Why the Crash Predictors Are Wrong About a Foreclosure “Crisis”

David:
This is the BiggerPockets Podcast show 871. What’s going on, everyone? It’s David Greene, your host of the BiggerPockets Real Estate Podcast, joined today by the data deli himself, Dave Meyer. And when you’ve got Dave and David together, you know what that means. It’s a bigger news podcast. In these shows, we dig into the news, the data, and the economics impacting the real estate industry, so you can use that information to build your wealth.
Dave, welcome to the show.

Dave:
Thank you, David. I appreciate it. I’m excited as always to be here, but today, I’m particularly excited because our guest is one of my all-time favorite guests. His name is Rick Sharga. And if you haven’t heard him on any of our shows before, Rick owns CJ Patrick. It’s a company that focuses on market intelligence, and data, economic research, all specifically for real estate investors. So all the work he and his team do is extremely relevant for the both of us and everyone listening to us. And today, we’re going to dig into some of the research he’s done specifically around foreclosures in the US and what’s going on in that part of the housing market.

David:
And after the interview, make sure you stick around all the way to the end of the show because Dave and I handle a question Seeing Greene style at the end of the podcast about a listener who’s trying to figure out if they should use a HELOC or a cash-out refinance to scale their portfolio. All that and more on today’s epic show. Let’s get to Rick.
Welcome to the show today, Rick. Excited to talk about foreclosures. That’s always a fun topic for real estate investors to get into. But before we talk about where they’re at today, let’s talk a little bit about historical foreclosure activity. What can you share with us?

Rick:
Yeah, thanks for having me on the show. Always good to talk to you guys.
Foreclosures are an unfortunate reality in the mortgage industry. Typically, people do pay their mortgages on time and regularly, but about 1 to 1 1/2 of loans at any point in time are usually in foreclosure. And about 4% of loans are delinquent but not yet in foreclosure. We saw a huge spike back leading into the Great Recession about 10 years ago, where foreclosure rates actually approached about 4% of all loans, which was just remarkably high, and about 12% of loans were delinquent. And a lot of that was because of really bad behavior on the part of the lenders, to be honest with you. And a lot of real estate speculation that was kind of reckless. But historically speaking, you’re looking at about 1 to 1.5% of loans in foreclosure, and that would represent a kind of normal year.

Dave:
I think a lot of real estate investors follow foreclosures really closely because it, one, has implications for housing prices if there’s all of a sudden huge influx of foreclosures that could put downward pressure on prices. But also just because recently, there’s been such a shortage of supply and inventory on the market. I think a lot of people are wondering if foreclosures are going to take up and perhaps increase the amount of homes that are up for sale or up for auction in the case of a foreclosure at any given time. So I’m just curious, Rick. What’s been happening recently, and is there any chance that foreclosures might add to some inventory in the coming year?

Rick:
Let’s unpack a couple of the things that you said there. The interest that I’ve seen from investors in foreclosure properties over the years is purely mathematical. Typically, you can buy a property in some stage of foreclosure for a whole lot less than you can buy a property at full market value. And we can talk about it as we get into our conversation a little bit. But there’re three different stages of properties and distress that people can buy foreclosures during, and the risk and reward varies accordingly.
When COVID hit, we were already in a market where there wasn’t a lot of foreclosure activity. We were probably running at about 60% of normal levels of foreclosure. So a little more than a half a percent of loans were in foreclosure at the time. Then the government put a foreclosure moratorium in place that lasted over two years. So really, about the only properties that were being foreclosed on during that pandemic era were commercial properties or properties that were vacant and abandoned. But if you had a more conventional, traditional loan, even if you were behind on your payments, you were fairly safe.
And then the government also put a mortgage forbearance program in place where basically all you had to do, as a homeowner, excuse me, was call your mortgage servicer, say that your income had been affected by COVID, and you were allowed to skip mortgage payments. And that program lasted for about two years. So we’re coming out of a period where we had virtually nothing going into foreclosure for an extended period of time, resulting in some of the lowest foreclosure activity levels in history. And even today, we’re running at about 60% of the level of activity we saw back in 2019, when, as I mentioned, foreclosures weren’t particularly high to begin with.
We’re also seeing a difference in the stages of foreclosure and the rate we’re seeing compared to pre-pandemic. So if you look at foreclosure starts, that’s the first legal notice a borrower gets that they’re in default on their loan. They’re coming back at about 70 to 80% of pre-pandemic numbers. But if you look at the number of properties being auctioned off in foreclosure sales, they’re still down at about 50% of pre-pandemic levels. And if you look at bank repossessions, which is what happens to properties that don’t sell at those auctions, they’re at about 30% of pre-pandemic levels. So if you’re an investor looking to buy a foreclosure property, the market’s a whole lot different than it was prior to the pandemic and way different than it was going back to the crisis in 2008.

