Housing Update - Rents Continue to Increase

From a July 2 article in the Wall Street Journal:
"Apartment landlords continued to push through hefty rent hikes in the second quarter, squeezing U.S. households that already are struggling financially after four years of steady increases.

The average monthly rent for an apartment rose to $1,099 in the second quarter, up 0.8% from the first quarter, according to data to be released Wednesday by real-estate research firm Reis Inc. That was the 18th consecutive quarter of rent increases. For the 12-month period ended in June, rents rose 3.4%."

This is good news for those who have been buying rental units since the real estate crash of 2008. Of course, it's not such good news for the tenants. Local factors influence the cost of rentals. However, the article pointed out that "Effective rents—which tend to be lower than asking rents—were up in all 79 U.S. metro areas tracked in the Reis report."

In other words, the rental increases appear to be geographically broad.

Factors Contributing to Higher Rents
It's all about supply and demand. Owning a home fell into disfavor when the "I'll get rich with my home" bubble popped. As we all must live somewhere and overall the population is increasing, there is a need for more housing. But we massively overbuilt for a decade, and when the bubble popped, builders stopped building while lenders and the government tightened lending standards. However, I have concluded that the primary problem we face today is the simple fact that home purchasing has fallen into disfavor. This has put pressure on availability of suitable housing and so rents are going up, and up. [Note: According to the U.S. Census Bureau the population has increased by 17 million since mid-2007.]

There has been a resurgence in home construction in the area. However, far too much is not affordable for the first time home buyer. Tear downs continue in neighboring communities such as Glen Ellyn and are welcomed by the municipal authorities as this guarantees higher real estate tax revenue. Geographically constrained, these communities can no longer annex property as Naperville did and so the next best thing is building a bigger, more expensive home on an existing piece of property.

However, higher rents are not simply about the cost of homes and condos.  It is also about the financial capacity of new buyers. That capacity, or ability to purchase, has apparently diminished in recent years. This is after factoring income, savings, debt and monthly expenses. Particularly hard hit are the millennials, or 20-somethings.

Caught in the "Permanent Debt" Trap
Many younger people now find that they cannot afford the things they want. After paying student loans and related debt, what is left goes to housing, food, entertainment and a car. Housing costs may be reduced by living with family. That may be prudent if that $1,000 per month is saved. But far too often it is spent on lifestyle options. 

However income is spent, there is apparently little left for amassing a down payment for residential real estate, or little interest to leave the nest. Some potential buyers discover there is are insufficient funds to cover the true cost of owning. For the residential buyer that cost includes servicing the mortgage, real estate taxes and maintenance.  For the condo buyer maintenance also includes HOA fees. While some think owning a condo is like owning an apartment, it isn't, While it is true that those HOA fees cover some of the things that homeowners maintain, there are a lot of items fees don't cover. For example, owners at BLMH are aware that their personal maintenance responsibility includes the HVAC system, water heater and fireplace. It also includes the unit plumbing and all fixtures, electrical, interior doors, floors and all windows and the patio door. 

There is a reason the units at BLMH may rent for $1,400 per month. It is not only because of market forces, but the landlord must collect at a minimum sufficient rent to cover all costs and make a modest profit.

Some who are caught in the debt trap realized that a home purchase was a mistake. Unable to escape the debt cycle they have foreclosed. Some have simply done the numbers and walked. Some have let the clock run out. Others who have recently discovered the full magnitude and consequences of their education debt have decided that the best solution is to press our politicians for debt forgiveness. What an elegant solution! Then the same people who overpaid for a college education can make another grand financial mistake, and buy a home or condo they possibly can't afford. And so the cycle continues. 

This is called the "debt trap." It is why the average personal debt of every man woman and child over the age of 16 in the U.S. today is about $10,000.

One of the consequences of that trap is more rental demand which has provided an incentive for investment buyers. Some people have snapped up condos and are now renting them. As is so true elsewhere, in housing there are winners and there are losers. Now, being a tenant is not necessarily a bad thing. However, paying $1,400 a month for life for a rental unit may not be the shrewdest financial move. Living in such an apartment for 50 years will require $840,000 even with absolutely no rental cost increases.

What About Your HOA?
Now the question that most owners in a HOA never ask is this "How many units are owned by offsite owners?"

I've made some predictions to members of the BLMH board about what the owners at BLMH can expect. I won't print it here, but let me simply say that some of our onsite owners, specifically those who think they live in an apartment complex, may get their wish.

