SEASONAL SLOWDOWN OR FUNDAMENTAL SHIFT?
Housing sales are up in key markets. This is not in dispute. The numbers are easy to read. But as investors we must constantly remind ourselves the pure number is just a snapshot that ignores history, context and a part of a continuum.
The latest trends we see in the May Altos Research data indicate an expansion of inventory (slow) in most of the top twenty cities. Minor exceptions exist in Phoenix, Las Vegas and Detroit, the cities of Dust, Lust & Rust!
CHARACTER & CHANGE
These three cities have had some level of economic and housing dysfunction over the last couple of decades. Arguably Phoenix only graduated from being a boom-bust waypoint on the trip to California to becoming real city in the last ten to fifteen years. It has gone from back office and manufacturing facilities for California financial and technology companies to a bona fide economic destination. Like Phoenix, the character of Las Vegas is changing but it still remains heavily influenced by casino tourism and a racy reputation.
Detroit has gained attention as a city of under-used factories, people leaving and spectacularly compromised municipal principles. As we speak the city of Detroit is structuring to default on bonds payments, union pension obligations and civic services commitments. Is it any wonder property is cheap?
MAINSTREAM STABILITY
The other seventeen cities in the Altos Research Top 20 cities, plus the Altos-Top 20 composite & Altos Mid-cities Composite show measurable inventory expansion. Days on Market are still improving and prices increasing across the board, but houses available inventories have been expanding.
There appears to be a self-fulfilling prophecy occurring with heightened demand, amplified by Wall Street fueled fund money driving up prices. As prices go up, returns go down for professional investors. As a result these funds move on to other markets, reducing their effect in a previous market. Inventory and days on market expand and if history is a guide, prices flatten out if new buyers do not move in to replace them.
FUNDAMENTALS RULE
The residential investment fund effect has been to drive sales expectations and prices up for retail home sellers and home buyers. When funds can no longer find the volume of properties at the prices they need to meet expected profits, timeline and scale, they move to the next market. This opens opportunity for small to medium investment company and individual investors who have more patience, less demanding return needs and a more distant sales horizon. They have the luxury to pick and choose based on a house being financially attractive and rentable.
PICKING UP THE PIECES?
A more disturbing problem that is showing up is the lack of qualified buyers or conventional lending because of The Consumer Financial Protection Bureau (Dodd-Frank) qualified mortgage and borrowers rules. The effect is clear in this Mortgage Banker Association data.
Sales are up (funds and cash investors) but mortgage purchase applications (from Mom and Pop home buyers) are down. Notice the growing deviation between the green & red trend lines on the right side of the MBA chart. In our opinion this creates a opening for aggressive investors willing to fulfill seller financing needs.
A SEASONAL HARVEST
The recovery of the market has had a huge jump-start with Fed QE 3 money that helped fuel fund buys of distressed housing. They will ultimately move on and leave the market to small- to medium-sized individual and professional investors.
Think of the market as a tree in full fruit over a harvest season: First, the low hanging fruit are the houses and markets that made sense for the margin, scale and horizon requirements of these funds. These were easy to pick.
Next phase is the smaller professional investors who know how to buy more specifically, do not need the scale of a Blackstone or Colony American residential fund. They are buying 100 homes over the course of a year (vs. thousands) for resale to individual investors or packaging as a small investment offering. Then there are individual do-it-yourself investors who buy two to three homes a year. To get to returns that exceed a typical 7 to 10% rental income return, capturing appreciation through sale is necessary, but with conventional mortgage lending tight this may be illusory.
INVESTOR OPPORTUNITY – WHAT THIS MEANS TO YOU
Many individual and mid-sized investors have sold many houses to funds. Now these funds have moved on. These individual investors remain working these markets but with a good deal more precision now that the funds have moved on.
We expect that to get returns better than the typical 7% rental returns now squeezed by more rental property availability providing credit repair, lease options and seller financing options will become mainstream as these investors sell to Mom and Pop home buyer until there is a return of conventional bank lending.
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