For those who know me, I’m not about the ‘house of your dreams’ narrative – I am pretty objective in my approach. I want my clients to understand the underlying value of what they are purchasing and not allow emotion to override logic.
America is the land of opportunity, right?
That said, I fully acknowledge there is a powerful emotional aspect to buying a home. Regardless of whether it is your first, third, or even the twentieth home, each connect you to a specific period in your life. Selling a home feels like closing a chapter, and when you buy one, a new chapter begins.
Sticks, Bricks, and a Vehicle for Wealth Creation
In the simplest sense, a home is nothing more than a stack of sticks and bricks on some dirt that keeps your stuff dry …
Yet despite the emotional attachment, in the simplest sense, a home is nothing more than a stack of sticks and bricks on some dirt that keeps your stuff dry. While we want to attach value to the colors of our walls, the shape of our exterior, and the brand of our appliances, in the grand scheme of things, housing is no different that any other asset whose value goes up or down given economic conditions.
And 2007 through 2011 notwithstanding, owning a home has created more wealth for the masses than any other asset class in history.
This is what has me worried.
No Crash on the Horizon
To begin, I am not worried about another crash. I have lived through two of them (1987 – 1992 and 2007 – 2011), and the current market looks nothing like the last two that crashed.
The current market looks nothing like the last two that crashed …
In both of the prior crashes, the economy was overheated and there was a tremendous oversupply that had been created to try to keep pace with a dizzying demand.
Currently, the economy is solid, employment is high, inflation is still shockingly low, and while the world is never fully at peace, there is relatively little global unrest (at least compared to prior periods) – and inventory is at all time lows.
Is there a correction coming? I think that some are beginning to predict a slight pullback at certain price points in 24 to 36 months. But I firmly believe that a crash is not imminent.
The Housing Divide
A home is quickly becoming an asset that only the wealthy can afford …
No, my worry is as follows — the price of housing is at the precipice of exceeding affordability for the average American, preventing an entire segment of the population from ever having access to home ownership.
[ And this recent article in The Atlantic seems to back the same narrative – especially Section 6 ]
In effect, a home is quickly becoming an asset that only the wealthy can afford, and, over time, will lead to a deepening of the divide between the ‘haves’ and the ‘have nots.’
Take a look at this chart.
Never has the discrepancy been greater, and I think that is a tragedy.
The blue line represents home ownership levels. In other words, what percentage of the population owns their own home.
The green line represents the median price of a new home.
Notice a trend??
Pricing is accelerating despite historically low ownership levels. The obvious implication is that as prices rise, fewer people will be able to buy – and we can see this playing out right before our eyes. Right now, due to a host of factors which we will touch on below, housing prices are increasing at a rate that is pushing ownership beyond the reach of far too many people.
Never has the discrepancy been greater, and I think that is a tragedy.
Time to Build More, Right?
An economist would argue that the problem will solve itself: As prices rise, more producers will be attracted to the market and supply will increase.
But that simply isn’t happening.
Take a look at this chart showing the number of new homes being built:
Again, notice a problem?
Despite the fact that housing is undersupplied and pricing is accelerating, we are still drastically under-supplying a market that desperately needs relief.
The Problem is Systemic
The problem is about price AND location …
Perhaps the underlying problems were already manifesting themselves as early as 2000 and we simply didn’t see it as the rapid price increases were masked by a insanely lax lending standards. But the issues are more than visible now.
Effectively, the problem is about price AND location. We cannot add supply at anything approaching a reasonable cost, and we absolutely cannot do so in areas where the populous wants to buy.
Issue One – Construction Costs are at an all time high
Building costs are through the roof (no pun intended.) Construction material costs have skyrocketed and the construction labor market pool simply isn’t there, causing extreme wage pressure.
When your material costs are up 30% and your labor pool down 50%, costs spike. And I don’t see an quick solution.
Issue Two – Governmental Mandates Mean Higher Costs
The collective increases become substantial – and the end user ends up footing the bill!
Each bill that is passed to make housing better is done so with good intentions – I honestly believe that. No one wants the US to build substandard and inefficient housing – AND no one wants to see another financial crisis, either.
However, each time Congress, the state legislature, or our local board of supervisors adds another layer of regulation, the cost to build a home goes up.
