Below I am going to share my thoughts on both the California (San Diego) SFR and MF markets which both have different dynamics at play that investors look at. No one has a crystal ball and mine is no better. Best thing anyone can do is source from multiple reliable industry professionals and come up with your best thesis on where the market is and where it is going. I try to keep things simple and easy to understand and cut through the noise and fat.
In general, I do not believe we will see a 2008 collapse in real estate values on SFR market. Here is why:
- Shortage of housing stock (builders have not been a participant to cause oversupply of inventory)
- 25% of US homeowners have mortgage rates below 3%
- 40% of US homeowners have mortgage rates below 4%
- 35% of US homeowners are free and clear of any debt encumbrances
- Credit qualifications for homeowners this cycle has been the best in US history
- Household balance sheets are strong
- 90% or more of mortgages are vanilla conservative 30 fixed
- There has been no speculative lending that we saw in the run up to 2008
- The REO market is non existent (no foreclosures)
With all that said, the debt homeowners have is now the asset and not the real estate itself. Why would any homeowner get rid of their 4% mortgage to go into the market and get a 7% mortgage? Why would any homeowner get rid of their 4% mortgage to go rent somewhere for $500 more a month? The answer...they won't! And if they do need to move for a job they will keep the house and rent it out to off-set the higher mortgage cost of a new home.
The median house price in CA is around $800k. Mathematically given the higher debt costs we should see a 40-45% correction in values. That is just the math and not including the other dynamics which will keep prices stable. Yes, we will see minor correction in price but not to the extent the math tells us. I get a chuckle when people tell me prices need to come down because interest rates are higher...this is false! History shows us this...1974-1981 interests rates went from 7.5% to 15%+ but values went up 300%. Fast forward to 2007-2012 interest rates where substantially lower then what they were in the 80s and yet we saw a price correction of 50%. Point being, there is more to the SFR market than just interest rates that need to be factored in. Homeowners don't buy a house based solely on values, they buy based on the mortgage payment they can afford. Investors might but not your average joe family looking to buy a home to live in forever.
What I believe we will see is a low volume market where potential sellers will wait it out for favorable debt markets return to consider selling. They don't need to sell at this time. The only metric that could possibly change this is the unemployment numbers. I am keeping an eye on that metric to show me how the SFR market responds and if this causes any issues. We will have to wait till mid-2023. In turn, the buyer pool more sensitive to the higher interest rate environment will sit out on the sidelines as well. The only buyers that will remain are those with the net worth and liquidity to buy all cash or 1031 exchange money that needs to buy. You will still have those first time home buyers but that pool will be limited. So smaller amount of sellers with a smaller amount of buyers equals price stability. Now how does this effect the MF market...
The above mention gives a positive outlook for the MF market to remain relatively stable in prices and continue to push rental rate stability. I see the same thing happening in the MF market where there will be less sellers and less buyers so lower volume. Investors are starting to push back on the higher debt costs pushing out some of the buyer pool. Which this may lead to some minor correction in MF values but not as much as investors are expecting. 5-year debt is around 5.5-5.75%. Good luck thinking you are going to see 6% cap rates even if interest rates go up further. I understand the concept investors like to make money on the spread between cap rates and interest rates but there is a point where the value of the asset trumps this concept. History shows us also that cap rates and interests rates are not always correlated. Investors in the MF space are in this business for the long-term passive income...5, 7, 10 years or never selling at all to build a passive rental income stream. Investors with shorter time horizons are definitely more interest rate and price sensitive.
I believe all cash, 1031 exchange money and seller-financing deals will become more prevalent in this market. Rental rates historically go up over time or remain flat so it may take a couple years for the rents to catch up to the higher debt costs, should they remain elevated, to entice the buyer pool currently remaining on the sidelines to jump back into the game. Rental rate increases I believe have peaked and will return to normal historical trends of 5-7% increases every year.
In conclusion, all of my thoughts are subject to change as the market changes and provides more data. Remember why investors are in this business in the first place, to create long-term cash flow and generate a higher net worth. If inflation is here to stay for a while, remember what commodity you are purchasing....land, lumber, copper, plaster, concrete, etc...all commodities in one basket with the bonus of generating cash flow, tax benefits, and ability to get leverage (essentially shorting the dollar that is depreciating everyday).
I hope this provides some useful perspectives to think about and discuss. It is critical, more than ever, to build relationships with the top industry professionals and gain knowledge and experience for when the market does positively change you will be ready for it. Once the FED gives the signal on a slowdown of rate increases or a pivot it is game on and the market will move fast!
Good luck everyone.
