PREPARING FOR THE 2020 ECONOMY

PREPARING FOR THE 2020 ECONOMY

The idea of an impending recession has made headline news all year, as news reporters and forecasters debate when, how and why it will happen. These “experts” cite an inverted yield curve, national debt, lower interest rates, Brexit, impeachment, the coming elections and a record long economic expansion as the needles that could prick this proverbial 2019 bubble.

That’s enough confusion to send investors and potential real estate buyers into sheer panic mode. No one wants a repeat of 2008. However, in reality, there are very few similarities between 2008 and today’s real estate cycle.

Mortgage Loans are Solid

In 2008, adjustable rate mortgages were in the process of resetting to higher rates. Millions of homeowners had qualified for their home loans with low teaser rates, and could not afford the new payment. This, of course, led to the mortgage meltdown and a bevy of foreclosures nationwide.

Today is a different story. According to the St. Louis Fed, delinquency rates on single family residential mortgages continues to decline. In Q2 of this year, delinquencies hit a record low of 2.59%, down from 11.54% in 2010.

If you are waiting for the next foreclosure crisis so that you can cash in on underpriced, distressed homes, you could be sitting on the sidelines for years.

The Dodd-Frank Act of 2010 heavily regulated banks and lenders. While some no-doc or low-doc loans may still be available from private lenders, they represent a very small percentage of home loans today and require high credit scores and high cash reserves.

New regulations just this year have made it even more difficult to qualify for a mortgage. In March of 2019, the FHA informed lenders it would require even more stringent standards to applicants with high debt and low FICO scores.

Credit Karma looked at credit scores from TransUnion for about 1 million Credit Karma members who took out a first-time mortgage between August 2017 and August 2018. It found that the average credit score among those homebuyers ranged from 662 to 730, depending on where they live. These borrowers needed high credit, low debt to income ratios and proof of their ability to afford the mortgage payment with a two year job history and plenty of reserves.

Home Equity at all time Highs

Owner equity in real estate has hit new highs of 18 trillion dollars. That’s up from the last peak in 2006, when home equity reached $14 trillion. It slid to $8 Trillion in 2012, which means that equity has more than doubled in just 7 years.

“Tappable” equity (equity that homeowners can borrow against) reached an all-time high of $6.3 Trillion this year, according to Black Knight. That’s 26% higher than the last high in 2006.

Even if we do see a recession, borrowers may be less likely to walk away from their homes if they are locked into monthly mortgage payments that are lower than rent, and if their homes carry their nest egg.

Lack of Housing Supply vs Demand

There simply isn’t enough affordable housing to meet demand today.

Home builders got hit hard by the last recession, and they have been slow to come back. In the meantime, the U.S. population has grown by over 25 million people since 2008 and household growth has increased by 10 million. Builders have not kept up with demand.

Adding to the lack of supply, the short-term rental business is booming, when it did not exist in 2008. Today, approximately 600,000 homes are now being used as short-term rentals according to Reuters. This new business has effectively taken long-term residential units off the market.

New medical technologies that didn’t exist last decade are keeping more seniors at home. “Aging-in-place” has become more commonplace, effectively tying up more housing that normally would have been released onto the market.

According to Insight, the shortfall of housing supply ranges from a low of 0.9 million to a high of 4.0 million housing units, as of the second quarter of 2018. According to Freddie Mac’s website, “If supply continues to fall short of demand, home prices and rents are likely to outpace income and household formation will fail to reach potential.”

Housing inventory levels started to grow a bit last year when interest rates increased. While news stations proclaimed we were in a “housing slump,” in reality the market was balancing out. Inventories increased slightly and price appreciation slowed down a bit, which was good for buyers.

When interest rates started to decline this past summer, home sales jumped. Now, housing supply is down by as much as 10% for affordable new homes priced under $200,000.

Robert Dietz, chief economist of the National Association of Home Builders, says, “Five years ago that share was 1 in 5, and 10 years ago it was 40% of new home sales were priced under $200,000.”

He added that, “It’s not just the overall supply of new construction that’s gone down, but the supply of starter homes, so it’s the affordability challenge at the entry level that’s been a particular challenge,”

Iinventory levels for homes between $200,000 and $750,000 is flat and starting to decline.

Due to the high cost of construction, builders have been bringing pricier homes to market, but that’s the category with the most supply. Inventory of homes priced above $750,000 was 4.7% higher in September compared with September 2018.

Affordability

Today’s low interest rates will certainly help more people buy a home the Fall, and probably into 2020. But it’s important to understand that there is an affordability ceiling.

Prices can’t rise forever, no matter how low interest rates go. Rents can’t climb forever either.

In Summary:

The theme of 2020 will most likely be a “Slowing but Growing Economy.”

Expect to see growth, but it will likely be slower than the past decade.

New supply of homes will be slow to market. Sales will be strong in affordable housing, moderate in median priced homes and slow in high priced property.

The current real estate cycle is indeed ending, and we are entering a new cycle of “normal” and “stable.” We are certainly not falling off a cliff.

Strategies for Real Estate Investors in 2020

While many of us long to return to 2012 so that we can pick up cheap real estate with double digit cap rates, that doesn’t exist anymore.

We are in an environment that requires a careful study of fundamentals. Strategies used over the past decade will not work in 2020 and beyond.

Landlords will have to accept lower returns as rents stabilize. Proformas should not assume rising rents.

House flippers will need to be more careful when calculating returns, and must get a great bargain at the outset. Repair costs need to be accurate, along with the cost of marketing, taxes, insurance and debt service. There will be less forgiveness when prices are stable.

Developers should look for ways to provide more affordable housing. This may mean smaller floorpans on smaller lots, or building up. At Real Wealth Network, we are also not taking on any builder debt. Instead, we raise enough money to acquire the land and build the first phases. Debt is what took builders down in the last cycle.

Bottomline

If you are keeping your money on the sidelines waiting for the next housing crash, you may never get to play the game.

If you play the game, focus on fundamentals.