Resiliency is a characteristic that I place much value on. The ability to bounce back from a crisis and return to normalcy or to face adversity and take losses while learning from failures is imperative in life, business, and specifically for our purposes here, real estate.
After 2008, the housing and financing sectors of the economy seemed to be wiped out after insurmountable losses in value and critical cracks in the global financial infrastructure caused by the sub-prime mortgage meltdown. At that time, many experts had forecast a 10-year recovery.
Ten years later, not only had the market recovered in half the time predicted, it reached new heights in pricing and valuation. As we enter 2019, we face a precipice and before us a downward slope. The key this time might be how to judge the angle of this slope and how to adjust to the coming challenges of a new market by employing resilient strategies to survive what I call The Great Adjustment.
My focus will be based primarily on the South Florida real estate market and its dynamics but will also serve to provide insights into overall national trends.
Let’s first begin with where the national market is in macroeconomic terms.
In a recent Forbes article, author Lawrence Yun, Chief Economist of the National Association of Realtors, cites the Federal Reserve on the national outstanding mortgage debt level, which is currently at $10.2 trillion. He compares this figure to the pre-subprime crisis number of $10.7 trillion. He argues that although there is an increase in mortgage debt, which took ten years to get to this level, the values of homes have increased from $18.6 trillion to $29 trillion. That equates to a current overall conservative 35% debt to value ratio.
As the NAR usually does, it provides the positive spin on numbers to maintain the auspices of the market but what many analysts are looking at is what that $29 trillion valuations are going to do in the next 18 – 24 months as rates, changing demographics, and global economic upheaval places pressures on the market. There is also much uncertainty, as a new generation’s views on homeownership are skewed by the current lack of affordability.
There should also be caution on the debt side, as the rise of Non- Prime lending is gaining traction and becoming more of a factor in new originations. If the increase in debt continues, now aided by a more relaxed lending environment, and you factor in a significant price correction, that debt to value number will begin to swell and place pressure on the entire market. If properties don’t sell because buyers will be on the fence and investors are thirsty to recapture their equity, we can predict a trend on cashing out.
In South Florida, a market dominated by pre-construction condo sales, the outlook is slow. Most of the inventory created in the upswing of the 2012-2014 cycle has delivered, yet many projects still have significant stock to sell and close as important international feeder markets like Venezuela, Argentina, and Brazil have faced immense political and economic disruption which has translated to a slowdown in investment in South Florida.
Even though the outlook seems bleak, some developers with patient capital are making bets on in the luxury market and waiting for new dynamics, specifically the Trump’s Federal Tax reform and emerging international markets to make a positive impact on sales. At the same time, other developers are feeling the crunch and might have to postpone their offerings before going into contracts.
Making this international investor driven sub-market feel more pressure is the glut of condo resales listings that are priced significantly lower than pre-construction.
According to a report by the Downtown Development Authority, “the average price per square foot in the first half of 2018 was $392, down from $405 in 2017, $426 in 2016 and $457 in 2015. That means the price per square foot was around 2013 levels. However, the lower pricing has caused sales volume to increase. Sales are faster in older buildings with lower prices than in newer buildings. Prices might decline to around $360 per square foot before they bounce back.”
This can provide an opportunity for domestic buyers that are looking to move to South Florida for its traditional allure of climate and cultural diversity but also because the new Tax reform is acting as a trigger to drive buyers from states with income tax like New York. Initially, the tax reform is providing more buyers in the luxury segment because they tend to be mobile and less anchored to jobs. However, eventually, as corporations begin to relocate for the same reasons, jobs will come to South Florida, and you will see an increase in upper- and middle-class buyers making a move as well.
The condo resales can also be an opportunity for bulk purchasers when prices reach a square foot mark which is consistent with current construction costs for high rise condominium projects. Investors could take advantage and acquire choice assets in diverse projects, rent and hold until the market corrects itself, playing for the upside while potentially enjoying better returns on stable rent values. To acquire a bulk of units in multiple projects, a blanket loan offered by a private lender can provide the flexibility and leverage to make a substantial and balanced acquisition.
The single-family market has been more dynamic, as it caters to local and domestic buyers looking to make South Florida their home. Sales have been steady and prices stable. The demand for modern single-family homes with updated technology and amenities is increasing, as millennial families dominate this segment. Their unique requirements coupled with their income constraints have placed pressure on affordability for many professional millennials and their families. Many of them continue to rent while setting more value on other experiences than that of homeownership.
Investors should consider looking at this dynamic as an opportunity. Land acquisition or demolition of older homes in good suburban neighborhoods will become more prevalent as investors try to and satisfy the demand for affordable, modern homes.
Traditional fix and flip investors are looking to diversify and become more ground up builders. The fix and flip market drove sales and homeownership during the recovery. They aided with the absorption of distressed assets and made them perform. Private money sources helped in the acquisition and rehab of these assets and had become the primary source of financing in the industry.
Many investors feel these assets have reached their peak in value now. Because of the nature of limited cosmetic upgrades, increasing pricing pressure, and changing buyer demographics, the need to create new, modern and energy efficient homes will drive investors to liquidate these assets. Moreover, the potential need for quick liquidity will shift the focus on recapturing equity through cash-out financing on their existing portfolio rather than on selling homes one at a time.
Ground up construction lending for these types of investors has been trying to find, as the equity requirements are higher than fix and flip. Some lenders in fix and flip are going as high as 90% LTC (Loan to Cost). In private money construction loans, the equity requirement will be closer to 35-40% and the rates will be higher, as there is more risk involved. Only experienced investors with the right team of professionals need to apply. That was part of the allure of fix and flip, you could have limited understanding and in a short period churn enough deals to demonstrate experience.
Resilient investors will need to reevaluate their strategies in the coming months as the Great Adjustment unfolds. The real estate and lending industries are also going through major transformations, as technology impacts the way real estate and mortgage professionals conduct business. If you follow the money trail, venture capital is focusing on Fintech and transparent analytics as the industry moves to more efficient and automated transactions.
Investors will need to partner with professionals that are employing the latest digital driven solutions in marketing, data analytics, sales, and financing to execute successful investment strategies in real estate. It’s a transformative moment, and 2019 will be a pivotal time where staying focused and resilient will help navigate the adjustment and eventually pay off with significant dividends.