Why Continued Positive Comments About the Housing Market Scare Me

As a broker I make my living assisting clients purchasing and divesting of their real estate holdings. In this market of ever seemingly positive news I should be thrilled. Yet as a 20+-year broker licensed in two states I have some serious concerns on the macro level, which truly reverberates beyond home sale statistics.

At present the Denver market as well as the US market looks very healthy. Demand is high, employment and wages are growing, and mortgage rates are low.

However based on reports out this past week, if one reads between the numbers and taking into account history and growth trends, the market is quite challenged. Not at present but longer term we may be setting ourselves up for a dramatic shift in the economy and wealth accumulation.

There is continued strength in the overall national housing market with prices 6% higher than the same period one year ago. Some local markets continue to show double-digit growth in prices. Metro Denver’s year over year was 7.9%. Such numbers are driven by the simple law of supply and demand and specifically the limited supply at the lower end of the market. Thus lower end homes are witnessing significant price appreciation due to more competition while higher end listings are languishing or having price reductions (see my last blog).

While I have mixed feelings on Zillow and similar sites, their insights and digesting of data is always an interesting read: “It sets up a situation in which the housing market looks largely healthy from a 50,000-foot view, but on the ground, the situation is much different, especially for younger, first-time buyers and/or buyers of more modest means,” wrote Svenja Gudell, chief economist at Zillow in a response to the latest home-price data. “Supply is low in general, but half of what is available to buy is priced in the top one-third of the market.”

So why is the inventory and supply on the lower end of the market so challenged? A few reasons and many can be seen in your local neighborhood:

Conversion of Inventory from Home Ownership to Rental: During the Great Recession which many of us brokers also call “a housing crash”, investors from large hedge funds to Ma and Pa purchased 100’s of thousands of foreclosed properties. While some were fix and flips, the vast majority became income-producing rentals. At present according to the U.S. Census there are 8 million more renter-occupied homes than there were in 2007.

Granted some renters may be scared off from purchasing and while the investors could cash out and after paying simple capital gains have a nice windfall, at present the cash-flow on rentals is one of the most attractive investments in the market coupled with the underlying equity appreciation of the real estate; thus the motivation to sell is limited. In turn lower end and moderate homes are not coming on the market in meaningful volume.

New Home Sales are Down: In August 2017 there was a 3.4% monthly drop concerning new home sales. If demand is so strong shouldn’t new home sales be booming? Well, it is again simple economics and in this case pricing.

In August just 2 percent of newly built homes sold were priced under $150,000, and just 14 percent priced under $200,000.

Builders advise they desire to build more affordable homes yet profit margins or the lack of is causing constraints. Builders blame the higher costs of land (exurbs with lower cost land is falling out of favor with 1st time home buyers who desire to be closer to urban centers), labor, materials and regulatory compliance i.e. building and zoning codes (and this is before the hurricanes decimated Houston, southern Florida, Puerto Rico and the US Virgin Islands which will demand laborers and materials to rebuild leading to eventual inflation in those industries and supply chains.

One could argue that market forces will eventually realign the housing market. Yet when this will happen is anyone’s guess. Considering we are still in a “Goldilocks economy for housing i.e. jobs and income continue to grow, interest rates remain at historically low levels, financing rules have become more flexible and inflation remains tame at below 2% annually. So what is the problem?

At present our inventory of new and existing homes is static with numbers similar to those found in the mid 1990’s a full 20+ years ago HOWEVER during those 20+ years the country’s population has expanded by 60M. Couple this with a mismatched market as home prices will not come down as long as there are buyers out there willing and able to spend more and more money for less and less house as we have witnessed in hot markets i.e. San Francisco Bay Area, The Northeast and other markets.

Longer term is my concern. We have witnessed locally in Denver our market moving from purchasers to renters. Good for investors not so good for individuals concerning personal wealth. Homeowners are known for making big-ticket purchases i.e. appliances and upkeep and maintenance sustains the construction sector i.e. additions, roofing and so forth.

If we move towards a renter oriented housing market fewer Americas will be able to save and grow their money associated with the ownership and upkeep of a personal owner-occupied residence. Due to demand rents may continue to rise (as less inventory on the market) and thus renters will have less disposable income to spend which will ripple through the economy beyond housing.