Each increase in the building code or protection baked into the financial markets is done so with the aim of increasing the quality, safety, accessibility, and energy efficiency of our housing stock. But with each mandate comes increased expense. A percentage point here and an increased fee there never seems like a lot on its own, but over time, the collective increases become substantial – and the end user ends up footing the bill!
Issue Three – Demographic Shifts
Demographics show a population that increasingly wants to live in cities. Urban schools are getting more funding, the commutes are shorter, public transportation is expanding its reach, and the entertainment districts are improving. But yet, the city is the hardest place to build houses.
An incredible 20,000 people came to Richmond in 5 years – and we built a mere 854 houses for them
To give you a sense of the problem – per the 2010 census:
The population in the city of Richmond increased 9.3% from 2010 to 2016, or by roughly 20,000 residents.
In the same time frame, MLS tracked 854 new home sales within the City of Richmond.
Stated differently, 854 new homes / 20,000 new people = 4.2%
For comparison’s sake, Chesterfield built just under 5,000 new homes in the same frame, or closer to 17% of their need.
Somehow, I don’t think 4.2% of the overall need being satisfied by new housing is going to fix the problem.
Issue Four – Gentrification
If you really want to see a mind-blowing statistic, look at these screenshots straight from the Richmond MLS.
The northeast section of the City of Richmond (Highland Park, North Church Hill, Union Hill) is in the midst of one of the most rapid price increases in the history of the city.
Inside of this zone:
This happened to prices in 5 years:
While that benefits some owners, it leaves many others wanting.
The New Normal
It is easy to build another million dollar home on a cul-de-sac in the latest community 10 minutes further out than the last one – but that is not the cure.
Am I saying that everyone should own a home? Hardly. We tried that once (2007) and it didn’t seem to work out very well.
But I do believe that a housing model in which ownership is reserved for only the elite is an equally dangerous model. America is the land of opportunity and when the idea of owning a home becomes an unattainable pipe dream, that is not a good answer either.
Look, it is easy to build another million dollar home on a cul-de-sac in the latest community 10 minutes further out than the last one – but that is not the cure. We have got to solve the need for reasonably affordable / attainable housing in neighborhoods that aren’t 45 minutes from the urban core.
The next generation of potential homeowners deserves the same opportunity as prior generations did to use housing as a fundamental way of building wealth. Everyone wins when our population has the ability to determine their own financial destiny.
Wage increases tend to lead to more disposable income
More disposable income tends to lead to more money to spend
More money to spend tends to lead to inflation
Inflation tends to lead to higher long term mortgage rates
Take a look at the correlation:
As you can see, even as the unemployment rate (the blue line) began to fall in the years following the collapse, wages (red line) didn’t really begin to trend upwards until the latter part of 2015, and even then, only negligibly. The most recent jobs report indicates that wages are starting to rise, a trend that is predicted to continue for some time.
So What Does it Mean for Housing?
Not much … yet. And as a matter of a fact, I am not unhappy to see the rise happening.
Why? Because it means the economy is healthy and people see positive things on the horizon. Trust me, I would rather be in a world with healthy economies and 6 to 7% long term rates than one teetering on the brink of collapse with 3.5% rates.
As we discussed in our 2018 Predictions only a few months back, we predicted a rate rise in 2018 and went into some detail about the implications. Effectively, if we are all making more money, then a slight rise in the cost of borrowing is not something that will cause the market to collapse. And furthermore, as long as credit standards remain reasonable (and consistent) then the risk of a ‘2008, The Sequel’ is quite low.
Home Prices Will Still Rise
Expect housing values to continue to rise, especially urban and affordable, due to a complete, thorough, absolute, and total lack of inventory. As the millennial generation begins to exit their downtown rentals and enter the buying market, affordable urban markets will continue to be starved for inventory.
Expect some of the upper end suburban markets to see slowing price gains due to the fact that homebuilding is finally cranked up again, mitigating some of this inventory shortage.
Think ‘Strategic Finance’
Remember, it is the long term rates that are the ones that have more room to rise. The 3, 5, and 7 year adjustable rate mortgages will still give buyers options a point or two below the long term rates, offsetting any rate increases.
