The Prices Come Tumbling Down

Some years ago I came face to face with a competitor over a Menlo Park Listing.  The owners were from Oregon.  They had owned the property for some time.  They were faced with updating and correcting many problems that would put them in violation of the Landlord/Renters Act if not repaired.  When they faced the costs of updating the house and property and rent the recapture rate was too far out based upon their age.  They opted to sell.

The agent I had known from his association with another Brokerage Firm of national recognition.  He was now an independent.  Going independent was not something new.  The real estate brokerage firms at that time had a scale of payouts based upon production.  The more the agent produced the higher the payout.  The exception to the rule were the agents who consistently were larger producers.  They got the highest payout both realtor and brokerage could agree upon.

The realtor made a proposal that put me back.  "I will buy the property, all cash, close in 10 days or at your discretion, no commission, no inspections, no state and federal regulatory forms. " 

I had the standard of disclosures, 5% commission, inspections, marketing plan and price based upon similar properties both active and sold.  I LOST.

The sale went through under a 1031 exchange.  The couple went back to Oregon. The realtor used an LLC, sub-divided the property, built two homes and eventually sold them for 4 times his purchase price.

This was my first introduction to the Fix & Flip buyer.  Coming from the investment community the concept of creating value from building and remodeling was not new.  But seeing it applied to residential single family homes was an eye opener,

Soon, this type of buyer began to proliferate the market place.  Realtors began to go independent and began prospecting as they did when they were with the major Real Estate Brokerages.  This time it was for themselves.  There were and are firms who will process a transaction for a minimal amount of money leaving the agent with well over 90% of the commissions.  If no commissions the cost of the transfer could be done directly with a local title company.

Sensing a change in the market banks and lending institutions began to offer construction contracts to the Fix & Flip buyer.  Terms were fairly easy.  70% of improved value loan required a qualified Broker Price Opinion of what the property would be worth when completed per a formal written opinion.  This started a new source of business that had gone idle after the Lehman Crash and the various Volker Rules.  The terms of the loans all varied by the institution but all were similar in the end.  Once the occupancy permit was issued by the City of County, the loan was due and payable within a set period of time. 

The search began for target properties. like any other realtor  The easiest target were the properties east of Highway 101.  Most were in lower income areas, many were rentals and many were in neglected condition.  Covid accelerated this market as the rent holdouts and foreclosure protection put the Mom and Pop landlords financially tight positions.  When a buyer sent out letters of all cash, no commissions and inspections there were responses.  The renters got Cash to vacate their back rent debt forgiven, the seller got out and what was left was financial opportunity.

This upset the statistics from reality.  The purchases did not show up in the multiple listing services.  Realtors did not see sale and the media only saw what was listed.  The assumption was no sales, lack of inventory was mistaken.  There was a very active "Dark" market outside of the MLS system. 

It was not too long for the major real estate firms to realize the game.  They too got into the game by working with large builders and buyers of income properties.  The negative to this was they still wanted a commission.

The Federal Reserve was pumping money into our financial system in record amounts with the total being around $9 Trillion.  A great deal of money seeking investments.  All types of Risk Assets soon saw astronomical rises.  New assets came about through the invention of technology and Wall Street Banks.   What was missed was the large source of funds available to the old stand by....Real Estate and a new buyer community.

Areas like East Palo Alto,East Menlo Park, East San Mateo saw a dramatic change in their character.  The character change was influenced further by the development of the Facebook Campus, and the numerous start ups that allowed inexpensive housing in the Cal Train Corridor to prosper.

Compared to the homes of Palo Alto, Menlo Park and San Mateo, Hillsborough and Burlingame; these homes were cheap!

All good things come to an end.  The FED increased interest rates to stop inflation, the virtual workers movement from working from an office had an impact on demand.  Higher mortgage rates put many homes out of reach.  Fortunately the homes East of 101 were still affordable.   They continued to move quickly.  This kept the flow of funds to pay off bank loans profitable to banks and lender alike.  The over bids continue in these comparatively low priced homes.

As rates increased soon the fear of Recession began to become a new conversation item in media.  Silicon Valley firms began to layoff employees and many accepted the virtual employee.  The virtual employees found small towns of Californai very acceptable.  El Dorado Hills became a community of young people with families and affordable homes, as many of similar communities have today.  Even the luxury market buyer found gated communities in Loomis and Granite Bay far more affordable than Atherton, Los Altos, Menlo Park, Woodside, Portola Valley or Hillsborough.