Notes on Student Debt and Job Opportunities
There have been some recent changes to federal student loans. There are programs called Pay As You Earn (PAYE) and the Income Based Repayment (IBR) plan. I'm not promoting these, merely pointing out that they exist. I have great concern about deferment plans which accrue interest, add it to principal and then drive up the debt of the borrower. If this seems familiar, it was the ploy that was used to great success by the lenders during the housing boom. So "buyer beware" is in order or as I like to say "There is no free money." Regarding PAYE and IBR; the U.S. Department of Education website says "Most federal student loans are eligible for at least one income-driven repayment plan."  Clicking will open a New Window> IBR Plan

As you may recall, in 2008-9 there were articles about how college students were opting to continue to get a Masters or other advanced degree. The plan was to ride out the bad economic times and get that swank job when the economy improved. At the time there were caution flags raised and I was of the opinion caution was in order and such thinking was overly optimistic and short sighted. Yes, continuing in college for another two years does give a student somewhere to live and something to do. On the other hand. that approach does carry risk and can be very costly. Not only is work income lost, but the total costs of achieving that education increases. The plan was based upon the assumption that the skill gained would be of increased value and the economy would be much improved in two years. With that enhanced education the student would finally graduate and get that dream job. Ah, yes, the "build it and they will come" mentality.

This type of thinking assumed that the cost of borrowing for college would be more than offset by a much better job. Not only did many of those jobs never materialize but on graduation the student discovered that they now owed far more in college debt, in the form of student loans and credit cards. Some found they have a serious skill-employment mismatch. For example, there is only so much one can earn in certain specialties. This is again an issue of "supply versus demand."

The Real Costs of Higher Education
Of course, the real cost of pursuing that higher degree is more than simply the out of pocket costs. That two to four years spent pursuing an advanced degree is time not spent earning and saving for retirement; it represents several years of lost income. It may mean working longer in one's lifetime to amass sufficient retirement savings. "That won't be necessary" or, "It won't happen to me" say the optimists. Yes, just as some believed that more education would provide a stellar job, and they would then be better able to manage their debts.

When considering an education it's prudent to look beyond "What do I want to do and where do I want to go to school?" An important question is "What will make me employable?" It's also prudent to consider education as preparing one for a lifetime of work. Not a year or two or ten. Spending 4 to 8 years in college as the final step in acquiring a useful job skill is an expensive proposition. Particularly expensive if the job evaporates in 5 years, or does not provide sufficient wages. "A living wage" is a wage relative to gross income minus all costs, including debt. Graduate at 25 and plan on retiring at 60? That gives one 35 years to pay off any debt, get the things one thinks they need or want, and save for retirement. 

There are many resources available to help plan a career. I for one am skeptical of guidance counselors provided by the schools. After all, those counselors are possibly biased in their assessment or have limited real world experience. I am an advocate of co-op programs, wherein the student works in their chosen field while attending college. This may require giving up those relaxing summers, and it may take an additional year to complete a four year program. On the other hand, costs are not necessarily higher as alternating semesters are spent as an employee, and real cash is earned. 

Another resource is the U.S. government. The U.S. Department of Labor publishes data on careers, hiring practices and wages for everyone from doctors to entertainers. There is simply no excuse for making terrible education decisions. These statistics are what parents and students should be tracking year by year, and educational decisions should be based in part of the ability to pay back that education AND earn a living wage. Reported mean wages range from $9.07 to $113.01 per hour.    Clicking will open a  New Window> Occupational Employment Statistics. This link provides detailed data by occupation

Real Estate Update Spring 2013

It's that time for a real estate update. Some continue to be discouraged because current prices haven't "snapped back." There are a lot of simple, common sense reasons for this.

There have been signs of life in residential real estate in Northern Illinois. However, while prices in some parts of the country have upticked in recent months, not all communities have experienced this. Yet, there is brisk sales activity in some communities. One nearby community has had 649 sales in the last two years, with only 251 currently on the market. In Wheaton, 1747 homes have been sold in the last two years, with 451 currently on the market. Prices are up about 6.4% over the previous year. and seem to be increasing.

