In the last couple of weeks there were four different, yet related, public discussions (TV or print media), on the current real estate market that were very interesting. The first discussion covered the re-emergence of the “competitive buying” phenomena that was prevalent before the “bubble burst” in 2008 when brokers were getting multiple offers on their listings. The thesis of the discussion was that improvements in the residential real estate market, suggesting a recovery, were bringing buyers back into the market. However, the discussion pointed out that the competitive nature of this market favored the “all cash” buyer (buyer’s not purchasing contingent on receiving a loan). The discussion also pointed out that the buyer’s were not, for the most part, “end users” (people buying the home to live in it). Rather, the buyers were “operators” purchasing multiple properties in the anticipation of continued market improvement and being able to re-position the homes in the market for a turnaround sale at a much higher price. This type of activity does not necessarily spell out the actuality of a long term improved market. The ultimate test will come when the properties are placed back on the market and “end users” step up to buy them. That may not be as easy as it seems. The ultimate homeowner is most probably dependent on conventional mortgage financing, which itself requires a good credit score and an income level satisfactory to service debt. This also raises the question of whether or not the economy has improved sufficiently to restore confidence in the mind of the home consumer. That has yet to be proven.
For most homebuyers, becoming involved in a “competitive” buying situation should be avoided because it can only lead to paying more for a property than it is worth. To avoid unwittingly being drawn into a competitive situation buyers should consider retaining their own agent, under contract, to act as the buyer’s exclusive agent charging that agent with responsibility for preventing being drawn into a competition. Offers to purchase should be very short term and should contain a provision that, if the offer is being submitted to the seller along with competing offers it is deemed immediately withdrawn. A buyer’s exclusive agent can help manage this process while dealing with only the seller’s agent offers little protection because the seller’s agent has a primary obligation to the seller and not the buyer. No potential buyer wants to have their offer become the “stalking horse for another offer from a competing buyer. Agents like long term exclusive buyer representations because they have an assurance that when the right situation is found the agent will get a pay day and, because of that the agent will work hard to find the right situation.
The next discussion reported a shortage of “mega mansions” (multi-million dollar homes) in many markets. This phenomena pops up in places like the San Francisco Bay Area where each new IPO involving a high tech company in Silicon Valley disgorges an army of new multi-millionaires into the market. This is an example of too much money chasing too few properties. The newly minted millionaires would be well advised to read a history of the local real estate market to learn what may have happened during previous market melt-downs. At the time of the dot.com bust many mega mansions suffered a substantial price decline. This could happen again. The shortage of mega mansions obviously creates an environment for competitive buying. Owning a mega mansion also requires the ability to remain super-rich. Forgetting the cost of debt service, the owner of a mega mansion in California, with a price of $15,000,000 would pay an annual real estate tax of $150,000+ on top of which would be high costs of maintenance, insurance, utilities etc. A buyer would need to be very comfortable that a sufficient fortune was possessed that there was no dependence on a job and an ever inflating value to the corporate stock held.
The third interesting discussion involved a discussion that the U S governments give home buyers a subsidy. That is a very interesting notion that completely overlooks the fact that there is already a substantial subsidy given in terms of very low mortgage interest (because of the monetary policy in place), coupled with a tax saving via the deductibility of mortgage interest and property taxes. Government policy that is designed to stimulate homeownership proved to be a total failure that, in part, brought about the 2008 meltdown. The development of new initiative to stimulate homeownership would, most likely, lead to another meltdown in the future. If government policies do anything, they should responsible ownership by precluding assuming more debt than can be serviced and encouraging higher equity so that a short term downturn in prices does not cause wholesale collapse.
Finally, this week REIT shares came under downward pressure because of concerns that interest rates would rise causing a potential future decline in income available for distribution. There is little question that the easy money policies of the government have subsidized growth in the REIT industry and it is natural to feel that a change in the interest rate environment will change things for the worst. There is every good reason for believing that interest rates will increase over time if the economy continues to improve. In terms of commercial real estate, rising interest rates may not only decrease net cash flow but will also decrease value because of the impact of interest rates on capitalization rates (the rate used to measure value).
At the present, despite published optimism, there is no certainty that the apparent improvement in the real estate markets will prove sustainable or of long term benefit to all segment of the market. The behavior of the stock market in the week of June 17, 2013 suggests that there is an overhang of uncertainty leading to increased volatility. While it is very easy to sell securities to quickly take profits or minimize loss, it is not so easy to sell real estate and that suggests avoiding aggressive acquisitions except under unusual circumstances.