s the US real estate market a bubble ready to pop? a Canadian investor’s perspective

Is the party over?

Joe Rickards
Other

The media is saying the US real estate party is over. We’ve missed the boat. We’re too late to cash in on the market recovery. In reality, that couldn’t be farther from the truth.

I’ll admit, on the surface of it all, to the non-expert eye that’s not out there doing deals, the US residential real estate market statistics look pretty frothy, and it’s easy to be misled into thinking a bubble is forming.

However, when you dig deeper, the real truth jumps out at you.

THE BOTTOM LINE:

In this article you will discover the cold hard facts I uncovered that shows why today’s US residential real estate market is the perfect storm opportunity for investors to cash in on the greatest recovery in US real estate in our generation, both for flippers and fundamental, cash flow investors.

Let’s bust the media-driven bubble myth.

The media typically reports the most visible statistics that lay on the surface, such as:
• Nationwide US prices are a mere 15% from the nations bubble peak of April 2006.
• The US real estate market has had 25 consecutive months of price increases;
• Prices jumped 27% in Las Vegas, 20% in Orlando (in 2013);

I’ll admit, these “on the surface” statistics can easily be misinterpreted as frothy in the eyes of any laymen. It’s no wonder the media looks at these figures and rings the WARNING bell crying chicken little, the sky is falling. It’s not their fault; the media are not real estate experts. While these figures are, for the most part true, they paint a very misleading and false picture of the US real estate market as a whole.

The illusion: housing is in short supply.

Having boots on the ground in the United States for the winter months of 2014, I discovered an obvious dichotomy in the real estate market. Just like there are two sides of the same coin, there are two distinct and vastly different parallel markets that exist in today’s real estate market. Let’s call Heads the “family (owner occupied) buyers” market and Tails the “investor buyers” market. The illusion of tight housing supply exists because the media is only reporting on the family market, not the hidden side of the coin: the investor market.

While the huge price gains seen in the past 2 years reflect a somewhat accurate picture of the “family” real estate market, it’s only half the story, just like Heads is only one side of a coin. After digging around for months in the US trenches trying to wrap my head around a market that just did not make any sense, a deeper truth came to light. The other, hidden side of the coin emerged bit by bit: Tails, a market driven by investors.

Heads: the family market.

Let’s take a look at the Heads side of the coin: the side controlled by family buyers. There is definitely a shortage of the “pretty homes” that families want, and it’s these family buyers that represent about 90% of the aggregate market buyer pool. They are the first time home buyer and the family upgrading their home. Also, housing starts ground to a complete halt 7 years ago and have just been starting to come back for about the last year or so. Between the robust demand and the 7-year dry spell of new homes, both new and pretty homes comprising the “pretty home” inventory are in awfully tight supply, which continues to aggressively push up prices.

Another market influencer is the fact that only 18% of owner occupied (ie, family) mortgage applications are being approved today. Well, just imagine what’s going to happen to demand (and hence price) for this already tight supply of pretty homes when banks loosen their purse strings and return to historical lending norms.

Tails: the investor market.

On the Tails side of the coin there are investors buying ugly houses: mostly REO’s (bank owned) foreclosures and short sale homes, which out number pretty houses by about two to one. The overwhelming majority of buyers of these ugly houses are investors, and they only represent about 10% of the aggregate market buyer pool. Families don’t want these ugly houses for good reason. Many have been vacant for years and the overwhelming majority need a ton of work, have mold and other serious issues. On top of that, they’re a major hassle, they’re more risky and Closings are fraught with delays, often leaving the buyer family out in the cold long past their expected Closing date.
With ugly houses you have only 1/10th of the buyer pool that have roughly twice the inventory to choose from. This has led to an oversupply of ugly houses, which has kept ugly house prices under wraps.
There is also two large market influencers that will continue to add more ugly house inventory to the market, which will continue to keep ugly house prices artificially low for some time to come.

Prices still 40 cents on the dollar.

