Landlord Inflation/Deflation Leveraged Downward Debt Trap Spiral
Assuming you, the reader, are a homeowner with a 3-4% fixed interest rate, that doesn’t want to sell, now believe house prices are going down for many reasons into the future for reasons such as: layoffs, unemployment, higher rates and possibly higher inventory.
Let’s not forget comps are being repriced downward weekly as there are very motivated sellers liquidating to very few cash buyers such as:
Failed eviction moratorium
Because sellers don’t want to wait 7-14 years for a rebound in equity and house prices they have other better options to invest that money for retirement. Due to aging and health, many will outlive their money if they don’t sell now.
So much of the GDP engine of economy was from people doing cash-out refi’s on residential and commercial real estate at low interest rates only and that’s coming to a halt.
Going forward your house ‘s appreciation and inflation won’t save you from buying at the wrong profitable numbers upfront.
High interest rates will limit credit lending now, whereas low interest rates are what allowed housing to keep going up in price for the past decade, and made the buyers ability to pay easier.
Imagine house prices going down monthly for years and years
So for example: a landlord’s $300,000 rental property going down $3000 to $5000 per month in equity for awhile due to lower buyer demand because of higher interest rates.
The landlord can’t make sense of a rate/term refi going from a 3% to 9% interest rate because they’d have negative cash flow. Then multiply that negative cash flow by 5-10 properties.
If the landlord does a cash-out refinance to get access to $50,000 in equity to try to buy more time in the downward spiral with inflation burning their cash flow, that doesn’t last long with a monthly mortgage payment at a 9% interest rate vs. a 3% interest rate.
That $50,000 in equity gets eaten away very quickly once they cash it out, but they won’t even be able to cash it out soon even if they wanted to because remember house values are dropping by the month and comps are being repriced (marked to market, known as price discovery).
In addition, lenders will just keep lowering the Loan to Value % lower and lower as they become more conservative with each passing month with tighter lending.
Also lenders will want to see solid and very recent comps vs. loose standards of not even looking at the house inside like in recent years. It will be common for lenders to throw out the relevancy of comps and cut appraisal prices lower. For example a spring refinance appraisal isn’t the real world now
If the landlord goes 30 days late on one payment, forget the option of ever refinancing and tapping into that equity
Lenders don’t want to lend on late house payments
The reason is many investors who buy the paper won’t want to buy the collateral and paper after it’s refinanced.
Remember the last 14 years was just the fed buying the mortgage backed securities on the backend to add liquidity to the real estate market. That market seems to be gone now.
You can see some multi-family lenders require 50% LTV and with single family by the time you get to 65% LTV, cut appraisals and not counting some comps, it may feel like 50% equity needed and that doesn’t even count pulling out cash.
Will landlords have over 50% in equity with all of their leverage? In other words I bet most landlords debt leverage will be at 70 to 95% LTV.
So a landlord feels trapped that they can’t sell, or refinance. Selling into a competitive high inventory market also has competition and typically money has to be invested into updates of carpet, paint and more just to compete when selling.
Because in a competitive market the buyers have so many options. After $10,000 or $20,000 is put in for some updates to the property, it’s still possible that the investor, or landlord won’t sell for a price they want after dropping, so how do they also get that money back, it feels like a short-term gamble In a way.
What’s left as a painful option is to keep the property for years and manage what’s left to keep that $400 per month cash flow
But that $400 per month cash flow can quickly evaporate, here’s why:
-Labor is hard to find, plus high inflation
-Supply prices go way up with inflation
-Association fees go up with inflation
-Insurance prices go up with inflation
-Property taxes go up with inflation
Deferred maintenance really surprises landlords on longer cycles on very expensive items:
Eventually inflation and deflation causes a leveraged debt trap that spirals out of control if landlords didn’t buy for the right price upfront. Sometimes insurance claims & timing save the day on the expensive long cycle items.
So a landlords equity and cash flow slowly bleed away to zero. If landlords end up with no equity then they’ll need to sell on a short sale.
There is a real estate liquidity mismatch from the wealth effect of the past 10+ years
There is a Compounding effect and momentum on the way down this time.
Imagine 1.5% per month inflation + 1.5% deflation + compound less commissions as income and tighter lending happening in real estate. That’s 18% annually
Minnesota has less speculators, so it could be a little lower.
I agree that it’s a ‘staring match’ in real estate, locked-in ‘golden handcuffs’ effect, homeowners don’t want to sell then buy with high interest rates. But with competition from multi-family’s higher building inventory, about 750,000 apartment units being built, the most in 41 years, that could drive down rents from higher inventory.
Inflation will continue to get worse on food, gas, utilities, car repairs , labor, house repairs 2% + a month is more like it. So landlords will run up credit cards that get maxed out which are at 25-30% rates.