Yet Denver may be the litmus test for the national economy as follows:

Upper-End of the Market: is slowing dramatically as prices rose to fast and thus not sustainable. Upper-end buyers are usually market savvy and thus will be more cautious entering the market. Even in the Country Club neighborhood I have witnessed price-drops and re-listings at lower prices all in an effort to generate activity; would have been rare one year ago

Lower-End of the Market: Supply is outstripping demand with the average home in Metro Denver over $410K; yet incomes/wages have not kept up as the average worker is slowly being shut out of the market and thus will be a perpetual renter,

Rentals: The vast majority of new rental buildings are priced at luxury levels (just look at the cranes in Cherry Creek North). Yet that market is slowing and many of the existing buildings are struggling to attract tenants and now offering rental incentives. Yet additional buildings continue to come out of the ground.

Zoning and Entitlements: In Denver while zoning has allowed additional density and not without controversy i.e. slot homes in Cherry Creek, while beneficial to rental development, most rentals are oriented to single and couple households, with few exceptions most new multi-family buildings are not designed for families or larger households.

The above is just some food for thought. Add an existential crisis and this housing “House of Cards” may come to an ugly resolution. While I am not predicting another housing crash, the off-balance market is not sustainable and the overall repercussions to the overall economy have not been considered, quite dangerous.

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April 2017 Statistics Are in the Books

While the news on the housing front continues to paint a rosy picture as we continue to be in a sellers market; statistically we may be entering a phase of normalicy concerning market conditions. While prices remain elevated and there is continued concern that average metro Denver incomes cannot keep up with the inflated housing market we are seeing signs of slowdowns concerning price appreciation and possibly an uptick in inventory coming to market.

Personally I enjoy looking at statistics. When combined with historical personal perspective i.e. lived through it there are insights and trends one may be able to extrapolate.

I was reviewing April 2017 market conditions:

In April 2017, there were 5,361 Active Listings in the metro area.

(Of note, the historical average # of listings in April is 15,710 based on statistics gathered between 1985 and 2016 also related usually the start of the Spring sales season).

Thus our average # of listings continues to be constrained especially when considering the increase of housing stock which has come on-line since the end of the great recession coupled with our population increase

Concerning sales prices:

The year-to-date average sales prices in April 2016 increased 6.05%.

In April 2015 that same statistic was 9.53%.

In April 2014 that same statistic was 12.9% (of note coming out of the recession).

Thus we are witnessing a slowdown in price appreciation (a good thing), slight increase in inventory (a good thing) and overall a potential plateau in the market.

Yes sales prices are stabilizing and getting closer to matching inflation and inventory is beginning to loosen HOWEVER couple this with the stock market at record highs, unemployment at record lows and no appreciable inflation or major interest rate hikes; we may be seeing signs of a housing slowdown in the metro area.

On the luxury side of the market while there have been some blockbuster sales of late, homes priced at $1M and over seem to be languishing on the market for longer periods coupled with price reductions. Granted some inventory came on market overpriced to start however price reductions are happening sooner and price cuts is more severe.

In my local Cherry Creek neighborhood which I admit is far from a barometer for the metro area the inventory of listings seems to be increasing and sales transactions are taking longer to close and usually after a price correction. Granted there has been a uptick in inventory south of 1st Avenue and much of the for sale inventory north of 1st Ave is east of Steele St. which some buyers consider less desirable yet the number of active listings continues to increase. As of this writing there were 41 active listings ranging from $215,000 to over $10M (of note both the lowest and highest price listings are condominiums).

Having been in the real estate brokerage business for a few decades now I am used to witnessing Metro Denver go through 5-7 year cycles concerning increased demand and then stability. While I do not believe we are in for a major correction, I do believe we will continue to see additional inventory come on-line and price appreciation slow to the inflation rate or a few ticks above which is the historic norm.

In the luxury market, which I track, I would be a little more concerned regarding price stability.

In the starter and move-up market baring a serious interest rate hike I am not concerned as demand will continue to outstrip supply. I would be hesitant concerning starter inventory in the exurbs as those markets are dependent on low fuel prices.

As I am advising clients at present:

Sellers: Consider putting on the market now as its low inventory and attractive interest rates.

