 money supply graph

But since then, the Fed has continued to increase its balance sheet (in ways that are beyond my ability to explain), and that is why you see the M2 is now increasing at a much faster rate than historically. And what this all amounts to is that about six years' worth of new money has been put in circulation in less than two years -- $6.3 trillion of new money.

And that money has to go somewhere.

And it is largely going into real estate. But that's not new or abnormal. In fact, the housing market has historically followed the M2 trend line very closely, which makes sense for a number of reasons. So of course we're seeing historically high home prices -- the Fed practically guaranteed it.

2. Record "dry powder"

This is the reason that ultimately forced me to stop "waiting for the bubble to burst" back in 2019. I realized that countless other investors were waiting for the same thing -- and still are. This article outlines the staggering amount of dry powder (i.e., capital committed by investors that has not been invested) that is just sitting there, waiting, looking to pounce on a decent deal. And when trillions of dollars are sitting there waiting for the housing market to crash, that basically ensures that it won't crash -- prices won't have to fall very far before investors start spending all that extra cash, which will stabilize the market. Again, this is very different from 2007, when there was about half as much dry powder as today.

3. Affordable housing inventory is still at historic lows

And nobody expects this to change anytime soon. In fact, I do think the affordable housing crisis will be solved within the next 20 years (for reasons I’ll get into in the future), but until then, that extra $6.3 trillion discussed in #1 will continue competing for a historically small supply.

How small of a supply? In 2008, just before the crash, monthly supply of inventory (the ratio of houses for sale to houses sold) was at an all-time high of 12 months (6 months is considered balanced); by the end of 2020 the supply was at an all-time low of 3.5 months. The relative supply has officially leveled out in recent months, but the actual supply hasn't: last month there were less than 500,000 active listings on the MLS -- down from 1.3 million just three years ago.

4. Banks' lending practices

This is maybe the biggest difference between 2007 and today. I won't go into too much depth since this is fairly common knowledge, but back then the banks were straight crazy. They gave loans to anyone and everyone. They were giving home equity loans up to 125% of your home's value. And they were giving everyone an adjustable rate. Together it all spelled disaster.

If you've never seen The Big Short, go watch it right now (highly entertaining and informative). There are many regulations in place now to make sure the banks stay more conservative.

5. History

Question: on average, excluding 2008, how much does the housing market drop in value during a recession?

Answer: it doesn't. It usually continues to go up. Check it out:

Recessions & housing prices

Because 2008 is forever seared into our collective conscience, it's easy to forget just how unique that time was and how incredibly stable the housing market has historically been otherwise.

Yes, but...

These are some of the reasons why I'm still buying with confidence. But of course I could be wrong. How might I be wrong? First, prices compared to income levels recently hit an all-time high. If incomes don't keep rising, prices will soon hit a ceiling.

Second, and related, the Fed is becoming increasingly hawkish -- they have no choice but to increase interest rates this year to fight rising inflation. Higher mortgage rates alone will likely be a wet blanket on home price growth. But it would not shock me if this also causes a recession. If that happens and hundreds of thousands of people lose their jobs, and congress doesn't enact another foreclosure moratorium (which they won't), then it's possible we see a flood of foreclosures (or pre-foreclosures) hit the market, which would certainly dampen prices.

But even so, it would not be anywhere near the number of foreclosures we saw in 2009 (because the housing inventory relative to the population was so much higher back then). So the worst case scenario I could see happening is housing prices dropping 1-5%. But that is a far cry from a bubble "popping."

And even if there is a 5% decrease (or worse), that still wouldn't phase me, because price appreciation isn't a big factor in my strategy -- cash flow is. And when you only buy houses that produce positive cash flow, you can survive any recession because rental rates are far more stable than home prices. And, as they say: people always need a place to live.


Conclusion

I don't know what the future holds, but I hope I've at least convinced you there is a strong case to be made that now is as good a time as any to be buying (the right) real estate.

If you agree and you want to get into real estate but don't know where to start, you're not alone. But it doesn't matter how much expertise, or time, or even how much money you have -- I believe there is a place for just about everyone at the table. So if you want to talk more about it, you know where to find me! I (obviously) could talk about this stuff all day every day.

Most Popular Reply

User Stats

4,311
Posts
3,998
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Jerry W.
  • Investor
  • Thermopolis, WY
3,998
Votes |
4,311
Posts
Jerry W.
  • Investor
  • Thermopolis, WY
ModeratorReplied

@Jake Moran, I really liked your post.  I have seen at least 4 major real estate market changes in my state prior to this one.  This one defies all the markers and indicators or any of the other bust/boom cycles I have ever seen.  I have bought real estate since the 1970s lol.  In my opinion there are a lot of driving factors.  The biggest factor is truly the Covid pandemic.  The fear from Covid is gradually lowering, but it ushered in remote working.  Previously if you wanted a job paying several hundred thousand dollars you about had to live in a town of over a million people.  With remote working folks can now live anywhere and still make serious money.  By moving out of the large metropolitan areas they flooded the housing markets of everywhere else.  It would only take less than 1.5% of California moving to WY to have more people from California living in WY than people from WY.  Next people were truly afraid of dying, I was.  The dream of someday leaving the crime infested, 2 hour traffic to get 30 miles to work life and raising kids in small towns with little league baseball and riding through town on a bike could be lost, so the decided now is the day.  People looked at riots and businesses burning and protestors blocking freeways and deciding that making $40K less a year but having safety and 3 minutes to work was worth it.  Ok that is the mental side of it.

Next we have the lack of any decent number of housing being built since the over supply from the 2008 crash.  Lots of builders went bankrupt, many more simply went out of business and found other jobs.  The number of competent builders is quite low compared to 2008.  There has been a deficit between demand for new houses and the amount being built for several years.

The price of lumber is insane.  I was $8 per sheet of 7/16 OSB in 2019, it hit $69 per sheet last year.  It is high $20s last I looked but it is still over 300% higher.  The cost to build is pretty high.  Until used houses get near the price of new houses they will keep going up.

This is not because of banks lending to anyone and massive speculation.  This is raw supply and demand.  Houses are in short supply.  Vacation rentals have become massively popular taking even more residential houses off the market.

Will prices drop?  Anything is possible, but not with demand still massively high, and the cost of building huge.  You won't see a mass of foreclosures driving prices down, because dam near every house has gone up 20 to 50% in value.  They can simply sell and put money in their pocket.  You couldn't do that in 2008.  

Finally inflation is eating up disposable income.  The massive influx of money spent by the current and past administration is staggering.  The amount of free money handed out is staggering.  The safest thing to invest in is real estate.

Prices could drop, but I doubt it.  My belief is that even marginal houses bought now will continue to appreciate and so will rental income, but your loan payments will remain the same.  My money is on continued price increases, but most likely at a slower rate.

  • Jerry W.
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