Is Recent Home Flipping Activity Warning of a Slowdown in the Market

While most of the country is enjoying an economic boom including housing which may be buoyed by low interest rates an interesting statistic crossed the wires last week: Home flipping in the U.S. has hit its highest rate since 2010*. The 49,000 homes that were flipped in 2019’s first quarter represented 7.2% of the total volume of sales.

Now before the other shoes drops please remember back to 2010, not even a full decade prior. The country was still in the depths of The Great Recession. Terms such as foreclosure, short sale, jingle-mail and so forth were in the daily vernacular of real estate brokers like myself. And many astute fix and flippers saw opportunity i.e. cheap homes, low-interest loans and potential opportunities once the market righted itself.

Ok, the other shoe: Despite the percentage increasing, the actual number of flipped homes fell by 8%, while the number investing in properties to flip declined by 11%. The median sales price of flipped homes was $215,000. With an average profit of $60,000, down $8,000 from a year earlier.

Now there could be many reasons for the down statistics above including lack of inventory, higher costs for materials and labor and so forth.  Yet let’s dive in a little deeper……

*Just over 49,000 single-family homes and condos were flipped in the first quarter of 2019; according to a recent report by real estate data firm Attom Data Solutions.

These homes comprised 7.2% of all home sales nationwide during that time period, representing the highest home-flipping rate since the first quarter of 2010. However do not consider this an indicator that the market is all peaches and cream…..

The number of homes that were flipped was actually down 8% from the previous year to a three-year low. And the number of investors engaging in home flipping has dropped 11% over the past year. Add to this the gross flipping profit was $60,000, down $8,000 from a year earlier to a three-year low. The take-away while home-flipping activity is increasing gross profit and Return on Investment (ROI) is decreasing.

Some brokers who work in this niche of the market are wondering if investors/fix & flippers are watching as their profit margins drop, time on the market increasing i.e. longer time on the market, most costly to hold have decided to sell now with the assumption that demand and thus prices will continue to weaken.

What is interesting as I noted a few weeks ago interest rates are at 18 month lows YET housing activity for which we are in what is historically the most active season is not increasing.

I have three additional comments concerning what I believe will be a soon to be upon us slowing market and one that may actually witness price drops.

First is the cooling of the luxury market across the country. In NYC we have witnessed a glut of luxury condos coming on the market and buyers sitting on their hands. Not only in New York City but also in Miami and throughout the country. Of note the first signs of positive indicators concerning climbing out from The Great Recession was the astute buyers acquiring luxury homes usually for cash that had been severely discounted.

Second is the influx of the iBuyers, the tech firms using algorithms to make instant home offers are proliferating across the country. Zillow in particular, has said it is investing more money into its home-buying and flipping operation, Zillow Offers, which launched last year. Yet here in Denver so far the short-term iBuyers have not been so successful. The following articles from BusinessDen are most insightful:

Third is the proliferation of the reduced fee brokerage signs I am witnessing and new entries into the market i.e. Rex Real Estate and others. The proliferation of signs from Redfin, Trelora and others may suggest strength in the market i.e. go the lower-cost option as the market is strong. I see the opposite i.e. as the market weakens and profit margins retreat sellers may opt for a lower-cost brokerage option to increase their already shrinking margins.

As many readers of my blog know we have been looking for out next home as well. In discussion with our financial planner we have decided to put that on hold for the immediate future as prices seem inflated and shorter-term upside seems limited. Yes we are long-term owners and can take advantage of low interest rates. However historically low-interest rates are indicative of a market needing a growth catalyst, thus personally I believe there are better options for our capital concerning the immediate future.

Of note I am not sure if I will be posting on Monday July 1st, 2019, may actually take a few days of personal time off.

 

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Unconventional Mortgages My Thoughts

Even though housing sales seem to be slowing throughout the country there is still an affordability crisis as asking prices have yet to adjust downward and while interest rates have stabilized (over the past 48 years, interest rates on the 30-year fixed-rate mortgage have ranged from as high as 18.63% in 1981 to as low as 3.31% in 2012) they are higher than the historical lows a few years back. The following bullet points were presented at a conference concerning the increase in unconventional mortgages; as a 2+decade broker having been through multiple market cycles, my thoughts in italics:

Unconventional mortgages–once blamed for contributing to the housing meltdown 10 years ago–are making a comeback as lenders look for new borrowers to drive growth, the Wall Street Journal reports. The reality is when interest rates rise there must be products available to allow for home ownership. These unconventional mortgages generally bring down the monthly payment and thus presented as a gateway to home ownership. Yet historically such mortgages prior to The Great Recession were oriented to more experienced and sophisticated purchasers. Many of these unconventional mortgages can impact the borrower if home prices stagnate or fall i.e. loss of equity, monthly payments can increase i.e. adjustable rate, interest-only can lead to negative equity in a down market and so forth.

