Is There an Impending Real Estate Crash?
Photo by Jilbert Ebrahimi on Unsplash
Yes, according to the "experts." In fact, "experts" have predicted a crash every year since about 2013. Note that I quoted "experts." These "expert's" opinions are distributed through the "news." I also quote "news" since what is represented as "news" is typically the writer's and or editor's political opinion, curated to cause fear. After all, fear stories get viewers. No one wants to hear about things that work or are going well.
How accurate are the "experts" opinions you read in the "news"? Below is just one example of the quality of the "news". This was from the Wall Street Journal
"Nearly a third of U.S. apartment renters didn’t pay any of their April rent during the first week of the month, according to new data to be released Wednesday by the National Multifamily Housing Council and a consortium of real-estate data providers."
The following is a statement by Scott Trench, CEO of Biggerpockets:
Does anyone reading remember when, in early April, a bunch of big time news outlets reported how "NEARLY A THIRD" of American renters didn’t pay April rent? Well, those headlines got a lot of clicks and some good discussion going on BiggerPockets, but the fact of the matter is that the biggest reason for that drop in April rent collections was that we were comparing rents collected April 1-5, 2019, with rents collected April 1-5, 2020. April 4th and 5th were Saturday and Sunday in 2020. Banks are closed on Sunday.
Oops. False alarm. The real estate market didn’t crash, and doomsday did not materialize.
In my experience, "experts" are only slightly better than rolling dice. Plus, they give opinions at the national level, but we live in a single state and city. For example, what the "experts" say may apply in New England but maybe wrong in Texas.
Back to the question at hand, will there be a market crash in the foreseeable future? I don't know, and neither does anyone else. However, I will provide what I believe to be compelling reasons why I do not see an imminent market crash in Las Vegas. Before I continue, my opinion on all predictions.
Predicting anything beyond yesterday is guessing ... Eric Fernwood
That said, below are my views on the current Las Vegas market and the foreseeable future.
Are we on the verge of another 2008?
No. The current market is different than 2008. In 2008 we had a combination of "liar-loans," nothing down loans, and a massive run-up in inventory, and the Fed, without warning, tightened the money supply, which caused Lemmon Brothers and others to crash. None of this exists in the current market. In fact it is quite the opposite today. However, let's pretend that there will be a 2008 type crash tomorrow. How would that impact rental properties in Las Vegas? It will be devastating for investors who own C and most B Class properties, just like in 2008, because their target tenant pool will likely lose their jobs and not pay the rent. However, our target tenant pool was selected because they stay employed, pay the rent, stay a long time, and take care of the properties. Therefore, our clients' properties will stay rented.
Why does our target tenant pool remain employed when other tenant pools do not? Below is an over-simplified look at three categories of tenants.
- Transient Renters: Low-paid hourly workers are the first to be laid off in times of economic trouble and the last to be rehired. When you hear about tenants not paying the rent who cannot be evicted due to the COVID moratorium, this is the group. These are the primary tenants for C and most B Class properties. Typical stay, one year.
- Permanent Renters: Either hourly or salaried and, while relatively low paid, they generate a large amount of income for their employers. No company lets these people go unless they are closing the business for good. Rental income security is why we selected this group to target. Typical stay, five years.
- Transitional Renters - Higher-end salaried workers. These are people who make enough money that they normally buy a home. However, due to some event in their lives, they decide to rent for a year or two until things are sorted out. Also, while not as vulnerable as low-end workers, many have jobs that are not direct income producers, so many were laid off. Typical stay, two years.
But what if a crash occurred? There are two concerns for real estate investors. One is a decreasing market value of the property, and the other is a loss of rental income. These are very different issues.
- Market value - This is subject to national and or regional trends. And there is nothing you can do to protect a property's market value from the national economy's whims. (All boats rise and fall with the tide.) When market value decreases, you will have less equity and fewer options to tap into your equity to finance more investments.