But that said, it is time to get a little more strategic about how you finance your home. Gone are the days of just taking a 30 year mortgage at 3.5% simply because it is a no-brainer to do so. Thinking long and hard about how long you expect to stay in the home will become a key ingredient to making the correct mortgage decision.
But it does feel like we have come to the end of an economic era – the end of the 4% 30 year mortgage. And while I will be a little sad to see it go, it indicates much better times are on the horizon.
Since the first article is now a bit outdated and we’re currently in the works of purchasing a home for our own child headed to VCU, we think now is the perfect time to take a deeper look at the concept.
First, lets look at some pricing statistics for the past several years.
For the City of Richmond as a whole, pricing has gone up by over $63,000 in 5 years. For the areas immediately surrounding VCU, the number is a mere $55,000. Depending on which statistic you choose to measure, the annualized rate of appreciation is anywhere from 4.7% to a high of 7.8%.
Per our rental managers, the average cost of rent is anywhere from $600-700 per bedroom in a standard house.
If they rent a 1 bedroom studio apartment, the number rises closer to $1,100-1,200.
Comparable sales suggest pricing to be roughly $300,000 to $350,000
2219 Parkwood Avenue (pictured) sold in 2 days.
The 3 bedroom/2 bath home was 1872 SF and priced at $325,000
It is roughly 12 blocks from the Monroe Park Campus
The Numbers
So using the scenario above, you could:
Purchase the home for $325,000 and sell it 4 years later for:
$380,000, given only a 4% annual appreciation rate (+$55k)
$395,000, given a 5% annual appreciation rate (+$70k)
$410,000, given a 6% annual appreciation rate (+$85k)
Instead of paying $7,200 in rooming costs to VCU, you received $1,300 in rent per month from two roommates
Paid down your mortgage balance by roughly $20,000
(As a small disclaimer: The past does not guarantee what the future will look like and the type of loan you choose and interest rate you receive will impact how quickly you pay down the mortgage balance.)
Loan Possibilities
Though there are some navigable hurdles, you can co-sign for your child and use a Maximum FHA loan that requires a very low down payment. There are also loan programs for non-owner occupied co-borrowers for less than 20% down. And finally, there are investor loans that allow you to purchase without requiring 20% down.
So all that said, you have options and not all of them require substantial amounts of cash.
So depending on what loan type you choose, we can help you find an originator who knows the market for investor and co-borrower loans.
But Aren’t Prices Going to Stop Rising?
Maybe if we solve the inventory problem or everyone decides to leave the city.
To solve the inventory issue, all we have to do is figure out how to build another, say, 3,000 or so houses per year around VCU (which if you aren’t detecting my sarcasm, is near impossible). Take a look at the chart below to get a sense of how incredible the inventory issue is in the City of Richmond.
And take a look at what the population of Richmond is doing:
So what we have is a really unique scenario: The rapid rise in prices is not due exclusively to a overabundance of risky buyers (a la 2008), but from a constrained supply of housing, especially in the urban neighborhoods, and a growth in population at a rate not seen in 50+ years.
Affordable and urban are the two safest and most recession proof segments of the market, by far.
So What is Available?
As much safety as the supply crunch offers, it does pose a buying challenge, and that is precisely why you need a good agent to help you.
Generally speaking, buying a home in an affordable urban segment requires immediate action when a target arises and a few contractual additions that will increase the likelihood of it being accepted (we can chat in more details about how we structure competitive contracts and how we tend to win more than we lose – we don’t want to publish all of our tricks for the world to see!)
Here is a list of the neighborhoods that surround the VCU campus and currently available housing:
Imagine sending your child to college, and then offering them a home as a gift to get their life started, or selling the home and paying off half or more of their college costs. Yes, there is risk in purchasing a home – stuff breaks, prices do sometimes go down, roommates might break a lease – but with all of the potential upside, the risks are minimal.
We are in the process right now of doing so ourselves… What could be a better endorsement than that??
The Next Crisis in Housing, and the 2018 Predictions
Each year, as December comes to a close and the promise of the new year begins, I try to share my thoughts on what the next 12 months will bring. And while I am not an economist, I did stay at a Holiday Inn Express last night … does that count?