Buyers: While rates are low, a good opportunity to lock in a fixed mortgage HOWEVER should consider waiting a few months to a year or two as inventory will continue to increase and while interest rates may tick up prices usually do the inverse.

Renters: Rents seem to be stabilizing and with the introduction of additional luxury inventory do not be surprised to see landlord concessions. Thus if in a rental consider resigning for another 6 months with an escape clause and if looking to rent, shop around and look for incentives to bring your net effective rent down.

 

 

To Buy or Rent that is the Dilemma

As a practicing real estate broker you would assume I would be an evangelical advocate for purchase. In general I am HOWEVER as a seasoned real estate broker I am a bit concerned about the existing market conditions in the Denver Metro area. In some neighborhoods I have witnessed prices and sales volume up 50% in 3 years and some 100% gains since the depths of the Great Recession. Of note Denver was NOT as hard hit as Las Vegas and Phoenix where such gains after an over-sold condition may be warranted.

Thus the following are the 5 questions I usually ask of prospective buyers and not only 1st time buyers. Of note I personally am going through a similar exercise as I am under contract to sell my residence, which I have called home for 28+ years. Due to the inflated (in my humble opinion) market and lack of inventory; the 5 questions are hitting me personally. Here you go and I must advise please be honest as the questions are also a self-assessment of sorts:

How long are you planning to stay in the Home/Neighborhood/Area?

The reality; it is unlikely we will witness the gains we have had during the past three years. Simple economics would argue median incomes cannot match the gain in housing prices especially in the upper-tier of the market. Thus I advise clients unless they plan to stay in their residence a minimum 3-5 years (assuming this is not a fix and flip situation), may wish to reassess purchases.

The purchase and selling of a residence is not only time consuming, it is also capital intensive. Costs usually associated on both sides include brokers fees (usually paid by the seller in Denver), mortgage applications/origination, appraisals, title insurance (usually paid by seller) and so forth.

In general the longer you retain your residence the more time you have to recoup costs and based on dollar cost averaging (yes values can decrease), the more opportunity you have to enjoy an overall increase in value. Of note for those who retain a house for less than two years and if there is an increase in value, must factor in capital gains taxes (sometimes can be offset by expenses incurred concerning the divesting of the residence).

In the question I mention neighborhood and area. Do you have young children or planning on having children? School districts are a major motivator concerning one’s residential address. When childless; the gentrifying neighborhood may be the hip choice yet when the children come into the picture and Kindergarten is around the corner all of a sudden the school district and distance to school is of paramount concern.

My opinion, if planning to stay 3 years or less, consider renting.

House Prices Always Go Up, Right?

How we have short memories. While the market slide beginning in 2007 may be recent memory and quite severe, it was not an anomaly. When I purchased in 1989, the seller had purchased the home in 1984. Five years later he sold it for 30% less than the purchase price 60 months earlier (not accounting for inflation). The seller brought cash to the closing table to satisfy the mortgage and compensate the brokers. This was an era before the term short sale and “jingle-mail” entered the popular lexicon.

More recently, the median home price in the United States dropped nearly 13% between 2007 and 2009, falling from $247,900 to $216,700. In some overheated markets, such as Las Vegas prices declined as much as 62% from their peak.

Before buying a home, consider how your personal finances would fare if your house’s value increased slowly or not at all. With 3% annual price appreciation, a $250,000 (considered a starter in Metro Denver) house would be worth more than $337,000 in 10 years. With a 1% annual price increase, the same house’s value would grow to just $276,000 over the same time period. Barring a recession, nominal inflation of 2% would keep up however due to the added expenses concerning home ownership; one could envision a scenario of flat and potential decrease of value. For my economic pundit peers, yes during inflationary times, houses in general increase in value HOWEVER with high interest rates associated with the taming of inflation, transactions become muted as affordability becomes more challenging).

I provide the above scenario as I have witnessed some buyers placing all their eggs in the housing basket assuming the gains will outpace other investments. Trust me I am the first to argue a home is a place to sleep at night; the brokerage firm holding your stocks or the bank holding your CD’s are not leaving the light on for your arrival to bed down for the night.

Shelter is needed I agree. However one should not look at their house as their sole investment or worse an ATM i.e. Home Equity Lines of Credit. I view a residence as shelter and if there is an increase in value an added bonus.

