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Tom Woiwode

What Will Happen When Real Estate Cools Off?


I lived through the Great Recession. It was a dark and dismal time for real estate. If you were a true professional, you re-tooled and moved forward. Opportunity exists in every market - you just need to be nimble enough and bold enough to make moves.

I learned a lot during those dark days. A cliche that rings in my ears to this day is the anonymous quote: "Any captain can steer the ship in calm waters." Real estate today is calm - busy - but calm. Anyone can steer the ship. As this bull market for real estate begins to lose its legs, (and I am not saying it is) the waters will begin to churn.

Never forget your history...

I was holding a sales meeting back in July, 2007 and at the time I paid close attention to the foreclosure data. We were discussing a concerning uptick in the foreclosure rates nationally. In Q4 2006, the foreclosure filings were about 250,000 nationally. By the end Q2 2007, they had increased to about 350,000. That was alarming change. A mortgage lender presenting to my affiliates in the meeting claimed he had over "495 different ways to get a buyer into a home." By noon that day - and just 60 minutes after his presentation - he came to me and told me all pending loan approvals had been pulled and all buyers would have to re-qualify. It seems the PMI (Private Mortgage Insurance) companies were alarmed at the foreclosure rate as well. I refer to this day in my memory and when I teach this lesson in my real estate class as "The day the music died."

By Q2 2008, foreclosure filings had reached 650,000, and by 2010 they were 950,000. The landscape of real estate was littered with abandoned homes, bankrupt developers, and seized banks. It was a devastating time for our economy and remains etched in my memory as some of the worst of times for the real estate industry.

Since circa 2011, the real estate industry has been in a slow but steady recovery. At one time in 2010, the average time it took to sell a home was 38 months. Today - in my market - it's 2 months. Its been 2 months for some time now and shows no signs of slowing. However, some industry players are beginning to sound alarms. "How long can this last?" "The major markets are slowing!" "Glendale, CA is sucking wind - and as Glendale goes, so goes the US!"

New players that were in grade school during The Great Recession...

There are large and innovative brokerages out there that are showing signs of difficulty. They've been funded by venture capitalists providing billions of dollars to go on spending sprees in buying up large teams, mid size companies, tech solutions, and so on. They use historical data of these companies to make wild claims about their sales volume and size. Anyone who's run a business knows that top line income is great in marketing, but means absolutely nothing in profit. Most of these "innovative" operators in the real estate space have never actually run a business, let alone a real estate brokerage/brand. They're tech centric wunderkinds.

At some point, investors in these brokerages/companies will expect their money back, and the shiny penny will begin to tarnish. It seems investors are beginning to wonder where all the money is going, when their investment will be returned, and when will income finally exceed operating costs. The mind of an investor is an odd thing. It seems of all those who buy stock and invest would be the least susceptible to hype. In reality, it appears they are the biggest suckers of all.

"We're just an advertising company..."

Zillow grew out of the Great Recession. The sellers of the time wanted their homes advertised everywhere. Zillow was happy to allow brokers to list their homes on Zillow for free. Back then, Zillow was just an advertising company. Now, they have Zillow Mortgage, Zillow Referral programs, Zillow iBuyer program, Trulia, DotLoop (real estate transaction platform), Streeteasy, Property management platforms, among many other interests. It seems Zillow is attempting to become the Amazon of real estate - all things to all people. They have brokers in many states now where they provide brokerage services. They've been a fascinating company to watch.

Zillow has ventured into the iBuyer realm, where Zillow purchases the home, then fixes it up in most cases, and lists the home for sale. Corporate flipping. This is not unique - there is OpenDoor and and Offerpad who compete with Zillow for the iBuyer space. The whole iBuyer phenomenon in my view is a product of the current robust real estate market. As soon as there is a hiccup in the market, the iBuyer space will begin to look a little too risky and competitors will exit the space. If they don't they will get caught with thousands of homes they cannot sell and will either dump them into the market and take huge losses or hold them and put renters in them. I manage 600 rentals. It is more than simply collecting rent. These big iBuyer companies like Zillow, OpenDoor, and Offerpad will find out very quickly that managing property at national scales is very, very difficult and costly.

Investors

So what happens if the market slows? Picture this... These new shiny penny brokerages will begin to have trouble getting venture capital. If they can't get the cash to burn, then the only thing left to do is go public. At that point, all their internal financials will have to be exposed and these Hype machines will be exposed as paper tigers. Can you imagine someone pouring millions of speculative money into a business that hasn't been through a single down cycle? And... has LOST money in one of the longest real estate recoveries in decades? Uber recently went public. The difference between Uber and these? Uber has a tangible, immediately paid for and provided service in which to build on even though they lost $3 Billion the year before going public. They have no "carrying costs" for purchased assets they can't sell, their model isn't based around a complex transaction that can take months to complete. Real estate brokerages depend on the fickleness (and I say that affectionately) of the independent contractor who can leave at the end of the day and take their business to the next shiny penny by morning. That's the brutal reality of the Real Estate Business - if the "It Factor" wears off, the assets of the company leave with few strings and so does the income. This can happen in a matter of 24 hours, on any day of any week, to any brokerage. Pretty scary if you're an investor, right? Even scarier if you own a brokerage...

So what will happen when real estate cools off? The professionals will survive. They are the ones that know how to prospect, build relationships, re-tool to foreclosures and short-sales, spend money on advertising, and answer their phones and emails - they will survive. The others? They'll be working at the local hardware store.

My Prediction...

I'm gonna get out my crystal ball. Full disclaimer - this prediction is worth what you've are paid. When the market stumbles, here is what happens:

  • Compass will file for an IPO (Initial Public Offering) in an attempt to pay back their creditors - which will expose the ugly truth of how unsustainable their model is will be revealed in a sea of red ink. The IPO will flop.

  • Offerpad and Opendoor will begin to lose money as they change their model from Buy / Sell to Buy / Hold. The investors will freak.

  • Zillow will begin to report massive losses on their iBuyer program and their investors will scream in quarterly earnings calls, exiting their stock in droves causing their it to plummet. Zillow will be forced to abandon the iBuyer program by their investors and they will retreat to their core business - selling ads to agents and mortgage brokers.

  • Professional brokers and agents will re-tool and be fine.

  • The market pendulum will swing from a Sellers market to a Buyers market.

  • Foreclosures will spike, but not as bad as 2008-2010.

  • in 5 to 8 years, the cycle will repeat...

If you lived through the down cycle, the following names will ring some bells:

Lendingtree, DiTech, Countrywide Mortgage, Lehman Brothers, Bear Stearns, WaMu (Washington Mutual) and many, many other names. Who will be added to this list when the market slumps? Time will tell...

From The Big Short, Paramount Pictures, 2015 (language warning)

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