What I deem a perfect storm is a set of circumstances that occur once, maybe twice in a lifetime that offers unparalleled opportunity to purchase undervalued real estate at unnaturally depressed prices. There was one similar opportunity in the late 1980s, early 1990s when the RTC (Resolution Trust Corporation – a government-run entity used to liquidate primarily foreclosed commercial assets) had one of the biggest fire-sales of commercial real estate in US history. This was a time that fortunes were made in the acquisition of overly distressed real estate assets. At that time, the market collapse was caused by 3 main factors (1) change in US tax laws affecting real estate investors, (2) Overbuilding, (3) The Savings & Loan banking scandal and fraudulent activity of mortgage lenders and appraisers.
So what’s causing the Perfect Storm Today?
(1) Massive residential property speculation in 2003-2006
(2) Too much credit available to purchase and finance real estate which was overused by lenders and uncreditworthy borrowers
(3) The current overall US market decline/recession that is spreading into a global crisis
(4) Current lack of funds for qualified borrowers
(5) Current oversupply of properties for sale
As you can see, there are 2 stages that follow one after another that lead to the creation of a Perfect Storm and opportunity to purchase real estate at incredible values – The Housing Speculation or Run-Up phase and the Market Collapse. We will examine each of these phases so you are more informed on what has led us to this perfect point in time to invest in real estate.
But first, we need to examine the most important issue a real estate investor must evaluate when choosing where and when to purchase a real estate investment – LOCATION.
Underlying Market Strength
I’m sure you’ve heard the age-old adage, “location, location, location”. I have a different spin on this saying. Mine goes more like, “location, timing, cash-flow”. Nevertheless, location is still number one on the list. If the underlying market is not strong with potential for rental and value increases in the future, then what’s the point of investing in the first place?
First, let’s look at Metropolitan Phoenix as a whole for location. Why the heck would you want to buy property in the middle of the desert?
Even though our market is severely depressed right now, Phoenix has shown remarkable resiliency and long term value appreciation for a number of reasons:
(1) Climate – People want to live here because of the warm, sunny weather. It is why snow-birds come in flocks for the winter and to retire. We all know that the baby boomers are reaching retirement age.
(2) Affordability – Phoenix is one of the most affordable places to live in the US. While this statistic took a temporary hit during the last boom, we have fallen back down to being extremely attractive to business based on real estate values, labor pool and overall cost of living. This will continue to attract business, labor and retirees to the area for the long term.
(3) Standard of Living – very high. Ease of commuting, and a fresh young, vibrant city leads people to want to live here.
These factors have led to the remarkable positive population growth Metro Phoenix has experience for the past 50 years. Even during times of economic hardship, people still continue to move here at a remarkable pace. This puts pressure on the housing market and inevitably leads to appreciation.
After deciding that Phoenix is the right spot to invest in real estate, your next task it to pick a sub-market within the metro region that makes the most investment sense. Some of the most important factors include:
(1) Area of greatest price declines
(2) Proximity to employment
(3) Proximity to amenities
(4) Quality of area
(5) Strength of rental market/values
These will be discussed later in this report and a qualified real estate professional can assist you in selecting sub-markets to invest in that match these criteria.
The Residential Housing Value Run-up
Phoenix real estate has always appreciated at a steady pace with the exception of a few massive run-ups in value followed by sharp declines. The decline of the late 1980s was briefly reviewed above. So what has caused the latest mass-speculation and run-up in values between 2003 and 2006?
Well there were a few culprits that acted together to create this latest debacle.
(1) Underlying Market Strength – As stated above, Metro Phoenix has inherent underlying market strength. That is what got the ball rolling and led to the mass speculation for 3+ years.
(2) Cheap Credit – Interest rates came down to unheard of levels making it easier to buy more assets with less money.
(3) Overabundance of Credit – It started in the late 1990s when Bill Clinton passed legislation freeing up credit to allow more people to buy homes – the sub-prime mortgage market was created. People that really shouldn’t have been buying homes in the first place were not only buying homes, but purchasing larger properties than they could afford. As credit loosened and values started to increase, a run on equity lines of credit and refinancing freed up the equity in people’s homes and allowed them to spend ‘invisible’ equity in the consumer markets on durable goods and services. This created the economic boom that we all experienced in the early to mid-2000s. The result: even homeowners that bought early in the boom and saw their property values increase 50-100% over a 5-6 year period had little to no equity left in their homes by the end of this appreciation cycle as they leached it all out through equity lines of credit and other borrowing methods.
(4) Investor Stupidity – As values went up and loans became easier to attain, investors started buying property with no money down and buying as many properties as they could get loans for (see next point below). It became an exercise in buy high and hope to sell higher.
It got to the point that, in 2005, there were actually busloads of investors that were driving around in town stopping in new housing subdivisions and lining up to buy new homes. Why did they concentrate on new homes? Because they could purchase a home to be built in the future, put little money down to secure it and watch the value of their property increase for 6-12 months without even owning it yet! Then they would either flip it right away when it was completed or hold it in hopes of it appreciating even more.
Builders were turning away buyers, holding lotteries and using other methods to hold back the swarm because they couldn’t build homes fast enough, even as they continued to raise prices on a monthly – sometimes even weekly basis! As a result, new homes were overbuilt in 2004, 2005 and 2006 by a wide margin due to ‘fake’ demand since many of the buyers were investors with no intention of ever living in the home!
This flawed philosophy worked for 2+ years at which time the greatest fool theory became a reality. You know how it works…As you build a pyramid of fools, there are less and less greater fools as you work your way to the top. When you finally reach the summit the greatest fool at the top looks around and sees no-one dumber than himself to buy his property for more money and so, the whole structure comes crashing to the ground. It took a while for owners of property who were trying to sell to realize that prices were in decline, not going up in mid 2006 which resulted in a massive number of listings coming on the market with few takers. This is further explained below under ‘The Market Collapse’.