PRICES COME TUMBLING DOWN

Sooner or later it was bound to happen.  Fear of Recession, inability to qualify to higher interest rates and pure simple fear of the future has caused price cuts of listed homes and sales price below list.

The pressure is now on the Fix and Flip buyer.  The banks all want their money within the terms.  There is no way to not evade the due on completion clause.  "Notice of Foreclosure" is now popping up.  Deed in leu of legal foreclosure keeps the property out of legal proceedings.  The bank sells the property and if there is anything left over it goes to the borrower.

As the FED raises near term rates mortgage rates increase.  As mortgage rates increase the pressure is on the buyer seeking finance.  Will they qualify.  Offers will all be subject to financing and appraisal.  Inability to pass will find the property back on the market.  All cash buyers will be faced with higher savings rates and the question is will the price come down and will I be wise to get higher interest on my cash balance than buy?

Sellers will have two choices:take the property off the market, wait, or cut the price and sell.  There really is no choice.  Cut the price and sell.  The price in the future will or could be lower.  To  the buyer it is opportunity.  The price is lower, the rate will be fixed and if they wait a lower price is not that much an advantage as the higher cost of the interest rate on the mortgage.

To the Fix and Flipper, the pressure is on.  Foreclosures are most certain for the novice who will hold out think the market will pop back.  Once the REO market returns buyers and investors will return.  To the average buyer this is a market they are restricted from. There is not bidding at the court house steps, sale occur between banks and well qualified buyers who will buy direct; without MLS REO listings.  To those who want a home put your offers in at what you can afford. 10% under the list or more.  The sellers of Fix and Flip have little choice.

I don't see much outlook for sellers in this market.  The speculators need to be washed out before our market returns to what it was before the FED flooded the economy with cash!

RENT DOMINO FALLING?

Rent is a function of value.  Consider the rent like interest you receive on an investment.  When interest rates rise and property values fall, rent cannot stay up!  Silicon Valley rental yields historically are about 3% of property value.  That means if you are renting a 3 bedroom, 2.5 bath house for $5000 per month the value of the house is $2.2 million.  If the prices of homes weaken the 3% remains the same and the rent declines.  

There is competition of rent to owning a home.  Rent can't go beyond the cost of home ownership. There is always a premium a buyer is willing to pay once they were a renter.  The corporate property owner is generally an apartment building.  Turnover occurs and rents rise on a regular basis.  The single family home is generally a "mom & pop" situation.  They will normally collect rent and repair the structure and most cases take care of the water and landscaping expenses.  They don't raise rents annually, but they are difficult to come immediately to make repairs.  When there is a property manager, he too will be difficult to get to work on the property if it becomes apparent there is a substantial amount of deferred maintenance.  The property manager usually get a 6% annual fee for their work.  Once the calls become more often then spend more time and make less.  At some point the property manager would rather ignore the requests and get the renter to move.  Property Manager and Owner win with a higher rent and a higher % fee to the Property Manager.  

Rents are not that easy to monitor.  This is an off the grid type of market.  Signs in the window, postings on Craig's List and Zillow or Zumper or another such service and no fees to a realtor.   Once it rents there is no notice of the rent agreed upon.  It becomes a word of mouth situation of a private under ground of real estate agents.  Today, prices are coming down.  Competition out of the area pulls rental prices down as does the value of the home.

This is all a part of killing Inflation.  The FED is committed to killing inflation so rents and home prices must go down.  This is opportunity.  The home buyer is the greatest benefactor than the renter.  Home prices will once again increase once the FED has killed inflation.  Home values will see value from accretion of equity from mortgage payments of principal and interest added to the increase in property value over the next 10-20 years.  Renters will still fight with landlords and land lords will want to get the most for as little cost to them.  Interest rates on mortgages today will be cheaper than in the future.  Whether the price of the home goes down further is of little consequences when the cost of the mortgage remains fixed and at a lower rates than the future market rate as the FED raises rates or shrinks money Supply by either selling FED inventory of bonds or letting them mature without re-investment the proceeds.