Feb 22, 201112:00 AMMad @ Mgmt
with Walter Simson
I feel a drift
Mad @ Mgmt addresses the concerns of middle market companies, including banking, family & succession issues, turnarounds & performance improvement and economic life in general. Walter Simson is founder and Principal of Ventor Consulting a firm dedicated to middle market companies.
As the maitre d' gives the couple their menus, she says to her companion, "I feel a draft."
Five years after the demise of the Goldilocks economy, which was just right, we have the lox 'n' bagels economy, which feels a draft.
I'm thinking specifically of housing. More specifically, of our houses. I fear that their value will drift downward. The basics for this are a decline in household formation as unemployed workers move in with friends, and younger people stay home as they look for work or start their careers. Edward Glaeser of Harvard has written extensively on this.
Another factor is the lending environment. I don't have any current figures on volume, but anecdotal evidence is that lenders are taking longer on mortgage applications and requiring inconveniences before they lend. Inconveniences such as down payments, job histories, and proof that the borrower is not currently in the hoosegow. In the good old days, none of these were impediments to a good relationship with your mortgage broker.
The oversupply of houses for sale will not necessarily lead to equilibrium of houses purchased. But it will lead to equilibrium of houses for rent. And the rental market has its own logic, especially to smart investors.
In the old days, investors were making home purchases based on the availability of credit and the promise that upward housing values would lead to a profitable and quick resale. Now, since that is not possible, owners are renting out the home instead of selling.
The value of the home is becoming stable, and the rent needs to compensate for the expense and risk of the rental business. The expense of the rental business varies from place to place, but the bother doesn't. So people will demand a higher cap rate on the property.
"Cap rate" is the implied rate of return. If you have a property worth $100,000 and you pay $3,000 in taxes, a rental of $1,000 a month will yield a cap rate of 9%. The math is 9,000 on the top line, 100,000 on the bottom line.
Nine percent is pretty good. Compare that return to a $100,000 CD, which is about zero. But a good return means that either the rent is high, or the value is low.
Rents aren't moving – not much – but values are. Downward. So if a rented house is to be sold, it has to be sold at a price that provides a good cap rate. In my experience, a new prospective landlord minimizes, in her own mind, the bother of having a tenant.
But an experienced owner of a rental property knows that there is no minimizing the future bother of having a tenant. So cap rates go up, and rental home prices will drift downward.
When house prices go down, the people who have been burned (the sellers who lost money) imagine that prices will always go down. In the 1950s, the survivors of the depression warned their children not to waste money in a house. But it took that generation, just home from the war and ready to have a lot of kids, to take the plunge.
I imagine that in our communities there will be a similar long-term memory of the problems associated with owning a home. It may take years – when the kids currently in junior high school are starting families – to erase the memory.
But on a positive note, the proliferation of rental homes and the greater proliferation of bother will mean that, in the meantime, there will be a huge demand for people to manage rental properties.Sign up for the free IB Update — your weekly resource for local business news, analysis, voices, and the names you need to know. Click here.