The borrowers are typically people who can’t get a conventional mortgage because they have a harder time proving income through the usual documentation such as pay stubs or tax forms. This is the new reality of the gig economy as the generation of long-term stable employment ending with retirement and a pension is long gone. The reality is mortgage lenders and regulators must understand the reality and present options and opportunities for such applicants. Personally I am old school i.e. the higher the risk or less documentation should require a higher down-payment to insure equity as a hedge against default, a simple risk analysis calculation.

Though still a tiny part of the overall mortgage market, these unconventional mortgages offerings are increasing while conventional home loans are decreasing. Not unexpected as by human nature we are chasing the least painful mortgage, the lowest monthly payment. However are we sacrificing prudent financial management i.e. a 30-yr fixed rate conventional loan in which the payments remain static for more exotic products which may look attractive for the immediate term yet detrimental long-term i.e. adjustable rate mortgages in a climbing interest rate environment? 

Lenders originated $34B of unconventional mortgages in the first three quarters of 2018, up 24% Y/Y, according to Inside Mortgage Finance. Overall mortgage originations during that time were $1.3T, down 1.2% Y/Y. Multiple factors at play from the higher-cost of housing to the wealth-effect of the equities market to the basic desires for the lowest monthly payment possible. 

Today’s “nonqualified” mortgages, though, have changed from their pre-crisis predecessors. These new loans comply with “ability-to-repay” rules and underwriting and due diligence are stronger than the pre-crisis era. This is a positive including review of bank statements and related documents. I believe the era of No-Doc Loans are long behind us however I am already witnessing low to no down-payment options, When we have the return of the 125% loan that’s when I start placing short bets on the mortgage marketplace. 

Some regulators, consumer advocates and others still worry that the growth for this type of mortgage and increasing competition to make such loans could lead to higher risks for the housing market. This is a given; history does in-fact repeat itself as if anyone says This Time is Different keep that look of skepticism discreet.

On a personal note when I am working with buyers and if requested I provide a list of at minimum three (3) lenders I know professionally and socially and suggest they contact all three to discuss options and opportunities coupled with additional guidance concerning their future i.e. how long do they plan to be in the home, lifestyle changes on the horizon, employment security and so forth. The reality is a mortgage and one’s home is the largest debt as well as potential wealth accumulation we will have in our life cycles; we need to be more diligent concerning mortgage products and candid about the advantages and disadvantages associated with the options presented. 

Month over Month showing Weakness

Late last week I posted a screenshot of the November 2018 sales statistics for Metro Denver. While the state economists today suggested 2019 should be a positive year for Colorado’s economy concerning job and wage growth across all sectors with a mild slowing;  the housing market may be advising differently.

Let me preface we have headwinds. While Denver may trail Seattle, San Francisco and Las Vegas concerning year-over-year price appreciation in percentage terms let us face the following realities locally and regionally:

  • Our housing market did not go into a free-fall unlike Las Vegas and Phoenix.
  • We have been in a 5+-year expansion concerning housing prices.
  • Wages are not keeping up with housing costs in Metro Denver.
  • New construction did not keep up with demand over the last 5 years.
  • Our economy is not Seattle and San Francisco nor is our population as noted below or geography i.e. available hinterlands versus coastal (Statistics from varied sources including Federal and Regional Census Data):

San Francisco:

  • Metro Population: San Francisco–Oakland–Hayward MSA: 4,335,400
  • San Jose–Sunnyvale–Santa Clara MSA: 1,837,000
  • Average Income: $96,600 / $110,000

Seattle:

  • Metro Population: Seattle–Tacoma–Bellevue, WA MSA: 3,867,000
  • Average Income: $78,612

Denver:

  • The 12-county Denver-Aurora-Boulder Combined SA: .3,150,000
  • Average Income: $71,926

In general housing costs in San Francisco and Seattle are more expensive then Denver HOWEVER their average incomes are higher and by geography their ability to expand and build outward is limited.

While housing prices in metro Denver were on what seemed like an exponential trajectory I have suggested prior and statistics may be validating we peaked a few months back. While sales prices continue to climb, inventory is increasing, days on market are increasing and eventually prices may begin to adjust downward or keep with inflation and not show oversized gains.

The November 2018 #’s are interesting and showing an impressive gain on a year-to-year basis and while month-over-month does not show a trend I suggest the real estate market is looking outward and showing some hesitation similar to how the stock market projects out 6-12 months.

What will be interesting in to see what November 2019 stats show. My gut is we will see prices either static or lower. Inventory will be higher and days on market will also increase.