Now imagine people have $50k in credit card debt and don’t care because they think they have access to $200k in equity which will disappear very quickly. Plus property taxes and insurance going way up. Supplies and labor going way up for landlords also from inflation.
With Equity, imagine it dropping 1% to 1.5% per month on its own for awhile, landlords are less likely to sell, or refinance to get the appraisal they need, many buyers will wait around for prices to drop.
Due to real estate stalling and high rates, and no real demand, what we are now seeing is those that are in the commission part of real estate business, leave the business, or make far less transactions. The smart ones will grow, but many in real estate won’t make what they use to, so they will use or max out credit cards or HELOC’s. HELOC rates are doubling in rates. Imagine how many took out $100,000 or $200,000 in equity only to soon see much of that evaporate and be over leveraged and 1-2 years from now need a short sale.
Lender’s are tightening equity-
Lenders are going to take 100% LTV loans, or 70% Non Owner Occupied refi standards and lower them a lot, plus not count some comps and they will cut appraisals because the mortgage back security is collateral and they need it to be very strong in order to resell that paper in the markets. Getting to 50% to 70% LTV happens very quickly. This makes it hard to access your equity for a cash out, but would you even want to with interest rates soon at 8-8.5% owner occupied and 9-10% non owner occupied? What if you want to pay off 25-30% interest rate credit cards so that you don’t ruin your credit?
Rents could fall with all of the apartments being built (most in 41 years) and sellers sell due to, death, probate, divorce, default, foreclosure, inherited, etc. Because renters can now live in that new vacant inventory.
Vacant houses could go down from failed Airbnb’s, 2nd and 3rd homes, while we are in a recession with many job layoffs, that’s when people will be forced to liquidate
All numbers for most homeowners will naturally go in the wrong direction, unlike when equity and assets only went up for the past 10 years
Smart investors will position themselves and grow
When inventory, MBS (Mortgage Back Securities) start selling ‘mark to market’. A credit contraction will come and what compounds with tighter lending, is that lenders will want higher credit scores, more reserves, more comps, more recent comps, and more of a down payment, this cuts the buyers pool down to very little, freezing the credit markets a lot. Which is what we are seeing right now.
There is literally like 10 things overlapped all compounding organically in the tighter downward direction as rates need to stay high because of high inflation
I heard that the USA needs to keep interest rates high to keep a strong dollar because the U.S. dollar is being used as a currency weapon, against the rest of the world owing US dollar debt in our currency
The global debt liquidity crisis in now unfolding
Remember everything above is compounding, probably over 10 things all at once
Employers, other projects, invoices, all of that starts getting delayed, lender funding, all gets delayed and slowed down
But money for your bills are due today
Imagine someone buys a $700k rehab, or 3 smaller rehabs at a time, but they bought when rates were only 4.5% to end buyer financing and they bought with short-term hard money.
The buyers left fast with these higher interest rates, so the rehabber can’t sell easily after dropping the price. Now they have to get end long-term financing on all of their properties for sale, for which they likely don’t have the credit capacity with lenders.
So now the rehabbers find themselves renting out the properties with rents keep dropping down and adding even more supply and renting for $1000 less per month and draining their 401k’s, or emergency savings.
Investor’s weren’t ready for such a quick reaction of such a quick rate increase.
Just giving people a heads up, imagine housing much like 2006-2007, but
A slower market going down in value, probably less deflation, but nominally adjusted for inflation, It may feel worse, globally I think it’s for sure worse than 2005-2007.
ARM loans and subprime underwriting is better this time I’d agree.
The fed wasn’t buying MBS before 2008 last time so that could get interesting, since they subsidized the housing economy so heavily for the past 14+ years
Here’s what I’d like people to understand about this ‘great debt deleverage’ unfolding in the USA
People may get a 5% wage increase and see 8.5% CPI annual inflation, but shadow stats shows almost 20% per year for inflation. You are commonly seeing 50%-300% inflation on food, gas, car repairs, and utilities.
Earlier in the year it was reported that people were making more money with home appreciation then at their job annually for income.
This was called ‘the wealth effect’
Now that real estate is going down homeowners lost an extra income and actually added an expense as it continues to depreciate
The savings from this equity is evaporating and is too expensive to access for most homeowners with banks at these suer high interest rates
These higher interest rates lowers public companies profits and earnings and many will be let go with possibly millions of layoffs. It’s going to be like going from 3 jobs to 1 job for many. That’s 70% less income/equity coming in than when house prices were going up. The stocks and crypto are down 30% to 95% for your retirement savings.
Google zombie companies, 20%-25% of companies today only have survived the last 10 years based on artificially cheap interest rates which caused malinvestment and inefficiencies.