If I Rent I am 1) Throwing Away Money and 2) Making my Landlord Rich?

On the surface such an argument does have some merit. Also I will avoid getting into the issues concerning home ownership restricting mobility concerning employment opportunities. I understand the line of most brokers i.e. owners are building equity in a valuable asset that can boost their long-term net worth whereas renting is spending not saving.

Home ownership has additional costs beyond the Principal and Interest on a loan.

Taxes: While metro Denver has in general low property taxes, it is still a recurring monthly expense. In the upper-tier of the market i.e. $500K and above, one can easily allocate $500/month just on real estate taxes.

Insurance: Home Owners Insurance in Colorado can be costly due to our climate i.e. hail, wind, heavy snow and other perils. While we do not have to worry about earthquakes; insurance rates in Colorado continue to escalate due to weather, cost of labor, materials and related factors; such rates rarely go down over time.

Basic Maintenance: I tell my clients to consider budgeting at minimum 1%-2% of their homes value towards maintenance and upkeep. This does not necessarily factor in unforeseen costs i.e. new hot water heater, roof repairs, HVAC and so forth. Condo owners you are not exempt, this is what monthly HOA fees are for.

In a rental such costs are borne by the landlord. However I will advise if renting do consider “Renters Insurance”, usually inexpensive and offers piece of mind. While you may have budgeted for your Principal, Interest, Taxes and Insurance, there are always other costs that can be budgeted for as well as surprises.

If I rent am I missing out on the tax benefits?

To be honest many homeowners do not realize the mortgage interest deduction is oriented towards larger mortgages and financial outlays. First as a homeowner you must itemize your deductions when claiming the mortgage interest deduction.

With the existing low-interest rate environment (and yes rates are still at historic lows) your itemized deductions should exceed the $12,600 standard deduction for married couples? This is OK if you have an upper-tier house with a large mortgage. Yet the reality is each year that goes by your deduction decreases as a larger portion of your monthly payment is allocated towards principal. Thus the deduction over time will decrease. (Of note, there are interest only mortgage instruments, unless truly financially savvy or blessed by your CFP or similar, I suggest avoiding).

When Does Buying Truly Makes Sense?

I always look at a rent versus buy scenario and run numbers accordingly usually in conjunction with a client’s financial and/or tax advisor. Yet sometimes I take the simple approach, which is basically, is it cheaper to purchase than to rent?

Beyond the down-payment (and please note I am not trivializing this, however when loans are available with 5% or less down, saving for a down payment is not as onerous as when I purchased my primary residence in 1989 and had to come up with 20%+) I look at basic monthly outlay after answering the prior questions.

Let us assume in metro Denver you are interested in a home that after the down payment the monthly PITI/Mortgage is $3,200. Now what if you could rent a similar property, apples to apples for $2,850/month?

One could argue for $350/month extra or $4,200/year you can have the security (and expenses) associated with home ownership.

Yet one could also argue that $4,200/yr. can be invested after taxes into a Roth IRA or similar instrument. For the uber conservative that person could buy bonds and secure a safe 2% return. For the more aggressive; there is the potential to be investing with returns of 5% or higher annually over a longer period; not unheard of (coupled with dollar cost averaging) and with a Roth monies going in post tax, comes out tax free. There are also options to use the monies for a down payment, however there are some tax implications, which are best, discussed with a tax advisor.

I also advise clients at the beginning of their home search consider using a price-to-rent ratio calculation. Price-to-rent ratio is calculated by dividing the home value by the annual rent amount. Generally speaking, if the price-to- rent ratio is less than 20, buying might be a better option. However, if the ratio is greater than 20, renting might be better. Needless to say, any ratio or comparison is meaningful only if you are comparing similar properties.

In closing I am just throwing our scenarios and “food for thought”. I am in a similar situation. As mentioned I am in the process of selling the residence I have been in for 28+ years and have enjoyed immensely. However due to the physical design and other factors it is time to move on. Assuming I close, I will be, guess what living in a rental! Yes I will be paying rent.

My personal view at present; I am more comfortable having the proceeds from the sale liquid and when the correct residence comes available for purchase at a price I feel is appropriate, I can proceed sans the restraints of trying to sell my residence and/or using a contingency clause which is never popular. In the interim, the money from the sale of my residence post taxes will be invested in short-term bonds throwing off income while retaining a margin of safety of the underlying principal.