This is not necessarily negative, as markets should over time trend back towards normalcy. For too many years we have been in a seller market and it is time to move back to equilibrium of sorts.  In high-end neighborhoods there seems to be a glut of expensive homes waiting a buyer or rental signs as owners wait our the market conditions. While there continues to be some blockbuster sales they are more of an anomaly versus weekly updates. Two recent high profiles sales in Cherry Creek North and Belcaro were to out-of-state buyers relocating as part of VF Corp. relocation to Denver.

My concern is for our local and regional population of move up and move down buyers. At present 1sttime homebuyers continue to be challenged in the market and even as prices may be stabilizing; interest rate increases negate the opportunity of lower pricing.

Move-up buyers are being challenged in finding suitable inventory. This is worrisome as families outgrow their first home or desire more space find inventory challenged in central Denver and will migrate to the suburbs/exurbs or worse leave the state. Move-down buyers those who may be downsizing can take advantage of the sellers market HOWEVER again their inventory for replacement is challenged and thus may consider regional relocation or out of state.

As a 20+year broker in Denver as mentioned prior I have been through these cycles including:

  • 1987-89: Downturn
  • 1991-1995: Upswing
  • 1996-2001: Pricing matching inflation
  • 2002-2006: Irrational Exuberance
  • 2007-2012: Downturn, depths of Great Recession and Foreclosure Crisis
  • 2013-Present: Upswing potential leveling off

While I am not predicting a severe downtown I would not be surprised to see a 5%-10% correct concerning housing prices over the next year across Metro Denver. I believe there are segments i.e. the luxury housing niche i.e. $750K and above that will see more severe adjustments.

Let’s just use this blog posting as an opportunity to revisit in one year.

Taking a Loss on Real Estate it Happens

With the run-up in real estate prices in Metro Denver since The Great Recession we are finally witnessing the cooling of the market memorialized in the New York Times a few weeks ago in an article titled: Housing Market Slows, as Rising Prices outpace Wages.

While those sellers who have owned their residences for over 3 years are probably fine with selling and gaining  a small profit; over the past few months I have written about a few residential sales which has actually taken a loss via actual recorded sales price and additional losses when factoring in commission and of course inflation which seems to rarely be factored into the transaction.

In the present environment of housing prices adjusting downward, interest rates continuing to increase and signs of instability in the equities markets those taking losses on their residences may become more commonplace depending when they purchased and how motivated they are to sell.

Of note in general a loss on the sale of a home is NOT deductible on one’s income tax. In general a loss concerning real estate is only deductible when the property has been used for business or investment purposes. One tip if a loss may be forthcoming consider turning the residence into a rental and then sell; the property is now considered related to investment. Of course one would need to consult with their professional tax advisor or financial planner to ascertain the legality and proper filing but this is an option.

I predict we will start seeing some losses on homes in the Denver Metro area that had been purchased within the last 12-36 months when the market seems unstoppable concerning price appreciation coupled with historically low interest rates. While it may seem counterintuitive when the employment market is at its zenith that housing should be lagging yet that is generally how the market behaves. This is partially due to interest rate impacts, inflation eroding the value of money and other factors. This is not a new phenomenon; happens with every business cycle. This is why longer-term holds on housing usually generates a hedge against inflation but the key is long-term i.e. 7,10, 20 years out. A few examples if I may including my personal residence.

Two years ago (April 2016) I sold my personal residence for $535,000. The net after commission and closing costs was $520,000 (and no I did not pay myself a commission).

I purchased the house in October 1989 for $140,000 or $266,692 in inflation dollars. Thus my actual net gain was $253,308….no I am not complaining. On a monthly basis I made about $800 +/- and when factoring in taxes, maintenance, upkeep…..lets just say I had a house over my head.

Now when I bought the house in 1989 the Denver housing market was in a deep regional recession two years post Wall Street Crash of 1987. The seller of the house actually bought the residence in 1984 for $200,000 from the developer, another high-point of real estate in Denver that decade, here are the inflation adjusted #’s:

  • 1984: $200,000 (or $238,566 in 1989 Dollars)
  • 1989: $140,000

Thus not including commissions in real dollars the seller not only took a $60,000 loss from his purchase to the sale in 5 years, when factoring in inflation i.e. $38,566 and commission (6% at $140,000 = $8,400) the seller lost $45,000+ or almost a quarter of the value of his home in that 5 year period and the loss was not deductible.

As mentioned I sold the house in April 2016 for $535,000.

The buyers actually resold the house in June 2017 for $560,000 due to a relocation thus even after commissions and closing costs they did OK. From what I understand the new owners plan to reside long-term and thus are somewhat insulated from the pending adjustments in housing prices I believe will be headwinds in the near future.

Denver is not unique in this situation. In New York where I also hold a license there was a major loss on a truly trophy condominium apartment as follows:

The single biggest sale last month (September 2018), at $42 million, was a penthouse covering the entire 77th floor of One57, the vitreous skyscraper in the heart of Manhattan’s Billionaires’ Row, at 157 West 57th Street. Monthly carrying charges are $15,214. The unnamed European seller took a loss, however, having paid nearly $47.8 million for the unit in May 2015. The 6,240-square-foot apartment has four bedrooms and five and a half baths, not to mention breathtaking views.