Do you know the % increase in wages on your job that you need to make up for this? For most there aren’t enough hours and action in a week to make up for this lost income.
Selling boats and 2nd cars are only temporary fixes. Hopefully your job is safe, but people are very over-leveraged.
When neighbors sell their houses for less, your house goes down in value even if you have a little saved up and an 800 credit score.
Imagine going from $200k a year (if you count home appreciation and you could cash-out refi your home’s equity) to $35k for one household income of gig work.
Imagine a family and household of 2 agents or 2 mortgage people with house transactions from lower demand down 50%, that’s 50% less in commissions and income.
Banks are going to tighten a lot more…
this means that banks want to see higher down payments, higher credit scores. More reserves and you’ll see higher rates to try to eliminate some of the risk on lending.
Banks will need to write-off a lot of bad debt, in the high billions of dollars in the near future from defaults
Forget the 8.5% fake CPI and 5% annual raise. That’s a tiny difference. This economic issue is way bigger than that
The fed was adding $115 billion to treasuries and MBS (mortgage back securities) liquidity monthly
The fed is suppose to reverse $95 billion per month. They won’t. That’s a $210 billion per month swing in liquidity in the economy, that’s hard to even put into any words
Liquidity is leaving the system quickly
Many mortgage people and agents will do 1/2 the transactions and will want to get creative because once house prices go down 30% that’s 30% less per transaction in commissionable income
Let’s do the math
30% less and 1/2 the volume
So $100k salary 1/2 the volume is $50,000
Then 30% less commissions from lower prices is $35,000 income
Again, 2 real estate people in one family is double the effect
$200,000 down to $70,000
How do you make up for $130,000 in lost income?
It doesn’t come from accessing falling equity that’s evaporating with an 8.5%+ fixed future interest rate on the horizon
Monthly bills and liabilities don’t go down 65% just like that, they stay the same
Unless homeowners go through a painful deleveraging process
Real estate is 17% of the GDP in the USA, it could affect 100’s of job types
Get creative to thrive and survive into the future
75 million Baby Boomers are retiring by 2030 and If real estate goes down for 7 years like it did from 2005-2012 that puts the decline to stop going down right as the last of boomer’s segment retire. We know that Boomer’s retiring are adding even more ongoing inventory soon after as many will be forced to live in group homes, assisted living, and nursing homes as alternatives.
Those in the real estate business that remain should learn:
Seller Financing (creative financing)
Rent to own
Contract for deed
Subject to existing financing
If you absolutely had to sell a home right now and buy another considering the real estate market could get really bad
What’s a good strategy you may ask?
Sell your house on a recorded contract for deed and get your max home price today. Then get a decent 10-20%+ down payment. Then use this income for your debt to income ratio with a lender (if needed). Then buy a duplex, triplex or four plex and live in one unit. Then Look for a low fixed rate
Sub2, CD, Rent to own, and refinance later when rates are low in the future. You may need a 5-7 year type of ballon term, in case it takes that long for interest rates to be low again.
Go with financing with a lender at higher rates as a worst-case scenario
In the above example, you are house hacking for a lower payment and also google ‘universal tax exclusion’.
It’s great that we don’t have ARM home loans like we did during the subprime crisis of 2007-2009, but 20-25% of companies are ‘zombie companies’ today that do have to refinance soon. These zombie companies aren’t profitable, and can’t afford higher rates and stay profitable, so they have to lay people off which is actually worse than a home ARM to homeowners in the bigger picture because It’s 50-100% decrease in household income from the major layoffs.
What about all of the homeowners with adjustable variable rate HELOC’s?
“Real estate investing takes zero expertise as the market rises and absolute expertise as it falls.”
We are seeing frozen credit markets where it’s “inflation on what we need and deflation on what we have (assets).”
As an investor, I would look forward to buying properties ‘subject to’ because no commissions, no loan closing costs and rates are historically low and locked-in.
Low interest rates were only artificial demand, the following example puts things into perspective:
For the last 10 years in real estate where you could just sell a home with NO marketing because of artificially low interest rates
If you bought and sold a house every year (10 houses for 10 years straight) as a flip rehab for profit and you lived in each one
If you then bought and sold with seller financing with NO agent commissions, NO mortgage commissions and almost NO title company costs and with hiring NO contractors and either scenarios of
multiple offers, or not
If you don’t count your payment to live there for the 12 months each year because you’d have to pay rent somewhere
You could have flipped 10 homes in 10 years for a nice profit on each home
And ALL you had to do the whole time was sweep a few things under the rug and have 10 profitable house flips
And nobody would have even noticed what was swept under the rug all along probably for 10 years
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