Interest rates are the best they will probably be for some time to come, and have begun to increase. 30 year conventional mortgage rates with 10% down are running 3.5% to 4.3%. It's been reported that new home construction has reached a point where there have been shortages of some materials, prompting manufacturers to open idled assembly lines for such things as plywood. According to the National Association of Home Builders as quoted at Morningstar April 15: "Many builders are expressing frustration over being unable to respond to the rising demand for new homes due to difficulties in obtaining construction credit, overly restrictive mortgage lending rules and construction costs that are increasing at a faster pace than appraised values,"

Inflation is relatively tame and that should keep interest rates low. However, this trend with inflation running 1 percent or more below long term averages will not continue. In fact, all that it will take is some sort of Middle East or North Korean episode and all bets will be off.

All Real Estate is Local
That's an important factor to keep in mind when listening to things such as the Case-Shiller home price indices or the statistics of the National Association of Realtors. Here's an example. Chicago's home market is struggling as it loses population, and yet a friend who is attempting to purchase a home out here, west of that city, has found that there is some serious competition for homes! He was looking for a home in 2005-6 but decided prices were too high, and we both agreed the economy was too fragile.

Since 2005 he's been sitting on the sidelines, saving and renting. After 8 years he decided that this was the time, and last week he put a bid on a home new to the market, but found that one day after listing there were three bids ahead of him, and one was for a price about 20% higher than the asking price.

That was an interesting development, and he stated after looking for a month that a lot of the better properties are moving at a fast pace. It's been reported that banks are beginning to release more foreclosed properties.

So why did he decide to take the plunge now? For one thing, and this is most important, he can afford to buy a home. He was pre-qualified by a bank for a mortgage and began looking only after he had decided how much "home" he was willing to buy. Currently, mortgage rates are increasing, home prices are increasing and rents are increasing. He's decided that it's time to make a modest change and he expects that he will "break even" in 3-5 years as compared to renting. He's of the opinion that residential real estate will only get more expensive from here.

Yet, prices remain off of their 2006 highs and in general are about 20% off of the peaks in Wheaton. Some are apparently waiting for a return of the "good old days" when we paid a lot more for a lot less home!

Factors Governing Home Sales
Prices are low, so what is the problem? In a nut shell, too many cannot afford a home. For another, there are an awful lot of short sighted people out there. For example, they'll trade in a used car for a new one carrying a 96 month loan. How expensive is this? A recent article in the Wall Street Journal mentioned such a buyer who was paying $36,000 for a $23,000 Toyota Camry!

My point is anyone who is willing to spend $13,000 extra to buy a car in this way is not going to have that money available to purchase a home. How much is $13,000?  It's a year of rent for a modest dwelling.  It could nearly purchase a new Honda Fit for $16,000 or it could fund a Roth-IRA for 2-1/2 years. It's also a 13% down payment on a $100,000 dwelling.

While some complain that a home is a terrible investment; home ownership was never supposed to be an "investment." A home is a place to live as an alternate to an apartment. Anyone who prefers to flush their income on more car than they need, or questionable car deals, etc. probably doesn't have the financial skills necessary to budget, save and purchase a home.

Here is a list of financial impediments to buying a home:

• Student Loans
• Revolving Credit debt including credit cards
• Auto loan debt
• Poor credit history or low credit scores.
• Lack of savings
• Poor financial and budgeting skills. 

All of the above reduce the purchasing power of the individual. While FHA will allow a home loan as high as 41% of  income, many financial planners recommend spending no more than 30% of one's take home pay to purchase a home. That 30% includes the mortgage, taxes and insurance. If a condominium, it should include fees and assessments.

A Tale of Two Economies
We continue to hear about high unemployment, and yet we also see the stock market hitting new highs. What's going on here?

I'm of the opinion that we now have two economies in the U.S. There are people with cash and retirement accounts who are employed and relatively debt free. Then there are the rest.

Contrary to some of the statistics, most are working, many do not carry excessive credit card debt, and so on. When we read that average credit card debt per borrower is approaching $5,500 that means that some have $0 credit card debt while others have $11,000.  The actual statistics are worse. The average household credit card debt is about $15,000. in other words, some households have $0 credit card debt, while an equal number have $30,000!

Average interest rates on credit cards are about 14.9%. That household with $30,000 credit card debt is paying $4,470 per year in interest! Add a 96 month car loan, and it's reasonable to assume that a home will not be a possibility for 8 or more years. Of course, in 8 years when that car is paid off, the individual in this example will probably buy a new car. Perhaps sooner. And so the cycle of debt continues.