I love data and what it can tell you if you look a little bit deeper. Furthermore, when you can add empirical evidence to anecdotal, you get some powerful intel about not only where the market is headed, but why it is headed where it is.
Welcome to 2018!
What the next 12 months will bring is important for all of us to know — from renters in Shockoe, to homebuilders in Chesterfield, to land owners in Goochland — in order to place our real estate holdings in the best position possible.
And just so you know, the words we will hear repeatedly in 2018:
Inventory
Interest rates
Affordability
Millennial
Inventory — Richmond, We Still Have a Problem
Unless you have been living under a rock (which also appreciated by about 4.8% last year), you have heard about the inventory crisis. Bidding wars are up, ‘Days on Market’ are down, houses are going for more than their asking prices on a regular basis, and everyone is clamoring for more inventory to help fix the problem.
If this chart doesn’t illustrate the extent of the problem, nothing can. This shows the available housing supply over the last 10 years.
In the aggregate, inventory levels are off by well over half from the heights in 2008 through 2010, and that doesn’t even look at the sub markets individually.
Now lets look at the buyer pool. The chart below tracks the number of houses that go under contract in any given month over the past 10 years (i.e. — absorption of housing)
Do you notice a trend?
The rate of sales, while not up anywhere as much as the inventory is down, it is still up by about 30% from the 2007-2011 period. As a matter of fact, there are actually more houses selling now than there were in 2007 and 2008.
So, just to reiterate:
↑ Absorption is up by about 30%
↓ Inventory is down by 60-70%
Yeah, that pretty much explains the price increases.
While I think we all recognize the inventory issue, unless you look at it critically, the deeper message is lost. What has really been happening is that population is realigning where it wants to live, impacting housing availability differently in individual sub-markets.
The Fall and Rise of the City
In the late 1980’s, Chesterfield, Henrico, and the City of Richmond were all populated equally with just over 200,000 residents each. Only a decade later (by 2000), the City’s population had fallen below 200,000 while both Chesterfield and Henrico had exploded to over 260,000 residents each.
It was an incredible shift.
Where Are the New Urban Houses?
But if you fast forward to today, what do you see? You see a city with a population growing at the same rate as the surrounding counties, if not slightly faster. And while growth of the urban core brings with it many positives, it poses a big problem with what is a fixed supply of housing.
Take a look at the table below — despite the same basic rate of growth in population, the number of new houses being built in the city accounts for anywhere from 4 to 6% of the overall market. When you compare that to 15 to 21% of the sales in Chesterfield being newly constructed homes, you begin to see the extent of the problem.
Year
New Homes in the City
Resale in the City
%
New Homes in Chesterfield
Resale in Chesterfield
%
2012
83
2110
3.9%
550
3588
15.3%
2013
121
2356
5.1%
723
3785
19.1%
2014
113
2370
4.8%
729
3818
19.1%
2015
108
2461
4.4%
828
4467
18.5%
2016
150
2629
5.7%
934
5039
18.5%
2017
154
2672
5.8%
1022
4819
21.2%
All cities, not just Richmond, lack sufficient land to develop housing with any scale. And when the population begins to seek housing in the urban environment, it puts pressure on the fixed stock of available housing. When supply is fixed and demand rising, you get rapid price increases. When supply can be added to offset demand, you might still see prices rise, just not at the same rates.
Richmond’s Affordable Housing
So where is the problem the most acute? In the affordable urban markets, that’s where.
The table below shows the number of sales in excess of $300,000 in the north and eastern quadrants of the city of Richmond, long a bastion of affordable housing. The number of transactions over $300,000 has increased from 15 to 129 in the past 5 years — nearly a 900% increase!!
Compare this to west/central Chesterfield and, while you still see a problem, a 264% increase to be exact, it’s not quite as dramatic. Furthermore, the ability for Chesterfield (or Henrico, or Hanover) to manage their affordability issue is far greater as they still have hundreds of thousands of acres to develop to relieve the pressure.
Primary Year
Number of Sales Above $300,000 in NE Richmond City
Number of Sales Above $300,000 in West Central Chesterfield
2012
15
318
2013
29
379
2014
38
451
2015
56
620
2016
88
812
2017
129
842
The Problem Becomes a Crisis
In my opinion, this lack of urban housing will make 2018 the year Richmond’s affordable housing problem becomes an affordable housing crisis.