While a $6M loss is painful when you consider the apartments were delivered with interiors unfinished, at that price-point you bring in your own designers and architects which can easily add $500,000 to $1M+ in finishes AND the monthly carrying charges i.e. HOA fees ranging increasing from $12,500/month to $15,214 at the time of sale that is over $150,000 annually just in common charges or another $500,000 paid during ownership. Thus all losses are relative; as we say on Wall Street you will never sell at the high and buy on the bottom.

A house is a home and should not necessarily be considered an investment or a hedge against inflation, it is shelter first and foremost.

Denver weather chills as does the real estate market and my visit to Hong Kong

While some brokers continue to suggest the recent slowdown in sales and significant and immediate price reductions is seasonal (and they may be correct) a few outlets are advising the slowdown in the market may be more serious. An article from The New York Times titled  Housing Market Slows as Rising Prices Outpace Wages provided their national and international readership with an interesting overview of Denver which is not flattering. Even during my recent trip to Hong Kong more than one person when realizing I reside in Denver mentioned the article.

Related according to the monthly report from the Denver Metro Association of RealtorsIn September (2018), housing inventory continued to move higher, even though it typically decreases this time of year, and home prices dropped nearly 5 percent since its record-peak highs this past May and June. Good for prospective buyers not necessarily welcome news for sellers.

Some of my readers have advised privately that I am a pessimist as I have been advising a downturn or the moving towards a more stable market. I do not consider myself a pessimist; more a realist. With 20+ years as a broker literally been there and gone through that. While I too have been impressed with the most recent expansion post The Great Recession I have been concerned about headwinds in the market from out-migration to increasing interest rates to incomes lagging housing price appreciation.

On the lighter side Hong Kong was as usual a frenetic, dynamic city which continues to be considered the most expensive housing market in the world. If you are feeling cramped in your residence or being priced out of the local market, the following quote excerpted from an article concerning a participant in the government sponsored Hong Kong housing lottery may change your prospective.  As published in The South China Morning Post

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(Above a housing block in the Quarry Bay neighborhood on Hong Kong Island)

“Feng Xinmei, a 46-year-old part-time construction worker, said she, her husband, two children and mother-in-law rented a 200 sq. ft. subdivided flat for HK $8,000 a month.

To place this in prospective, a undivided flat means the 200 sq. ft. Ms. Feng rents is part of another apartment. Their rent in US Dollars is $1,021/month. The average hotel room in the United States is 325 sq. ft. or 125 sq. ft. larger than the living space for this family of 5!

While I have in general been against the concept of slot homes due to its impact on the existing urban fabric of traditionally single-family and duplex neighborhoods; all of a sudden Hong Kong makes such density look palatable even preferable.

 

Charting the Market in One Property over the Past 5 years the Trend says Caution

Per my past blogs I am not providing the address of the following (I can advise within 1 block of King Soopers and adjacent neighborhood retail) I am using this listing as an indicator of the market and possible predictor of the near future. The residence is a historic 1/2 duplex, part of a grouping of townhomes dating to c. 1908 located in a desirable central Denver neighborhood yet addressed and fronting on a busier one-way Avenue.

With 3 bedrooms, multiple levels, approximately 1,800 SF finished square feet, reserved parking and low HOA/taxes an attractive listing and opportunity for the correct buyer. Personally as a prospective buyer and real estate broker I see challenges from being semi-detached i.e. sharing a common wall to the frontage on a busier roadway to reserved yet uncovered parking but this is the logical side of me.

I decided to look at the history of this listing as I pass it almost daily on my commute from Cherry Creek North to Downtown Denver.

The residence first came on the market as follows listed with a full-service brokerage offering a 2.8% co-op:

  • 7/9/13:          Initial Price:               $360,000
  • 7/9/13:          Price Increase:           $375,000
  • 7/11/13:        Goes Under Contract
  • 8/2/13:          Sold and Closed:        $375,000

The same unit enters the market again with a full-service brokerage offering a 2.8% co-op as follows:

  • 7/13/16:       Initial Price:               $585,000
  • 7/21/16:       Price Reduction:        $574,900
  • 9/11/16:       Listing Expires

Five (5) days later the listing reappears with a different full-service broker and brokerage firm offering a 2.8% co-op yet $35,000 lower asking.

  • 9/16/16:       Initial Price:               $535,000
  • 9/26/16:       Goes Under Contract
  • 11/21/16:     Sold and Closed:        $536,000

Thus the seller who purchased in 8/13 for $375,000 has sold 3 years later for $536,000 or $161,000 gross profit in excess of 40% before commissions, fees and closing costs. Over three (3) years an attractive return coupled with being a nice abode.