- Loss of rental income - This is usually the most critical factor. The last thing people need during times of economic stress is a vacant rental property. How did our tenant pool fare in 2008? During the 2008 crash, our clients had zero change in rental income (no decrease, no vacancy).
Below are two charts showing how market prices and rents fared for properties that conformed to our property profile (rented to our target tenant pool) during and after the 2008 crash. Before the 2008 crash, conforming properties were selling for an average price of approximately $120/SqFt. By 2012 the average price fell to approximately $70/SqFt.
Below is a chart showing $/SqFt rental rates for conforming properties for the same time period as the above.
As you can see, our clients rental income was not impacted by the crash.
How about now (COVID)? Despite the virtual end of tourism in Las Vegas for some time, only a minimal number (<10) of our tenants have had problems paying the rent on time.
Below are three factors to consider when looking at the Las Vegas market for the foreseeable future.
Increasing number of jobs - Rental properties are no better than the jobs around it. Today, there is still about $24B under construction in Las Vegas, with more announced. For example, the $1.2B Google data center, new Amazon facilities, new hotels and resorts. All these new facilities will create thousands of new jobs, which will bring more people to Las Vegas. These people will need housing, which will continue to drive up prices. Most of these jobs are conformant with our target tenant pool, so we believe that rents will continue to increase for the foreseeable future.
Rising demand - New jobs will bring more people to Las Vegas. These additional people will need a place to live, which will continue to fuel demand driving up prices and rents. Fortunately, the Las Vegas population growth continues at a very sustainable 2.5% to 3% annual rate. I hope that all the R&D continues moving to Austin and similar places, and that infrastructure moves to Las Vegas. For example, the $1.2B data center Google is building in Henderson. I have seen companies lay off thousands of engineers and software developers on a single day, but no one walks away from infrastructure, like a $1.2B data center.
Land shortage - I have never heard of a situation where an increasing amount of money chasing a limited supply where prices do not increase. The shortage of developable land in the Las Vegas valley creates this situation. The GIF below shows land consumption up to 2018. As you can see, most of the land has already been developed. This land shortage combined with an increasing population almost guarantees that prices and rents will increase.
This is not 2008. In 2008, all properties were under water; foreclosure was the only option. Today, almost all properties are above water. If people get into financial trouble today, the majority will sell their homes, pocket the profit, and rent a place to live. How serious is the distressed property situation in Las Vegas today? I searched the MLS for distressed properties:
- Bank owned: 20
- Short sale: 19
- Foreclosure started: 7
Not a significant percentage of all available properties.
Is the market over heated? - Housing prices for Las Vegas are still well below the 2006 peak prices. See the chart below. If you ignore inflation, prices have almost reached the 2006/2007 peak. However, inflation is real and must be considered. $143/SF in 2008 dollars is the same as $174/SF in 2020 dollars so there is still a long way to go.
What about oversupply like in 2008? - The chart below shows the historical months of supply for all single family homes (both new and resale). You can clearly see the massive inventory run-up in 2006 before the crash (90 months of supply!). Today, the rolling 12 months average is just under 2 months.
What about the eviction moratorium extension? - The CDC extended the eviction moratorium through June 30. What does this mean for our clients? Almost nothing. As mentioned earlier, only a minimal number (<10) of our tenants have had problems paying rent on time due to COVID. Most of them have caught up now. For owners of C and most B Class, this is a serious problem. Why is it not a problem for our clients?
The tenant pool we target is not so much concerned about the physical act of eviction, moving. What they fear is a credit hit. Our target tenant pool is credit-based. They know that a late payment, let alone an eviction, will hurt their credit for years. Also, if they have an eviction on their record, no property manager will lease an A Class property to them. Their only option will likely be to rent a C Class property in a much less desirable area. So, moratorium or not, they pay the rent on time. Our target tenant pool's credit-based nature is why we have had only five evictions in the last 15 years.