So if you are looking for urban housing, especially a more ‘affordable’ home in the city, here are some strategies you should employ to make your efforts as successful as possible:
get started earlier than normal
steer clear of online lenders as sellers — ok, seller’s agents — hate Quicken and USAA. Oh and their rates are the same, if not worse, so don’t believe the hype
expect to be involved in a bidding war
don’t rely solely on last year’s comparable sales to dictate predict pricing
act with urgency
(And if you want to read a reeeeeallly deep dive on affordable housing, you can do so here — The Affordable Housing Post)
Interest Rates
I think we have all been dreading the day when rates will rise. Sorry, but I’m calling it. Rates will rise in 2018 and continue to do so until they return to ‘normal’ levels in the coming 3 to 5 years.
Why? The economy is actually pretty healthy. Tax breaks, North Korea, and bipartisan bickering aside, we are doing pretty well, at least economically. Yes, we have crushing debt that our children’s children’s children will have to deal with, but all in all, employment is solid and the economy is growing at a decent pace.
So what is a ‘normal’ interest rate? I think the new normal remains to be seen as the inputs have all changed, but 6% to 7.5% or so for 30 year mortgages is what I think most industry veterans would consider to be ‘normal.’
Inflation
One of the primary drivers of interest rates (ok, mortgage rates) is inflation and when the market sees that inflation is creeping up, the price of money rises to hedge the loss of buying power over time. Stated differently, when you borrow money, each dollar you repay the bank has lost a little bit of its value. And while dollar today will have a similar value tomorrow, how much buying power is lost 5, 10 or 30 years in the future? You get the picture.
So the more inflation the market expects, the higher rates will rise, and as you can see, the trend line, while still below historical norms, seems to be moving up more than it is moving down.
And when you take the same chart and add historical mortgage rates, you see what is a pretty strong correlation. As inflation expectations rise, the interest rates tend to do the same thing (at least once the housing market stabilized in 2013.)
So if you want to know where the mortgage rates are headed? Keep an eye on the inflation expectation in the market. It will tell you (most) all of what you need to know.
Rising Rates — Good or Bad?
So are rising interest rates a bad thing? Does it matter if that rates are in the 5’s, 6’s, or <gasp!> even in the 7’s if the economy is roaring? If salaries are up, the stock market is at record highs, and profits are everywhere, does a mortgage payment 15 to 20% higher than today really matter?
As you can see, the percentage of our collective incomes that we spend on housing is not nearly as out of whack as it was in the years preceding the bubble — and that makes me feel good.
Do you know what else makes me feel good? The amount of housing debt we currently have outstanding relative to where we were. (And, for what it is worth, I am yet to see a chart that better illustrates the ‘bubble’ and the impact of it’s bursting …)
The bottom line is that we are still well below the debt levels of the bubble, and we are spending less of of our incomes on housing.
And also know that, as rates rise, people will begin to use loan products with built in rate adjustments to offset the increased mortgage payments.
Which leads us to …
Adjustable Rate Mortgages (ARMs) and 2018
Wait, did I just say adjustable rate mortgage?!? Isn’t what that got us in trouble the last time?!? Aren’t those loan products evil, and dangerous?!? Oh no, we are doomed!
Don’t panic …
In 2008, these were the reasons we developed a bubble, not the existence of the adjustable rate mortgage:
Credit score requirements were essentially non-existent
Verification of salary, job history, and liquid assets, all of which should have been confirmed by underwriters and processors, were not
Intentionally fraudulent (think — criminal) underwriting was far too common
Down payment requirements were as low as 0% (or even lower in some cases — do you remember the 125% mortgage?!?)
Many loans were interest only
No rate caps during each adjustment period
So when you allow someone with no liquid assets, a shaky job history, and basically no skin in the game to buy a house with a payment that will not only double in a year, but never pay down the debt, then yeah, you have a big problem.
The ARMs of Today
The adjustable rate loan products today look nothing like the adjustable rate products of 2006-2008. Today’s ARMs have realistic rate caps (meaning how much they can rise is limited), less frequent adjustment periods (every 3 years, 5 years or 7 years), and are underwritten to higher standards for income, debt, job history, and down payment.
