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I like to say is a hurricane over real estate right now I do think the economy is weakening I have some concerns two influential figures in the world of finance bill Amman and Barry Stern are sending out urgent warnings about the real estate market Amman the CEO of persing square a highly respected Wall Street firm cautions about an imminent wave of real estate bankruptcies his concerns highlight the potential for massive economic repercussions with hundreds of billions of dollars at stake what's going to be interesting is to see what happens when people get have to repic their debt and I think that can have sort of a cliff-like effect and you're certainly seeing that uh in real estate on the other hand Stern lick the CEO of Starwood Capital group an investment fund managing over $120 billion in assets compares the looming crisis to a category 5 hurricane Category 5 hurricane and it's sort of a black out hovering over the entire industry until we get some relief or some understanding of what the fed's going to do their warnings serve as a crucial reminder of the potential challenges ahead in the real estate sector now let's delve into their perspectives to better understand the gravity of this unfolding situation but before we do don't forget to hit that subscribe button stay tuned until the end of this video to learn more about what this means for you so to figure out what's brewing in the real estate storm we need to see how it connects to another key player interest rates real estate is like a piggy bank that gives you a steady stream of cash year after year think of it like a predictable income similar to a job salary for example imagine you own a small apartment building each year it throws off $100,000 in rent like a steady wage coming in this is what we call the income stream of the building now subtract any costs you have for things like repairs taxes and upkeep that's your net income from the building now here's where interest rates come in Imagine you get a chance to buy another apartment building just like yours but this time you need to borrow money for it the amount you have to pay back each month the mortgage payment depends on the interest rate the bank charges you if interest rates go up your monthly mortgage payment goes up too that means you have less money left over from your buildings income stream it's like your salary getting smaller this smaller net income makes the building less attractive to buy and when something is less appealing its price usually goes down that's why higher interest rates often lead to lower real estate values so when Stern talks about a category 5 hurricane he's worried that Rising interest rates will tighten belts for many real estate owners leading to potential price drops and Market slowdowns consider a $100,000 a year apartment building the rent Rises by 5% each year similar to a raise at work after 5 years we sell it for a nice profit but how much is it worth right now that's where Cap rates come in it's basically a way to estimate a property's value based on its yearly income think of it like a price to earnings ratio for stocks but for buildings in our example we'll use a 5% cap rate so we take the building's yearly income of $100,000 divide it by the cap rate5 % and boom we get the estimated value at $2 million but wait we're not done yet remember inflation money today is worth more than money tomorrow so to get the real value today we need to adjust for that using another concept called discounted cash flow basically we imagine taking all the future income from the building and bringing it back to today's value we use an interest rate let's say 6% to do this calculation after all the math our little apartment building is actually worth about $2.2 million today let's see what happens when the interest rate storm hits first we bump the discount rate from 6% to 7% imagine this like a higher time machine tax for bringing future income back to today this shrinks the building's value to $2.18 million a cool $100,000 less but the storm is isn't over investors want a bigger piece of the pie now so they demand a higher cap rate when they buy the building in 5 years we bump it from 5% to 6% this means the building will be worth less at that point further reducing its present value to $1.89 million let's keep going we crank the discount rate to 9% and the cap rate to 8% it's like a hurricane of interest rates this time the apartment buildings value plummets to a shocking $1.41 million see how even though the building's income stayed the same Rising interest rates caused its value to seriously drop that's why Stern lick and Bill Amman are worried higher rates can shrink the value of many real estate Investments they think the good times in real estate healthy cash flow won't last leading to a possible us recession it's all about supply and demand Rising interest rates might scare off borrowers slowing down new construction that could mean less Supply potentially pushing rents higher and keeping the real estate market afloat at least for a while but if the economy sputters and people lose jobs suddenly we could have too many apartments and not enough renters driving rents down and dragging real estate values with them a healthy real estate market means more people want Apartments than there are available high demand low Supply that's like a long line outside of popular restaurant landlords can charge more rent because everyone wants in over the past few years things were booming strong economy meant more jobs and money government gave extra cash to people home prices shot up leaving many stuck renting all these factors led to higher rent prices and made apartment buildings even more valuable however the tables can turn quickly when the economy slows down people lose jobs and can't afford their own places they move in with family or roommates to save money some even get evicted reducing the building's income these things mean fewer people want Apartments meanwhile remember all those new apartment buildings planned during the good times they're finished now adding more supply to the market just as demand drops think of it like bringing pizzas to a party after everyone's already full this pushes the supply line to the right creating a glut of empty Apartments the result is much lower rent prices Stern l is especially concerned about two types of buildings offices and Retail spaces first the elephant in the room remote work Stern lick thinks it's a big deal in the US where many people haven't returned to their offices but he points out that's not the case everywhere places like Germany have low vacancy rates meaning most offices are filled people are back to work even the Middle East in Asia have busy offices it seems remote work hasn't taken hold as much there so what's Stern Lick's prediction for the US office Market a two-tier system highquality buildings these modern attractive offices like the one we're in will probably stay full people enjoy coming to work here because it's a pleasant experience average and below average buildings these older less appealing offices might face trouble they could become empty like fields of grain leaving no choice but to turn them into Parks or something else entirely for some C-Class buildings it's cheaper to tear them down than keep them empty sad but it might mean more parks in the future one question on everyone's mind will houses get cheaper Stern lick a big-time housing owner believes prices might fall eventually but it's a bit complicated why prices might hold interest rate hikes have made borrowing pricier discouraging some homeowners from selling and buying new places this keeps available houses scarce and scarcity tends to keep prices up many homeowners secured low mortgage rates before the hike they're less likely to sell while those rates still benefit them why prices might drop if interest rates decrease again some homeowners might finally decide to sell flooding the market with more houses this could push prices down as things stabilize construction companies might start building more houses again adding even more supplies and potentially dropping prices further Billionaire's prediction is that the housing market might just stay stuck for a while with prices neither Rising nor falling dramatically but in the long run he expects them to go back up looking to buy a house you're not alone but getting your foot on the property ladder is tougher than ever in the US why two main reasons one homes are ridiculously expensive the average cost has gone from $315,000 in2 18 to a whopping $416,000 in 2023 two remember those super low morgage rates a few years ago they're gone rates have doubled to around 7% making borrowing much more expensive so what does this mean housing affordability is at a historic low many Americans are simply priced out of the market and worries about a housing bubble or growing we might expect High interest rates to crash prices but something unexpected is happening turns out folks with low rate mortgages are stuck like they're wearing golden handcuffs selling would mean leaving behind those sweet sweet low rates so they're keeping their houses off the market this lack of Supply just like in our supply and demand example is keeping prices stubbornly high so it's important to remember that when the real estate market gets stormy it's not just about a few guys making more money it can have a big impact on everyone the rich and the not so rich we need to think about both the good and the bad when things get wild in the housing world the next year and a half could be bumpy maybe even a hurricane as Stern lick says but here's a ray of sunshine if you can ride out the storm till 2025 there might be a pot of gold on the other side remember investing is a marathon not a Sprint to discover more Financial Insights especially from other Financial experts like Warren Buffett check out the video on your screen keep learning with us thank you for joining us until we meet again start small think big and stay financially enlightened as you build your future
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