Here's a graph that illustrates the problem. It shows household debt payments as a percent of disposable income. It peaked at a little over 14% in 2007 and as of October 1, 2012 had decreased to about 10.4%. I understand it has increased since October. It's again useful to realize that these are averages. Some households have 0% debt, while some have 21% payments. For some households, this is more than 41% of their income!

An Absence of New Buyers
The major problem is the absence of new buyers. For the reasons stated, many cannot buy a home, and a few could, but have decided not to. That is a significant change in the home market, which saw annual percentage increases since 1945.  Back then about 45% owned a home. By 1990 it was about 60% and today it's about 70%. How did that happen? The government in an ill planned move, decided that "we should all be homeowners." That decision was good for the banks who make the loans, good for the construction companies and workers, good for the realtor estate brokers, and good for all kinds of manufacturers who provided the goods and services that are necessary for a new home.

It was unfortunate, but to entice more and more buyers into homes, the government made it ever easier. 0% down loans, reduced requirements to get a FHA loan, and so on. This had the desired effect as more could buy a home. It also opened the flood gates to all kinds of questionable and unsustainable practices, including "liar loans."

So where do new buyers come from? From the young. Interestingly, in the age group 20-24 about 35% own their homes free and clear. At the other end of the scale, about 25% of retirees own their home. Currently about 70% of us do live in a home or condo and have a mortgage.

Another disturbing trend of the 2000's? A lot of people used their homes as a "piggy bank" and took out large mortgages. Now, at 65 when they should be reducing debt, they find that they continue to pay a mortgage from their social security income. Well, it was fun while it lasted, and they can take solace from that fact that a lot of banks prospered from these loans!

The largest group of possible new owners are younger people. However, it seems there is a concentration of younger people who have excessive debt including student loans. Others in that age group have been struggling to get a job at a wage that matches their skills. Younger buyers are usually a peak market for home purchases. Today it's been reported that older people who have amassed cash through years of savings are purchasing second or third homes. These are considered true investments and alternatives to that 1% CD, bonds paying 2% and the foibles of the stock market.

Sometimes, people use the term investor as a dirty word. I prefer a more simplistic view. There are savers in our society and there are spenders. Those who save accumulate wealth and then have the problem of determining where to put those savings. Some will fund a Roth-IRA for retirement, some will be parked in a bank as a 6 month emergency fund, and the rest? Most savers have learned through trial and error to live within their means. No fancy car, no McMansion, no iPhone and other toys. Savers will accumulate 10% of their annual wages. Super savers will accumulate more. Over 40 years, that's $2 million or more. That is why the Obama administration is now promoting limiting the retirement savings of "super savers." Better it be spent on junk, or anything that the government can tax.

It's interesting, but older people are buying homes as investments which they will rent to the younger people who shun them! The current situation is somewhat reminiscent of portions of DuPage County in the early 1980s and New York City in the 1970s. A lot of people bought real estate as an investment at that time, and have done quite well from the rents collected and the appreciation of the properties.

Today, we again have two distinct groups. Those who have saved and are looking for a place to invest it, and those who would normally be buyers, but cannot or will not because of high debt, disinterest, or poor financial skills.

Can I Afford a Home or a Condominium?
Here are some sample figures for a rock bottom home in Wheaton with a price of $100,000 and nothing down. This is a best case example:

• Annual mortgage at 4.0% = $4,512.
• Taxes: $3,153.
• Mortgage Insurance (PMI): $500.
• Home Insurance: $500.
• Total = $8,665 per year.

Using the above and assuming the cost of a home represents 30% of one's take home pay, that means that anyone who takes home more than $29,000 a year should be able to afford such a home. Of course, finding something suitable for $100,000 may not be easy.

Condominium prices have been lower than home prices and there are condos in the Wheaton area for $100,000. Here's an example for a condominium:

• Annual mortgage at 4.0% = $4,512.
• Taxes: $3,153.
• Mortgage Insurance (PMI): $500.
• Home Insurance: $500.
• Condo Fees at $250 per month = $3,000.
• Total = $11,665 per year.

Using the above and assuming the cost of a home represents 30% of one's take home pay, that means that anyone who takes home more than $38,900 a year should be able to afford such a condo.

Here's a current graph of the interest rates for a 30-year conventional mortgage from January 1, 2000 to March 1, 2013.

So What's the Problem?