Bubble Probably Not. Am I Still Concerned Yes

Between reading The Denver Post article concerning record low inventories, visiting listings and chatter at open houses we seem to be in a Goldilocks period for home sellers and a Draconian period for buyers.

I will be the first to admit there is a severe lack of inventory at all price levels which based on the laws of supply and demand will raise prices. Thus why should I be concerned? As a broker I should be thrilled! Let me preface the following with the disclosure that my market niche is deluxe and luxury.

Irrational Pricing and Exuberance: Last week I went to look at a listing in a very in-demand neighborhood in Denver where average prices are triple of the average of the Metro area.The house I felt was priced on the upper-end of the Per Square Foot for the neighborhood. Granted great location, well-kept yet some design issues and so forth (yes no house is perfect). Within 2 days of my visit I received a note from the listing broker advising the sellers recieved a strong offer and if my client were interested, they needed to get an offer in ASAP. My client and I both felt the house was not for them and it was in our humble opinion overpriced. 5 days later I receive a notification from our MLS service that the house which received a strong offer suddenly had a price reduction.

Even earlier today I went to a public open house. The house was not correct for my client i.e. larger lot than they desired; however there was the appeal of some unique features including a carriage house and the perfect 1st level of entertaining. As assumed the house was not for my client. The 2nd level was two bedrooms with a shared jack and jill bathroom. Thus realistically a two bedroom house. Basement was OK, nothing out of the ordinary. The carriage house, while a rare amenity was basically a dated studio sized apartment and advertised as the 3rd legal bedroom (I saw income rental potential both long-term and transient) .

The Open House was packed. I heard one of the brokers mention the listing already had 15+ scheduled showings before the open-house . Yet across the street were two houses which sold last summer, comparable size, more conventional bedroom layouts, slightly smaller lots and more traditional design. Both sold for almost half of what the listing price on this listing. Now I am not suggesting the larger lot and carriage house would not increase the value, yet by double? Coupled with limited bedrooms, unconventional design and double the price in one year, sustainable? Probably not.

Are Stock Market Paper Gains Sustainable? It is no secret the stock market has been hitting new records and the market usually looks to the future; thus we may believe the overall economy will continue to expand. The Federal Reserve believes so i.e. advising a rise in interest rates is forthcoming. However is a sell-off in the immediate future?  Most real estate brokers know a downturn in the market also challenges confidence concerning real estate purchases as the wealth effect is psychologically proven.

Interest Rates Will Continue to Rise: Interest rates can only go up assuming no major shock to the overall economy i.e. war, terrorist-attack. Granted we have been within a historically low interest-rate environment for way too long. The low-interest rates naturally raised housing prices as many buyers were purchasing a payment and not necessarily underlying equity. Yet this is a dangerous precedent. Except in markets with rampant inflation; in general higher interest rates translate to lower housing prices as the cost to borrow money increases.

This is worrisome; as interest rate hikes usually impact the first-time home buyers, yet the ripple effects can impact all facets of the market as move-up and move-down buyers are also impacted concerning the distribution/inventory within the overall system.

A healthy housing market is usually considered fluid corresponding with life and circumstance changes. When supply and demand is disrupted and housing becomes challenging to either acquire or sell, the ripple effects are felt within all aspects of the local economy. Few may remember the late 1980’s in Denver when the HUD Foreclosures insert in the Rocky Mountain News was literally as thick as the newspaper it was included in. More recently between 2007 and 2009 For-Sale signs dominated the landscape during the “Great Recession”. Those buyers will eventually be sellers, sooner than later?

Investors Having Realized Gains Begin Selling: One of the reasons we have such low inventory is from past investor activity plowing cash into the housing market during the tail-end of the Great Recession. However with recent gains in the stock market, higher interest rate yields in fixed-income markets and weakness in some rental markets do not be surprised if those investors having enjoyed equity appreciation and now having owned long enough to just pay ordinary capital gains on appreciation we may see investors begin to relinquish their inventory sooner that later.