Now fast forward to June 2018 or just shy of 18 months after the last purchase. The unit is placed on the market with a fixed fee brokerage and offering a co-op of 2.5%

  • 6/7/18:         Initial Price:               $590,000
  • 6/23/18:       Price Reduction:        $585,000
  • 8/11/18:       Price Reduction:        $575,000
  • 8/30/18:       Listing Expired

If the seller above did sell for $575,000; their gross profit would be $39,000. After the fixed fee commission and the 2.5% co-op to the selling broker AKA the buyer broker their net profit would be approximately $22,000 before closing costs and Title Insurance. Not to shabby for 18 months, basically generating $1,200/month in profit HOWEVER, the unit did not sell.

The unit has been placed back on the market as follows with a full service broker (a firm/broker/team that is quite well-respected and knowledgeable) and a co-op of 2.5%.

  • 9/14/18:       Initial Price:               $575,000

Now let’s assume with the new broker/brokerage and the co-op, let’s assume 5% of the closing purchase price. My gut says the unit will close between $545,000 and $555,000. Let’s see what the net is after commission of 5% sans closing costs and Title Insurance:

  • At $575,000 – 5%($28,750) = $546,250
  • At $567,500 – 5%($28,375) = $539,125
  • At $560,000 – 5%($28,000) = $532,000
  • At $553,500 – 5%($27,675) = $525,825
  • At $545,000 – 5%($27,250) = $517,750

Thus not even considering inflation which is now evident or the Time Value of Money, unless this sellers assuming a 5% commission structure transacts at $565,000 or above a strong possibility of actual net loss over the last 18 months.

I understand the initial listing with a fixed rate brokerage as in a strong sellers market there is this assumption that all full-service brokers due it place in MLS and other distribution channels and wait for the phone to ring. I with 3 decades as a broker can attest this is far from reality, however the perception continues.

Yet consider this, while listed with the fixed price brokerage for three months the seller  I assume was paying on a mortgage, thus those 3 months of payments are not coming back and doubtful much impact towards principal. With the new listing I would not be surprised to see reductions before the end of September.

Granted there may be new prospective buyers who have not seen the listing prior. Yet with continued forecasted interest rate hikes and a general slowing of demand, whether seasonal or I assume more indicative due to a lack of demand I would be surprised if the unit sells at the asking of $575,000.

Again my gut advises the unit will sell for between $545,000 and $555,000 assuming no Fall Surprise in the equity markets; not much more than when sold two years prior and if factoring in closing costs and inflation, an actual monetary loss. Will keep all posted.

 

A Broker Makes a Rational Offer for his Future Residence the Results

My wife and I have been looking for a home (for followers of my blog we sold our primary residence of just shy of 30 years back in April 2017). We have kept our eye on a listing in one of Denver’s most desirable and stable (concerning values over the long-term) neighborhoods. The home we expressed interest in is small (similar houses have been expanded), requires updating to present code including electrical, no garage and the basement shows evidence of past and more recent water damage.  Coupled with all the above information the most recent index by Beracha, Hardin & Johnson Buy vs. Rent Index suggests we would be better of renting than purchasing at present yet as brokers we too sometimes operate on emotion and we are looking longer-term.

While the index does somewhat influence my decision; being a logical broker I conducted my due diligence concerning comparable properties in the same block on the same side of the street. I went back a few years and extrapolated the comparable’s using an inflation calculator to justify our offer.

While I will not disclose the address, the asking based on above grade SF is approximately $625 Per Square Foot (PSF). The comparable properties all have similar lot size and as mentioned on the same side of the street on the same block:

  • Comp 1: Sold – 3/2018:

Sold for $459/PSF Above Grade

Inflation Factor: N/A

-This home is in meticulous shape including the architecturally designed addition on the rear with the expanded kitchen, family room with fireplace, 2-car garage and professionally landscaped front, rear and side.

  • Comp 2: Sold -10/2017

Sold for $417/PSF Above Grade

Inflation Factor: $429 PSF Above Grade

-While I have not seen the inside except from the exterior new lighting, new windows, architect-designed extensions on the rear, garage parking to match. It is a duplex and both sides sold together as one structure. Each 1/2 of the duplex has 3 bedrooms and 2.5 bathrooms, larger than the subject property.

  • Comp 3: Sold – 6/2017

Sold for $532/PSF Above Grade

Inflation Factor: $546 PSF Above Grade

-While used as a pied-a-terre the interior condition is similar. The kitchen was outdated however larger space, has a garage and deep south setback with a lot that is 1,000+ SF larger than subject property.

