Founder of Apartment Loan Store a Commercial Mortgage Firm. Author of “The Encyclopedia of Commercial Real Estate Advice,” Publisher- Wiley.
Imagine you are out shopping for toilet paper. You go to a large grocery and find the shelves completely bare. The manager says they are getting more in soon. Uncertainty is not your thing; you are relieved to find some (at an exorbitant price) at a convenience store. Darn, it’s the one-ply rough type you’re not fond of — but it’s yours if you want to pay three bucks a roll. Should you wait a bit longer to see what the large store gets in? Maybe it will even be the soft cushy stuff you like?
I know, it seems like a joke to compare shopping for toilet paper to shopping for real estate, but in today’s market, there are some similarities. Yes, really: Both are affected by the laws of supply and demand. Remember, the scenario above actually did happen at the beginning of the Covid-19 pandemic when toilet tissue became a rare find. And today, except for retail, office and hotel properties, there is a historically low inventory of almost all types of real estate for sale, pushing prices up. And instead of buyers waiting to find that property that really fits their practical, financial and aesthetic objectives, many opt to buy something that is far from their dream and overpriced to boot. Why? Because they are afraid if they don’t buy today, prices will only go higher tomorrow.
Why is it such a seller’s market right now?
According to realtor.com, housing inventory declined by 39.6% in 2020. This is huge and, combined with an increase in demand, has created unrealistically high prices. To add insult to injury, many owners who would like to sell have been hesitant to list their properties for sale. They seem to be worried about finding a suitable replacement property with so few to choose from and most being overpriced. And some think they will lose out if they sell today. They think prices will go up even higher if they wait. Compounding this, the pandemic has caused many sellers to be sluggish in showing their properties, hesitant to offer viewings to buyers who may expose them to the virus.
With mortgage rates still at all-time lows, you might think there would be an abundance of new construction starts. This would solve some of the problem by adding more inventory. But this is not happening, because there is nothing lenders hate more than uncertainty. We are talking about high unemployment, the number of properties in forbearance, the record number of tenants paying late or not paying at all and not knowing how long new properties will take to get occupied. So, with lenders calling the shots, loan guidelines are more stringent and loan-to-cost and loan-to-value ratios are lowering. This has resulted in many borrowers not qualifying and fewer residential and commercial construction starts.
MORE FOR YOU
How do you know if you are buying at the bottom of the market?
I’ve covered the four stages of the real estate market cycle and the best time to buy in detail for my book. Simply, the recession phase is followed by the recovery phase, expansion phase and hyper-supply phase. As the recession phase moves into the recovery phase, prices are at their lowest, foreclosures are at their highest and this is usually the bottom of the market — and the best time to buy.
We have been in the coronavirus recession for about a year now, and real estate prices should be coming down. In fact, we should be hitting close to the bottom of the market. But conversely, prices are still going up. This is likely due to this recession being an anomaly caused by a pandemic during strong economic times. Recessions are commonly caused by unrealistically high real estate prices during weak economic times, which causes the bubble to burst. High prices topple because they have been based on smoke and mirrors, or should I say the whims of buyers, sellers and real estate brokers. Ideally, they should be supported by growth in jobs, wages and GDP.
How do you know if you are buying at the top of the market?
If real estate prices have gone up because of a strong economy — we are talking about growth in jobs, wages and GDP — then you are likely not buying at the top of the market. But if prices are at their highest because of low inventory, and it doesn’t look like more will be coming online soon, this could be a sign that you are buying at the top of the market. After all, it is just a matter of time before there is a correction. Yes, the market cycle will change just as it always has. There will be new construction again and more properties put up for sale, causing inventories to rise and prices to come down.
Commercial and investment real estate have an additional factor. If you are paying a price that currently does not even come close to giving you the cash-on-cash return you should be earning, then you are almost certainly a candidate for buying at the top of the market. Be careful if you are leaning toward buying a property today that is overpriced thinking it will be worth more in the future. Does this really make sense? OK, if it’s in a great neighborhood with under-market rents and you don’t have to make many improvements to raise rents and you can achieve this in a year, then maybe yes.
Foremost, keep in mind that buying at the top of the market creates sellers who win and buyers who lose. Be clear about which side of this coin you want to be on. In other words, if the shelves are almost bare, don’t panic and buy a property because it’s the best of the worst that are available. Sit back and relax. Take the time to find the property that meets your practical, financial and aesthetic objectives.