Reduced Equity Can Happen: For buyers who purchase at the top or pinnacle of the market cycle the ramifications can be challenging. One of the hallmarks of the Great Recession was the Negative Equity associated with many purchases made at the top of the market assuming housing prices do not go down. Granted I am advising clients if they plan to stay in residence for 5 years or more they usually can ride out a cycle. However if one is purchasing investment property at present, my more experienced clients are literally selling or sitting on the sidelines and looking at alternative investments.

Fix and Flips Less Common: With the boost in prices, fix and flippers are having challenges fining acceptable inventory and foreclosures. While this may be a sign of a healthier market the ripple/multiplier effect can be worrisome i.e. general/sub contractors, building material suppliers, retailers such as Home Depot and Lowe’s and so forth may be challenges ahead. While the service economy may continue to hum along, blue-collar trades and related industry may be challenged.

The Next 12-18 Months: While I do not have a crystal ball and I have been told I am a pessimist I do have the luxury of the knowledge of history having been in the real estate trade since the late 1980’s in Metro Denver. I do not believe business cycles have ended and while at present demand outstrips supply, I do not believe this market is sustainable. What I feel we need to look out for is as follows:

Challenges to the Luxury Market i.e. $600K and Above: The luxury market is usually the first markets to show weakness. Due to the uniqueness of the market i.e. cash buyers, not necessarily dependent on income ratios, experienced buyers and sellers, this is where I would watch for issues pending. If we suddenly see an influx of luxury listings hitting the market and absorption slows, this to see is a signal that astute and more experienced buyers are sitting on the sidelines waiting for prices to correct somewhat.

Glut of Deluxe and Luxury Condominiums: Based on underlying ground prices new condominium construction is usually oriented to the deluxe and luxury buyer.  However what are the depths of this market? Seeing the skyline of Cherry Creek and Downtown leads me to be a bit concerned. Denver for the most part has been a home market. Yes the aging population may desire condos for the ease of maintenance and younger buyers may desire condos for the same reason. However younger buyers may begin having families; will they remain in the condos or eventually sell or place on the rental market. With the majority of new construction in the one and two bedroom range, these condos are not oriented towards emerging families or longer-term retention.

Rent Prices Coming Down Incentives Increase: Part of the downturn in rental rates is due to the glut of luxury rentals. Cherry Creek is a perfect example (just look at the east-side of the Steele Street and 1st Avenue intersection); the same trend is happening in Downtown. Is our influx of millennial and others with disposable incomes sustainable?  Are these renters now suddenly purchasing? Yet with low inventory it’s a challenge.

We shall see what the traditional Spring Selling Season brings to market. Will there be a controlled flow of inventory hitting the market or will we witness a glut or continued tightness i.e. lack of inventory.

If I were considering selling, I would be placing on the market immediately to take advantage of the low supply and high demand. With interest rates on the rise future prices will be challenged. While interested rates on borrowing money continues to be attractive, lower rates will not last forever (when I purchased my residence in 1989, I paid 12% interest on a 15 yr. mortgage with 20%+ down-payment!).

If I am a buyer and I had the option I would probably sit on the sidelines and consider renting for the immediate future. Granted if one’s dream home hits the market, go ahead and purchase it. However if settling or to purchase just to purchase, I would suggest take a step back and reassess and take the emotion out of the process.

 

Most Expensive Rentals in Denver

Well, its semi-official, downtown adjacent Golden Triangle neighborhood is the most expensive neighborhood on average for a one-bedroom rental with a median (half were higher, half were lower) of $2,275/month in October 2015 according to San Francisco based Zumper, an apartment rental search and application app.

What is interesting is this is a neighborhood which has transformed immensely over the past two decades. While always home to the Denver Art Museum on the south-side of Civic Center (and of course the Burnham Hoyt/Michael Graves Denver Public Library), the area boomed when luxury condos were built between Lincoln Street and Speer Boulevard from 7th Avenue to 14th Avenue. In addition, the area welcomes the Clyfford Still Museum, a few unique mixed use projects and of course a central location.

Yet historically the mid-rises east of Lincoln Street have historically offered affordable rentals north and west of the Governors Park neighborhood  as well as across Cherry Creek at Parkway Center.

If you have driven northbound on Speer Boulevard you will see new luxury rentals sprouting up along this historic street. At the intersection of 6th/Speer what was once a large gas station has given way to a mid-rise new development as has a lot to the northwest beyond Broadway.

For additional details, here is a link to the article in the Denver Business Journal