  • Comp 4: Sold – 7/2015

Sold for $395 PSF

Inflation Factor: $420 PSF Above Grade

The house is very similar to Comp 1 (next door) yet narrower lot and smaller size overall. Excellent design and layout. The rear and upper extension were beautifully designed and executed with functionality i.e. den w/ fireplace, expanded kitchen with breakfast area, 2 car garage made of brick to match the historic urban fabric coupled with a professionally landscaped yard.

Thus concerning the comparable properties using 2018 dollars the prices per square foot above grade range from $420 to $546. While 4 homes do not make a proper statistical average would be $463.50 PSF based on inflation with the $546/PSF sale skewing the average upward do to limited sample size. Of note the Median is $444/PSF.

Many of my peer brokers believe the peak of the market was 6-12 months prior as prices are beginning to slip, inventory is increasing coupled with rising mortgage interest rates.

Based on the $463 PSF average noted the house we made the offer upon should be priced at approximately $625,000 which may even be somewhat aggressive as the comparables are homes that have been extensively renovated or updated and all include alley access garages.

We offered $560 PSF or 20% above the comparable properties identified on a PSF basis.

Our offer was promptly rejected as the seller is asking $625 PSF.

While no fault of the out-of-state seller if /when the residence goes under contract and assuming there is an appraisal there may be a rude awakening. We could have offered full price and use the appraisal and inspection contingencies to eventually close at a lower market oriented price; however that is not our method of operation.

We made a viable offer, provided statistical pricing guidance and was subsequently rejected based on I assume emotion and/or irrational exuberance concerning valuation. I have been incorrect before and the residence may actually sell for asking (of note at present on the market almost two months and one price reduction to date); on this one we like it (we do not love it) however we willing to wait it out or pass altogether as inventory increases and pricing pressures are forecast to be in our (buyers) favor.

 

Denver Real Estate Market seems to be slowing yet irrational exuberance has not been tempered just yet

Preparing for the Next Cycle

Earlier this week REColorado AKA our Multilist service advised of a “Summer Cooldown” in Metro Denver. Anecdotally we are witnessing an increase in available inventory, longer periods between on market to under contract and pricing that seems to be adjusting to the new reality of lessening demand coupled with higher interest rates.

Thus I was amused to see a new listing in my neighborhood of Cherry Creek, which seems to defy conventional logic. I am not the broker, I am not the owner/seller and I have no idea what the motivation or rationale concerning pricing is HOWEVER I will keep an eye on this one just for my own edification.

While I will not disclose the exact address, the residence is within the 300 block just north of the Business Improvement District aka Cherry Creek North. Many could consider this block prime (I am mixed as it has a concentration of condominiums, curb-cuts and cut-through traffic but I am also trained as an urban planner thus I see what many prospective buyers do not).  Thus owners are literally a few hundred yards away from a wine bar, artisanal coffee, restaurants and so forth. Thus true urban lifestyle with a suburban design and space.

Concerning pricing, here is the history of the residence:

  • February 1999:         Sold for $620,000/$146 PSF ($937,837 in 2018)
  • May 2006:                 Sold for $950,000/$223  ($1,187,527 in 2018)
  • -Of note top of the market, yet good for the seller, 53% gain in 7 years.

 

  • October 2015:           On market for $1,595,000/$376PSF ($1,695,868 in 2018)
  • Did Not Sell: if sold would be a 68% increase over the last sale at the top of the market during the last up-cycle.

 

  • November 2015:       Price reduced to $1,495,000/$352PSF ($1,589,544 in 2018)
  • -Did Not Sell
  • July 2018:                  Place on market for $1,650,000/$388PSF

At $1,650,000 I wish the sellers the best of success. If they are indeed successful selling at asking they will have matched inflation, which is commendable considering, they purchased at the top of the market. Of course when factoring in upkeep, taxes, interest on the mortgage and so forth the calculus changes however they have also had a roof over their heads.

Just for fun I compared the returns above against the S&P 500 with dividend reinvest and not considering inflation, just in real dollars:

Between February 1999 and May 2006

  • The residence appreciated 223%
  • The S&P 500 appreciated 15.5%

Thus residential real estate was the way to invest over those years.

Between May 2006 and June 2018 (most recent S&P Calculator month)

  • The residence (assuming a sale at asking) appreciated 75%
  • The S&P 500 appreciated 172%

During the post Great Recession period we have witnessed the values of real estate and equities rise in tandem. Based in the period from 1999 to 2006 real estate was the better investment. Yet from the Great Recession to today we have witnessed equities and real estate both escalate in tandem. While I am not an economist some would argue bubbles are forming or have formed.

In a Continuing Education class this past week we were collectively discussing the return of non-conforming loans; the ones that brought on the last recession i.e. non-income verification, low or no money down mortgages and other exotic mortgage vehicles. Granted most mortgages are repackaged and sold to investors through various channels.

