Strategy for Owners of Investment Property,
Rent vs. Sell

Perhaps you've heard of owners who say they can*t currently sell their homes for what they think they're worth in this market and have opted for a strategy of renting their properties out until prices "come back" in a year (or two) at which time they*ll sell. This "rent and see" strategy seems particularly prevalent in the mid- to high-end of the market. Though no one likes to hear that their reasoning is flawed, it is for so many reasons.

First of all, the exotic loan programs and the liberal guidelines that fueled the stratospheric price increases that we saw from 2003 to 2007 no longer exist, e.g., the option ARMs, the No Doc, No Ratio, or NINAs (No Income, No Asset). Stated Income loans and 100% financing deals have also disappeared. The only vestiges of "times gone by" are the Interest Only loans, but those have more stringent guidelines, now.

Two years ago, a household income of $100k a year could legitimately buy an $800k home with almost nothing down and afford the payments using a Pay Option ARM. Now, to buy the same house, you need $160k down and an income of $200k a year. In the upper price tiers (just as in the lower ones) most people need to sell their old home for the down payment on the new one and carrying the mortgage payments on two properties simultaneously would render them ineligible for the new loan because of excessive debt-to-income ratios.

But in San Francisco, long thought to be safe-haven for housing prices, owners are resorting to renting out their properties. A real estate colleague I know sent me this note the other day that I thought bore repeating. He had been scouting relocation properties for an out-of-town associate.

"I walked through a beautiful home in Pacific Heights yesterday. It was listed at $6M about a month and a half ago. The price has been cut three times now and it currently listed at $4.95M. The amazing part is that the owner is now trying to rent it for one year (and I quote the agent) "and then sell it when the market comes back."

When I asked her what made her think the market would come back when rates were going higher, availability of credit was down, incomes were down, unemployment was up and willingness and availability of people to spend was down, she had no answer. Even more amazing was that we looked at four other properties in a similar price range and almost all of them had a similar strategy "rent it out for a year and then sell when things get better."

Because of the epidemic negative equity across the mid-to-high end, a large percentage of high-leverage exotic loans are still in place. In every case, the homeowner or Realtor managing the lease says "we want to wait a year or two until the market comes back". Why is there such feckless optimism that the prices of expensive homes will come roaring back or is it just wishful thinking? If not for interest only loans, Pay Option ARMs, stated income programs and 100% financing the mid-to-high end values would have never gotten there in the first place.

As was the case with the sub-prime market and the conforming tiers, the mid-to-high end housing strata are beginning to "have their day in the barrel". High-end communities are now experiencing the phenomenon of relative overnight re-prices.
Sales transactions have increased over the past couple of months, but largely because sellers are finally capitulating or desperate. The properties being sold now are either by folks with lots of equity who can afford to sell now and are doing so whenever they see market blips or by those that are counting on being able to steal the new house that they buy and they view their sale as a wash. Lenders still appear to be tight-fisted about approving short sales. And, just as was the case in the lower price bands, foreclosures are beginning to grow.

The relative overnight home re-price phenomenon that we saw in the lower price tiers in 2008 is now playing out among the higher end properties with alt-A and A-paper loans. As values fall, more borrowers fall into an incurable negative equity position, which leads to more loan defaults, increased foreclosures, a supply exceeding demand and ultimately lower prices. The cycle is repeated until supply and demand fundamentals neutralize. Eventually, prices will come down to a point where the market will clear. But we are still a long ways from that.

Bottom Line

There is a massive supply of quality single family residences for rent in California. So, rents are falling. Which begs the question why would anyone want to plunk down a $500,000 down payment with payments more costly than comparable rents in a falling market? Prices have much further to go on the downside. Homes in these price tiers (in California) are still 30% overvalued, on average.

Copyright 2020 Rod Haase.  All rights reserved.