So don’t worry, the adjustable rate mortgage that will soon reappear will be strategically used by buyers who are making a bet about how long they will live in a home, and not as bait to lure ill-prepared buyers into a ticking time bomb.
And the chart (below) showing homeowner ship rates in the US would seem to corroborate that statement.
The mortgage practices that created the 2008 bubble seem to not be in practice today.
Home Building
I’m worried about Richmond’s home building industry.
Huntt’s Row was a 8 units upscale town home project in Richmond’s Fan District.
Am I worried it is going to crash? No, not at all. I think you might see a little softening at some of the upper price points, but nothing to worry about.
Am I worried about the land developers? Not really, provided they have enough Xanax to deal with the public process that rezoning and development has become. But headaches aside, creating lots right now is not where the danger is (like it was in 2008.)
Then who am I worried about? I am worried about Richmond’s smaller and mid-sized, LOCAL homebuilders right now. They are in trouble if they don’t understand what is coming at them and adjust their business models.
Subs Rule
So imagine you are a subcontractor — bricklayer, carpenter, plumber, roofer, etc. — and you are bidding a job in Richmond for a local homebuilder. You turn on CNN and see Hurricane Harvey flooding out Houston ($200B in damage), followed immediately by Irma ($67B in damage) cruising up the gulf coast of Florida flooding out houses and ripping off roofs. And then a few short months later, you see that California is completely on fire (and still is as we write this article) with entire communities going up in flames instantaneously.
So what do you do? Do you pack up the van and move to Houston, Tampa, or Santa Barbara to set up shop for the next several years while rebuilding beachfront mansions on the insurance company’s dime? Or do you simply add 20 to 30% to your bid knowing that many of your competitors are already on 64W or 85S to do exactly that.
In 2008, when new homebuilding essentially ceased, much of the homebuilding labor pool disappeared. They retired, got other jobs, or simply left the business altogether. So when you combine an already reduced labor pool with a sharp demand increase in extremely affluent markets (i.e. — California / Florida’s gulf coast) destroyed by recent natural disasters, you can imagine the impact not only on the price of labor, but of materials.
The Big Guys Have Arrived
And if a spike in labor and materials is not reason enough to stress, Richmond now is home to two new regional / national homebuilders who bring efficiencies and economies of scale that can suck all of the margins out of a market.
DR Horton, the nations LARGEST homebuilder, and Schell Brothers (only #74 if you are scoring at home, but still an extremely large regional homebuilder), arrived in 2017. Stanley Martin, #57, arrived in 2015, and lets not forget about NVR / Ryan Homes (#4 overall) that has been building in Richmond for decades.
DR Horton closed 41,000 houses in 2016, if you care to know…
The big guys come with unlimited buying power to take control of the available lot inventory, the ability to build models that contain every imaginable option to wow the public, a sales organization designed to hook the buyers with low prices and then upgrade the heck out of ’em, the promise of volume to suck up all of the labor, and engineered floorpans that can be built at significant cost savings.
AND (and this is a big AND), the national builders build fast. When they get rolling, they can produce housing at an incredible rate. When the music stops (and it will, but I still don’t think it is anytime soon), overproduction will impact both the rate and the length of the housing adjustment. So when they decide the time has come to cut prices and unload inventory, their actions can really hurt the smaller guys whose pockets are not nearly as deep.
Local vs. National
When compared to the smaller and mid-sized builders that have traditionally populated Richmond’s building scene, you can see how the future for our local guys will be far more difficult.
In 2018, I think you will see a fundamental shift in power from the 5 to 50 home per year local builder to a 100 unit-per-quarter type publicly traded builder, especially at the middle and upper price points, whose production machine will change the way Richmond builds (and buys) houses.
So while home pricing might be going up and demand is still rising, building costs are rising even faster and competition from extremely well funded large builders is rising as well. Much like the impact WalMart and Target had on local retail, the arrival of the big builders will drive down margins to levels that will make building a very dangerous endeavor for those who lack the ability to build at greatly reduced costs.