With interest rates going up and inflation a distinct possibility not to mention trade wars, currency issues (see the Turkish Lira) and investors chasing more aggressive returns…..my advice, sit on the sidelines or better hedge and buckle your seat belts as the old adage goes History Repeats Itself and we all have short memories.

 

 

 

 

Why One in Three Millennials may be making a serious mistake when purchasing a home

It was not so long ago when one purchased a home with the rationale of not only having a roof over’s one head but also a vehicle to keep up with and even better beat inflation and have enjoy some added tax deduction benefits.

While the above value concept may have been eroding for some time:

  • Assuming a residence can only increase in value (the Great Recession shattered that myth).
  • Using equity in one’s residence as leverage (the House as Personal ATM).
  • Limitations on the deductibility concerning real estate taxes.

As a broker I completely understand the desire for a home purchase especially when we see markets with low inventory and continued historically low-interest rates. Yet are Millennials setting themselves up for future challenges?

Yes most millennials went through the Great Recession and while experienced may not have been in the workforce or owned a residence. They may not have witnessed the job losses, foreclosures and the evaporation of paper wealth over that period. While the economy has come roaring back (even though I question the longevity of this bull market) as I always advise past performance is not indicative of future returns.

This is why a recent survey from The Bank of the West truly concerns me as follows:  “The fact that nearly one in three millennials who already own their homes have dipped into their retirement nest eggs to finance their down payment is alarming. With careful financial planning, millennials can have it all – the dream home today, without compromising their retirement security tomorrow.” Ryan Bailey, Head of the Retail Banking Group at Bank of the West.

Basic reality; a mortgage is debt, plan and simple. While a long-term mortgage with a low monthly payment and a fixed interest rate may be attractive and definitely can be a hedge in an inflationary environment, it is still debt.

Yes the mortgage payment may in fact be less than comparable rent (yet did the buyer factor in the down-payment).

While there are tax advantages including mortgage interest and real estate tax deductions, are the benefits truly appreciable concerning one’s income? The debt to income ratio can be an eye-opener.

Unlike retirement investing which is usually liquid and easily revised depending on market conditions, a residence is truly illiquid and can incur major costs when trying to sell i.e. commissions, preparation to sell and so forth.

Home ownership can be a foundation for a lifetime. This is not necessarily a positive attribute. What happens if the homeowner decides to entertain an employment opportunity elsewhere? What if the market during that time is a buyer’s market?  What if market rent would NOT cover the monthly PITI? In such scenarios one may be losing precious investment opportunities while covering the monthly payment coupled with an inflation reduced asset.

Mortgages do provide leverage and equity via one’s down-payment HOWEVER during the recession the terms negative equity, short-sales and foreclosures entered the vernacular and unfortunately we all have collective short-memories. Just last week I viewed a home on S. Monaco in the Southmoor neighborhood. While needing some cosmetic updates the home is in good condition and state of repair. Lowest priced home in the area concerning both asking and on a PSF basis. The asking $475,000 yet this is a short-sale with a loan balance of $515,000. Yes in the present sellers market a short-sale!

In addition to all of the above what concerns me locally here in Denver is the type and location of residences millennial’s are purchasing. I am seeing a proliferation of townhouse style residences as well as condos and similar attached multi-family construction in all the most desirable neighborhoods i.e. Golden Triangle, LoHi, Highlands, Sloans Lake and others. Concerning affordable, think again, many are $500K+ some pushing 7 figures. Yet I am seeing younger buyers purchasing with the assumption that 1) housing will continue to appreciate,  2) they plan to live in or potentially rent if they move or lifestyle change and 3) using monies allocated for retirement and/or using family capital to assist in purchase with the belief that inflation coupled with low mortgage loan rates is a winning combination.

While these new homes are beautiful and contemporary and perfect for the single or young DINK (dual-income no kids) couple; lifestyles change. Are these buyers considering children in the future? Are the local schools the caliber they desire for their offspring? Is there a risk of a glut in the area when the market adjusts course? How deep is the rental market for their unit style? Will rent cover their PITI?

I recently worked with a couple and this was their course concerning home ownership over the past decade and my forecast for their future:

  • Years 1-4: First Purchase: Smaller Home in West Washington Park
  • Years 4-8: Sold West Washington Park Home. Purchased in Stapleton as one child heading to elementary school and another on the way.
  • Year 10: Sold out of Stapleton, purchased in Littleton, house triple the size of Denver and large lot, literally 1/2 the cost of anything within 8 miles of downtown, more attractive school system yet more challenging commute (both work in downtown) however easy access to light-rail and Santa Fe Drive.
  • ————————————————————-
  • Year 10-15: Forecast – Will stay in Littleton until youngest goes off to college.
  • Year 16: Forecast – Sell Littleton home, move to Cherry Creek North.