The problem?  One thing that might be holding some back is reality. You can't get a McMansion for $100,000. Another is student debt, which is rising. Student Loans exceeded credit card debt and approached $1 Trillion in 2012! This figure ignores the fact that many college graduates not only get a sheepskin for the wall, but walk away from that 4-year university with significant credit card debt.

Here's a current graph of consumer credit:

Recent school graduates or new families comprised of recent graduates have traditionally been a source of home buyers.  However, when these new families are strapped with college loans, credit card and new car debt, they are sometimes automatically disqualified from obtaining a home loan. 

Here's a partial list of the impediments to purchasing a home or condo:

• The glow is off of residential real estate.
• Many possible first time buyers would prefer to rent
• Many first time buyers have too much debt to qualify for even the simplest home FHA loan.
• Some would rather buy a new Toyota Camry for $36,000.
• Lack financial skills. 
• Short term thinking. 

Am I Being Too Harsh?

Not at all. Simple arithmetic indicates that one can buy a small abode for $100,000 and if the costs are compared to even basic rent at $1,100 a month, the cost to buy versus rent is better after 2 years.  Yes, you did read that correctly. One can buy something for $100,000 today, and the break even as compared to rent is 2 years! Even a condo with $300 monthly fees will break even within 4 years!

Of course, after that break even point, the owner finds that they are accumulating some equity and are financially ahead, and that is comparing a 3% annual rent increase and a 2% annual increase in home value. 

Is a 3% annual rent increase realistic? Here's a chart from the St. Louis Federal Reserve. 3% annual increases may be a bit too low!

What's the Big Problem?

I suggest that one of the impediments to purchasing a home is financial skill and literacy. This begins at an early age, 16 or younger. By the time the average graduate, who is supposed to be our "brightest" has exited college, they carry with them an average $30,000 student loan debt. In other words, some have $0 debt and some have $60,000 in debt. Add to that credit cards and the auto loan. Some have dubious degrees and will take decades to earn enough to live and pay for those school loans. Some did not understand that college is not an alternative to working. It's a part of a long term education to prepare one for 40 years of working and saving. 

So Who is Buying Today?

To repeat, one of the sectors fueling the real estate market is investors who are dissatisfied with the 1% they get in CDs at the local bank, and the perceived risks in the stock market. 

Real estate is cheap today, and it's very easy to get a 35% return on investment in rental real estate. I'll say that again. A 35% annual return. So would you rather put your money in a bank at 1%? Apparently, many people have decided otherwise.

"Investors" with good credit and who can put down a sizable down payment have recently gotten 15 year mortgages for 2.2%! 

Alternative Perspective

The bottom line about buying a home is this. Can we afford it?

 Even Suze Orman has gone on the record and apologized for steering us into owning a home. Back in 2011 she said "The American Financial Dream is Dead." Orman has since promoted renting. But is it really that bleak? Here's a video from 2011. She states the problem very well.

Oh, by the way, the government in order to pay for all of those failed mortgages via FHA, has recently increased the requirement for Private Mortgage Insurance. For mortgages with terms more than 15 years, the annual mortgage insurance premiums will be canceled when the Loan to Value ratio reaches 78 percent, provided the mortgagor has paid the annual premium for at least 5 years. In other words, a FHA borrower will be required to purchase PMI until almost 80% of the loan has been paid off!

The Bottom Line

"The impact of low mortgage rates is profound. Before the Fed began buying mortgage-backed securities in late 2008, rates for 30-year fixed mortgages stood at around 6.1%, and a borrower who could qualify for a $1,000 monthly payment could get a $165,000 mortgage. Today, that same borrower, at a 3.5% rate, can borrow as much as $222,000. In other words, the Fed's low-rate campaign has increased purchasing power by a third." From The Wall Street Journal April 7, 2013

According to that same article in the Journal "The housing sector is finally healing. But the sector may be in for more volatility until there is more demand from—and credit for—people who want to buy homes that they plan to live in."

Yes, people can buy more home at current low rates. However, these rates also allow buyers to get a home at a lower annual cost. Using the above example and the figures from the WSJ, one can buy that $165,000 home for a monthly mortgage payment of about $750. That's a reduction of $250 a month to pay taxes or PMI insurance. Yet, there is a call from some for more government intervention to make homes even more "affordable." We've been there and done that, as Suze Orman says, and we know how it turned out, don't we?