And I am not ok with that, if you care to know. Maybe it is the prideful Richmonder in me, but I don’t like the idea of national homebuilders determining our local stock of homes and the Richmond stalwarts getting squeezed.
So What Does it Mean for the Local Guy?
It means being nimble, opportunistic, and above all else, smart.
Going head to head with Ryan, DR Horton or even local behemoths like Eagle or HH Hunt is a no-win game. The new way will be more of a hit and run model, seek opportunity where others are not looking, operating in markets where it is difficult to find scale (think — infill and urban markets!), and/or establishing a specific stylistic niche that will cause clients to seek you out.
Trying to beat a national volume builder with endless capital is like trying to beat a Las Vegas casino — over time, the casino always wins. Their cost of capital, cost of labor and materials, access to lots, and sales infrastructure give them a 10 to 15% baked in advantage — and those advantages are really hard to compete with day in and day out.
The Commercial BOOM
Most of you probably realize that One South is a mixed-use firm that offers residential sales, commercial sales, and development representation, and thus we can speak about the commercial market a bit as well.
From Richmond BizSense’s commercial market round up a few months back. It was a good week, to say the least.
The commercial market is rolling, in case you haven’t heard.
Without going into too much nitty gritty detail, pricing on the commercial side is pretty insane. Cap Rates (which represent the ratio of income to price) have shifted significantly in the past 24 months – about a 2 to 3 point shift – especially for multi-family opportunities.
When Cap Rates shift from 7% to 5%, a property that used to cost $1,000,000, will now trade closer to $1,400,000. That’s no small change.
From REIS, Inc, a real estate data provider. This chart shows nationwide Multi-Family cap rates over 5 years.
Why the Shift?
The reasons are many but what is driving the market as much as anything is an influx of out of town buyers who have been priced out of the larger metropolitan areas (D.C, NYC, Charlotte) looking for deals in Richmond. Richmond’s improving profile and exploding local scene, as well as the insatiable appetite for apartments mostly driven by VCU, has given larger regional and national players in the multi-family scene reason to stop in and buy up our buildings. And when they look at our relative value, they feel excited to pick up properties here that are fully leased, well built, and extremely well located.
So to Summarize
If you made it this far, thanks.
And while we covered a lot, we didn’t even touch on rising rents, the Bus Rapid Transit that has physically destroyed Broad Street, the condo market, college debt, or tax breaks, either!
I guess we’ll save those topics for another day.
But don’t worry! Despite rising pricing, 2008 redux is not on the horizon. The conditions that existed in 2008 do not, I repeat, DO NOT exist currently. (And if you want to dive in deeper to the differences, you can read this article — The B Word, Bubble — that we wrote last year.)
Can pricing continue to rise unabated?
If demand outpaces supply, then yes it can.
Are we seeing some some softness in the suburban new home markets at upper price points? Maybe. But as a whole, the market is still significantly undersupplied.
Furthermore, there is neither a fix for the supply issue (other than building more homes further and further from the urban core) nor a likelihood that the first time homebuyer will give up and stay a tenant. As a matter of a fact, I actually think the buyer supply will increase as more and more millennials decide to become homeowners and the supply problem will get worse before it gets better.
Will interest rates rising make housing more expensive to own and temper prices?
Perhaps, but when our wallets are fat and our confidence high, then we buy, even if our mortgage payments take a little more of our disposable income. I don’t think we will see prices flatten until we see 2 to 3 points of increase in long term mortgage rates.
So if you are getting ready to buy …
Prepare yourself.
It is a highly competitive market, especially if you are looking at urban markets or for quality affordable housing.
If you are thinking of selling …
Make sure to extract the correct terms from your buyer that will allow you to re-purchase comfortably and without undue stress (just ask us how!)
And if you decide to build a new home …
And you are buying it from one of the large builders in Richmond with a flashy showroom and highly skilled upgraders, beware. They are reeeeeallly good at their job.
For what it is worth, the 2017 real estate season was a blur. And we began 2017 on the heels of what we thought was a blur of a season in 2016. Ditto 2015, and 2014 before that.
All About 2017
For each of the past several years, the market has pushed itself upwards at ever increasing rates in terms of both pricing and sales volume.
