posted on 24 August 2016
by Lee Adler, Wall Street Examiner
According to Jeff Reeves at Marketwatch, this is the best time in history to invest in real estate. Having spent half my professional life in the real estate and real estate finance businesses, let's just say I was "curious" as to how he reached that conclusion. So I wiped the chocolate milk off my face that I had just spit up through my nose, took a deep breath, and dove in.
Reeves started out on the right foot:
But it was only a diversion. What followed was either disingenuous, desperate, or delusional.
The next 1500 words were both tortuous and torturous. Unless you are a masterful long form writer with an encyclopedic first hand knowledge of the facts and history as, for example, Mr. Stockman, most media hacks are pumping gibberish once they get past 1000 words. They're lost in the woods.
But I resolved to pick through the word salad to figure out just what the writer's point was. I won't bore you with a point by point examination and rebuttal. I'll just give you a preamble on my general feelings about the issue, and then rebut a couple of Mr. Reeves's key points.
I have no idea what Reeves's background and experience in real estate are. But, just so you know where I'm coming from, I'm not a real estate investor. I own two homes free and clear, neither of which is much of an investment. I did sell a home in Florida at the top of the bubble in 2005. I had bought the house at the bottom of the 1990-91 real estate crash. Buying at the bottom and selling at the top was pretty good first hand experience. Doing commercial appraisal work for banks and property owners, and especially for the FDIC and RTC from 1987 to 2001, was also pretty good experience with the best and the worst of the real estate cycle.
During that period as a commercial real estate analyst, I appraised hundreds of large commercial and investment properties, and did numerous market studies for big development deals. When the deal was atrocious, and many were, I warned the client and appraised the property accordingly. They would then find another appraiser to give them what they wanted for the deal to go forward. Then a year or a couple of years later, the bank or the RTC would come back to me to get the property reappraised after it had been foreclosed. Some of those deals were even worse than I thought. I also saw good deals, and I fought for them with facts, data, and honest analysis.
Before that, I cut my teeth in the business selling residential real estate, followed by a few years working as a residential mortgage broker. I have had my boots on the ground in both real estate bubble markets and real estate depressions. I've experienced all of it first hand and I analyzed the market intensively for a long time.
The other thing I've experienced is a family that has been in the real estate business for more than 100 years. I have witnessed their feast or famine cycles first hand. I know the stories of what the conditions were like in each of those cycles.
Simply based on the intuition drawn from spending my entire life either actively involved in or around the real estate business, I feel reasonably confident that this is not "The Best Time In History To Invest In Real Estate."
In fact, I feel reasonably certain that this is one of the worst times that I have ever lived through to "invest" in real estate. I'm almost 66 and have been paying attention to these things for about 40 years. I can't say it's the worst time in history to invest, but I can say it's one of the worst times I have seen in the last 40 years. 2005 was the worst, and today is just as bad in many ways, and worse in one way in particular that I'll get to later.
Today's market may not have the insane froth that blew off in 2005, but the fundamentals really are atrocious. In order to believe that you have a shot at not losing money, you must first believe that central banks will keep printing money and suppressing mortgage rates forever. With rates at these historically low levels there's just no margin for error. If and when commercial mortgage rates rise, real estate cap rates will necessarily go with them, the property's market value will fall accordingly and your "equity" in your real estate investment will disappear in a Palm Beach minute.
So, sure... if you believe rates will stay low forever, be my guest! Jump right in with your investment capital. Take that risk. Just be prepared to lose it all. Owning a multifamily building is like buying a stock as a long term investment on 80% margin. Would you do that? If the answer is no, then you shouldn't be buying real estate. Because real estate is far more complicated, time consuming, and headache prone than stock ownership.
What can go wrong? Let me count the ways.
For example, a 20% increase in the cap rate, say going from today's 5% for a top quality property in a great location, to 6% in a slightly tighter credit environment would virtually wipe out your equity. Another quarter point or so would probably finish the job.
Then the question is whether you can maintain rent levels through an economic "soft spot," hold expenses down and continue to make the payments if you are underwater on your equity. Because the minute you go into default by being a little too late with a payment, or breaking some other obscure mortgage covenant, if it's a great property in a great location, the bank will waste no time foreclosing on you. Good luck trying to stop that in bankruptcy court.
And please be aware, virtually all commercial mortgages have balloons every 5 or 8 or 10 years. At one of those rollovers you will face a come to Jesus moment when the inevitable soft market comes around. You had better pray that you've been able to hold the property long enough that you've had some equity buildup, or that the pollyanna market of today lasts long enough to have another 5-6 years of 5-6% real estate inflation, so that you have an equity cushion.
And this business about using the word "appreciation" to describe what is the purest form of inflation. Stop it already. It's inflation. You're betting that wage inflation will keep up with rent inflation so that you can keep your property 95% occupied. Because that's the occupancy assumption on which your initial 5% cap rate is based. There, again, is no margin for error. If rents go up too fast, renters will double up faster, and it won't take long for the property that was 95% occupied to go to 80%, and you'll have problems collecting the rent on another 10%. If that happens, there you go again: Goodbye equity.
I'm on a roll here but I think I'll stop for now and start tearing apart Jeff Reeves's piece point by point in a Part 2 post tomorrow. Who knows, there might even be a Part 3. Hell, I might even serialize it. This could be a 10,000 word financial opinion prize winner! The Bullblitzer Prize.
Before I leave you to think about this, let me take Point 1 in rebuttal to Mr. Reeves. He starts his thesis focusing not on home ownership as an investment. Instead he says, "considering the investment potential - particularly in the rental market - you may want to take another look". He's clearly talking about the multifamily housing market.
The first thing I want to pick on is the citing of Realtor.com as a source of "information" supporting the idea that the current housing market in general is not in a bubble. Realtor.com! For goodness sakes.
Let's be clear about who owns Realtor.com and what its business is. Realtor.com is the primary website for Move Inc. Move Inc. is the online marketing arm of the National Association of Realtors. Its job is the marketing and advertising of houses. It works for the Realtors' housing market cartel. It's not here to give us the bad news, or to even give an honest appraisal of the market. Its sole job is to get us to push the BUY button, or to list our property for sale with one of its members. Of course it will find ways to "prove" that this is a great time to buy! You'll get all the pros, and none of the cons of buying housing now.
Move Inc. is a subsidiary of, drum roll please... News Corporation. Do you know who else News Corp. owns? That's right, it owns Dow Jones Marketwatch, the very publication for which Mr. Reeves works. A serious, objective analyst would not cite Realtor.com as an unbiased source of real estate market information. At the very least, and I mean VERY least, journalistic ethics would demand that these relationships be disclosed.
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