I am a firm believe one’s first home can be a great foundation for future success from lifestyle to investing. However I also feel one’s first home should not be over-extended i.e. live within one’s means, consider allocating some housing expenditures to the equities market to take advantage of compound interest and if planning so change jobs, careers, locations be realistic as if changes are happening in 3-5 years the potential loss of equity concerning one’s home can happen. Ask all the buyers in 2006 which sold between 2008 and 2013…..

 

$60,500 in 2014 sold for $199,000 in 2018 Would You Take That Return

Compelling yes; however what about the person who purchased in 1998 and 10 years later lost the unit to foreclosure.

Earlier this week I closed the seller-side of a condo at Monaco Place in SE Denver.  From a previous blog post I suggested this complex represented the Denver Real Estate Market of the past decade.

This is a complex with a stellar location i.e. 1 block east of I-25 and Hampden Avenue. Excellent walk score, units ranging from 1-2 bedrooms in various configurations. Ample open areas professionally landscaped. Amenities include an indoor pool, workout facility and the HOA provides both heat and air-conditioning.

The complex was built in the early to mid 1970’s. Stacked 2-3 stories most units included wood burning fireplaces. Top floor units have vaulted ceilings. There are communal washers/dryers and some units have stackable units installed.  Each unit comes with one deeded carport parking space and guest parking is ample. The units did fall on hard times from decay of the exteriors to investment units outnumbering owner-occupied (of note at present 63% owner-occupied and climbing).

Thus the unit I am going to profile I believe represents the Denver market and may be an indicator of where the market is going. Spoiler alert, softening yet not a crash landing.

Being respectful of the seller and buyer I will not disclose the actual address and unit #. I can advise the unit is a 2BD/1.75BA top floor condo. My seller during his tenure did various cosmetic and mechanical upgrades totaling approximately $15,000 over his time of ownership during which time the unit was rented.

Based on Denver Assessor Office Records:

  • 9/30/98:       Purchased for $59,000
    •            -$91,210 in today’s dollars
  • 7/9/08           Foreclosed upon by Bank of New York
  • 9/5/08           Placed on market by Bank of New York asking $29,500
    •                -$34, 526 in today’s dollars
  • 10/30/08      Unit sells and closes for $36,375
    •             -$42,573 in today’s dollars
  • 2/14/14        Placed on market for $69,000
  • 2/24/14        Sold for $60,500
    •            -$64,400 in today’s dollars
  • 6/6/18           Placed on market for $209,900
    •             – Asking based on comps selling for $209-$216 within prior 3 month
  • 6/17/18        Asking reduced to $199,000
    •             -Prior week 4 showings no offer
  • 7/23/18        Sold for $199,000 minus $3,000 Concession
    •            Net Sale $196,000

Thus looking at the history, the 10 years between 1998 and 2008 were not kind to the owner of this unit including a foreclosure during the Great Recession.

The next owner did well i.e. in 6 years of ownership enjoyed a gain of $24,000 or $4,000/year equity appreciation. Of note the seller was attending college in the area, thus owning not only comparable to rent yet also enjoyed equity appreciation of $4,000/year.

However my seller literally knocked it out of the ballpark with a gain of $135,500!

In addition to the rental income i.e. $1,200/month – HOA fees of approximately $450/month, my seller was netting $750/month on his initial $60,500 investment.

Over the 4 years and 3 months of ownership:

  • Initial Investment     ($60,500)
  • Net Rental Income    $38,250
  • Upkeep and Maint.   ($15,000)

Thus just from rental income over the 4 years 3 months of ownership my seller netted literally half his initial investment.

And he sold the unit for $196,000 after seller concession.

Thus once calculating all the numbers, his net gain over the 4 years and 3 months excluding commissions:

$158,750 or a staggering $3,100/month during his ownership tenure.

My view is a follows:

  • Such gains will NOT be replicated for the foreseeable future if ever.
  • When we priced at $209,900 was based on market, had to reduce to $199K to sell.
  • Market may be softening due to higher yet still historically low interest rates.
  • Rents seem to be retreating coupled with additional inventory.

At $199K w/ 30 year fixed including HOA and taxes comparable rent i.e. similar unit asking $1,495/month. Factor in tax benefits and potential equity appreciation still an attractive opportunity for the buyer.

While I am not an economic forecaster I do believe within the next few years we will witness a softening of the market in real estate coupled with the potential of a mild recession. Further out I am more concerned with another Great Recession or potential Depression gripping the world economy around 2030.

My prediction is based on economic cycles, tax cuts which will balloon our deficit, rising interest rates worldwide to tame potential inflation, higher oil and overall commodity prices and I have not even considered the potential impacts of a trade war waged with tariffs.

BTW: I am not alone in my thinking: Dr. Alan Beaulieu, President of ITR Economics

The following article is great reading: 2019 Recession/2030 Depression