Most people are shocked when I tell them just how low you can still buy highly positive cash flow properties in good areas in many States. As low as 40 cents of the 2006 market high price levels, with CAP rates as high as 18%. There are an abundance of sources of these great investor properties, including, REO’s, pre-foreclosures (great no money down opportunity for Canadian’s to help defaulted homeowners), foreclosures, tax deed auctions, IRS auctions, short sales, estate sales, and even probate.

Kink in the foreclosure fire hose.

First, their is still a kink in the foreclosure fire hose due to the “Robo signing” fiasco, which has prevented houses from gushing onto the market. This was where banks were caught red handed fraudulently re-producing ten’s of thousands of missing original mortgage documents needed by judicial State courts to foreclose (and not one banking exec has ever done jail time for it!). This caused the government to step in by legislating the “Homeowner Bill of Rights,” which protects homeowners from such fraudulent bank activities. As a result, foreclosures have nearly ground to a halt in some judicial States, such as Nevada.

The 60 million shadow inventory.

Second, there is the massive shadow inventory stat’s that they hide from us. That is, a shocking 60 million Americans are still underwater (owe more on their home than its worth) and 9.3 million are upside down by 25% or more! For example 41% of Vegas homes are still underwater by 25% or more. In Orlando Florida, 36% remain underwater and in Tampa it’s 35%.

What does the future hold?

I think the big question is: when interest rates inevitably come up from their historical lows (which the market now takes for granted), and homeowners can no longer afford the payments on their underwater homes, what do you think they will do? Will they walk away by the millions like they did after the 2007 crash?
Now let’s take a look at a real wildcard that’s going to hit the market in August 2014. The US Federal government has legislated that banks must start dumping their shadow inventory (estimated at 60 millions homes), which they’ve been stockpiling for years. Have you ever wondered why on earth would banks let millions of their REO’s (bank owned) properties sit empty, creating dangerous liabilities and eroding the value of their real estate asset base? Let me circle back to that in a bit.

When the banks start dumping their shadow inventory that will of course dramatically increase the supply of ugly houses for investors, but remember, this supply isn’t really adding to the overall market supply of family homes (what 90% of buyers want) and it’s this family market that largely influences MLS market price levels, suggesting overall market prices will not likely soften as bank shadow inventories hit the market. The caveat to my prediction here is that banks continue to dribble out their inventories like they have been their REO and foreclosure inventories since 2007. If they were to open the floodgates, it would be a much different story, albeit unlikely based on how they dealt with their huge inventory problems since the crash.

Bank fraud endorsed by Financial Accounting Standards Board.

Okay, let’s circle back and take a look at why banks have been hording their REO inventory since the 2007 crash. It’s simply really. By holding mortgage assets on their underwater properties, they don’t have to take the hit and realize the loss until the property sells. Once upon a time, that kind of conduct was considered fraudulent accounting practices, but in the wake of the financial crisis, the American Bankers Association lobbied the Financial Accounting Standards Board to change the accounting rules that gave the banks greater discretion in determining prices for certain types of illiquid securities on their balance sheets. As a result, today banks can say a $100,000 house is worth $200,000 and get away with it.

If you’re asking the question: should I invest in Canadian or US real estate, consider these facts:

• Real estate is overvalued by 64% and 30% when compared to rents and incomes, respectively.
• Our home prices are now almost double that of the US, yet we only have one-tenth of their population. Between 2000-2012, Canadian home prices went up 140%, while real incomes are merely up by an anemic 8%.
• The average Canadian household debt-to-income ratio just broke a new record at 165%: higher than the US record set in 2006 right before its crash. The increase in household debt as a percent of GDP since 2006 has been faster in Canada than anywhere else in the world!
• Canada’s price-to-rent ratio is currently 60% above its long-term average: higher than any other developed country in the world – even worse than the US was in 2006, just before their bubble burst!

Copyright 2013 Wealthy Real Estate Investor