So what did we see in 2017?
we saw prices rise in most markets rather substantially
we saw transactional volume climb
we saw inventory continue to be at historic lows
we saw new housing starts continue to lag
we saw multiple offers and bidding wars in increasing numbers
But do you know what we didn’t see? We did not see interest rates climb.
As a matter of a fact, they actually fell.
Wait, what?!?
Rates Remained in the 3’s for Much of 2017
Yes, rates DECLINED over the course of 2017.
Despite Janet Yellen’s imminent departure as Chair of the Federal Reserve, the North Korean nuclear threat, BREXIT, Russian election meddling, pending changes in the tax code, low unemployment and a booming stock market, 30 year mortgage pricing actually declined by about 1/2 point from January through November.
Go figure.
See the chart below to see how 30 year mortgage rates tracked over the past 5 years.
You can see the trend — and (at least for now) it isn’t up.
So When Will They Go Up?
Good question and no one really knows — and that includes the Federal Reserve.
Despite the fact that the US economy is on increasingly solid footing with low unemployment and a robust stock market, there is little inflation on the horizon. And for those who maybe slept through their economic classes, inflation (or the expectation of it) is what drives pricing for the long term interest rates.
The chart below shows the inflation expectation in the market and as you can see, it is not on an upward trajectory.
So until the numbers show inflation creeping in, interest rates will stay well below historical norms.
But more on that in a moment.
What Happens When Rates Rise?
So what will happen when rates do rise? Will rising rates stem the tide of price increases? Or will home prices actually begin to decline? Or even worse, will it be 2008 all over again?
No, not likely at all. As a matter of a fact, rising rates might mean housing prices rise, too.
WHAT?!?
Inflation generally occurs when two things happen — the economy is growing AND wages are rising. Right now, despite an economy that is doing fairly well, wages are stagnant, and have been so for some time.
So if the market begins to experience inflation, it means that wages are likely rising, too, and the economy is really starting to heat up. So any negative impact rising rates will be offset by rising wages. Stated differently, the home buying public will not only have the income necessary to cover the rising cost of the mortgage, they are likely to have income in excess of what is required and buy bigger, better and newer housing.
Take a look at the chart below to see how much we are spending on our housing and you can see how much more (in theory) we could be spending on housing before it becomes an issue.
Does that make you feel any better?
Remember the ARM?
Another very important factor is the type of mortgage buyers will choose.
When 30 year mortgage rates rise, buyers tend to migrate into the adjustable rate mortgage products like the 7/23, 3/1, 5/1 and 7/1 ARM’s. ARM products (aka Adjustable Rate Mortgages) offer a mortgage with a fixed rate for a shorter time frame (typically 3, 5 or 7 years) and then begin to adjust based on a predetermined index.
See the chart below to compare. Would you take a 20-25% lower mortgage payment for 5 years of mortgage certainty? Many would, especially if they expect to stay in the home for 5 to 10 years. Think of it this way — why would you pay to have a mortgage rate for 30 years when you are only going to be in the home for a fraction of the time?
In more normal interest rate markets, ARM products can be anywhere from 1 to 3 rate points better, and that is a big enough spread to make people change from the 30 year fixed rate to one of the hybrid products.
So when rates start to climb into the 6’s and 7’s, you can rest assured that many buyers will elect ARM’s that will have start rates in the 4’s and 5’s — keeping affordability similar to where it is now.
Don’t Worry About Rates
Am I saying that prices will continue to climb unabated? No, I am not. Any number of factors could cause an adjustment — but interest rates rising into the 6’s won’t be the cause. As a matter of a fact, most experts feel that house pricing is immune to interest rates even into the middle 7’s — so interest rates can nearly double before buyers will change behavior.
Take a look below at interest rates over the past 50 years to get a sense of how rare this interest rate environment actually is. For those who entered the housing market after the 2008 crash, then all you know is rates below 5%. But for those who have owned housing as far back as the 1980’s or 1990’s, today’s rates seem laughably low.
So if you want to find something to worry about, keep you eye on the economy, tax reform, housing inventory, construction starts, and rent levels (ok, and North Korea) and stop worrying about rising interest rates changing housing’s trajectory.
Jarvis Grandchildren: ‘Grandpa, please tell us a story about the way real estate used to be!’
