The Federal reserve in their recent Report on Economic Well being made two very concerning discoveries: 1) 40% of all adults if faced with an unexpected expense of $400 would not be able to cover it 2) 25% of all adults are not able to pay all of their current months bills in full (source Federal Reserve). Both revelations were surprising, but especially that 40% of all households are living this close to the “financial edge”. Even if you aren’t in the 40% this information impacts you. What are the real estate implications? What step must you take today?
Living on the edge:
This report highlights that 40% are living close to the financial edge. This is an improvement from 2013 when 50% of adults could not absorb a $400-dollar unexpected expense. What this says is that 40% of all Americans are living pretty close to paycheck to paycheck with little in savings for the unexpected than inevitably happen (car breaks down, need a new furnace on the house, rent increases, medical bill, etc.…). What happens when there is a hiccup in the economy like in 07 where many lost jobs and those that kept their jobs might have taken pay cuts.
Increased Volatility:
The shear number living paycheck to paycheck increases volatility both in the overall economy and ultimately real estate. When an economic hiccup occurs auto, credit cards, and rent payments will likely be missed. This will create a cascading effect through the economy as recipients of these payments are impacted as well. For example, if a rental payment is missed on a property, the property owners cash flow will be impacted and therefore economic spending throughout the economy will be curtailed. Even if you aren’t part of the 40% on the financial edge, you might be as a result cascading impact on your cash flow due to non collections. With 40% of adults in this predicament, the cascading impact of an economic hiccup is amplified.
Real Estate impacts
- Home Owners:
- The homeownership rate is around 65% now and peaked at almost 70% during the last recession. Assuming that 50% of all adults will be on the financial edge during an economic cycle (in 2013 50% were paycheck to paycheck), then off the bat 20% of mortgages will default (in the last cycle government sponsored mortgages peaked at a default rate of around 35%). If 20% of mortgages default, prices will fall precipitously like in the last cycle 10 years ago. Note this default will not be uniform in all markets just like we saw in the last cycle, certain markets fared considerably better than others.
- Renters:
- With the large number of adults living paycheck to paycheck, during the next economic cycle, there will also be elevated levels of non payments on rent. The vast majority of rental homes are owned by small investors who will have their cash flow severely strained. This will also impact larger apartment/multifamily property owners. This reduction in rents collected will place huge financial strain on the property owners and many will subsequently default on their underlying mortgage like in the last cycle.
What should you do?
The advice is simply stated, but much harder to implement. Increase your cash reserves! Anyone involved in real estate must be keeping ample cash to weather hiccups. Property owners cannot live on the financial edge. The last recession showed how badly it ended for many who were asset rich and cash poor. Will you to take action today to step away from the financial edge?
Resources/Additional Reading
- https://www.federalreserve.gov/publications/files/2017-report-economic-well-being-us-households-201805.pdf
- https://fred.stlouisfed.org/series/RHORUSQ156N
- http://money.cnn.com/2018/05/22/pf/emergency-expenses-household-finances/index.html
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, Illinois, and Florida. They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide. To get started on a loan all they need is their simple one page application (no upfront fees or other games).