David:
You mentioned there’s three levels of foreclosure. Can you briefly cover what those are, and then we’ll talk about how those are different now compared to where they were in the past?

Rick:
Yeah, sure. That’s a great question. There’s what we call a pre-foreclosure stage, and that’s when the borrower gets that first legal notice of foreclosure. In a state like California or Texas where the foreclosures are done in a non-judicial process, that’s called a notice of default. If you’re in a state like New York, or Florida, or Illinois where it’s a judicial foreclosure process, it’s called a lis pendens filing. So you get that first legal notice, and that starts the gears moving on a foreclosure. There’s a timeline that every state has that goes from that first stage to the second stage, and that’s a notice of sale. That’s when the borrower has kind of exhausted that pre-foreclosure period. And the lenders basically told them that the property is going to be auctioned off either by a courthouse auction or a share of sale on a certain date. So that’s the second stage of foreclosure. And that results in that auction, that share of sale, taking place, where typically a lot of investors will buy those properties.
The properties that fail to sell at those auctions are typically repossessed by the lenders. Those properties are taken back as something the industry refers to as REOs, that stands for real estate owned, because the industry has no creativity whatsoever in naming things. But at that point, the bank or the lender has repossessed the property to basically make it whole for whatever the unpaid loan balance was. And they’ll resell those properties either through a real estate agent or through one of the online auction companies. So those are your three stages of foreclosure.

David:
And so pre-foreclosure would be like a notice of default, and anything else would be included there.

Rick:
Yeah, and what’s really interesting in today’s market, David, is that we’ve seen the percentage of sales of distressed properties shift dramatically from where it was five or 10 years ago. So normally, you see a pretty high percentage of distressed property selling at the auction or selling as lender-owned REO assets. Today, about 65% of distressed property sales are in the pre-foreclosure period. So the homeowner’s getting that first notice of default. And rather than losing everything at a foreclosure auction, they’re selling the property themselves on the open market to avoid losing everything to a foreclosure.

David:
Perfect. So you’ve got pre-foreclosure, which is when you’ve missed payments, you’ve fallen behind, the bank sends you a letter saying, “Hey, you’re in default.” I believe in most states they have to put something in the newspaper. There needs to be some kind of public declaration that the person is going into foreclosure. Funny, I see Dave making a face because that’s weird, right? Why are you putting our business out in the streets like that? But I think the idea was people could say, “Well, I never got that letter.”
So a long time ago, they would post it out there in the community bulletin board or put it in a public space so that the person couldn’t claim that they weren’t notified. That’s what most of the wholesalers or the people that are looking for off-market deals, they’re fishing in that pond. They’re like, “Who’s got a notice of default or an NOD? How do we get ahold of them, because if they have some equity but they’re going to lose the property, let’s buy it first?” You mentioned that, Rick. If that doesn’t work, the bank then says, “Hey, we’re going to sell the house on the courthouse steps in some kind of a public auction and get our money back from the person if it’s a non-recourse loan. If your property sells for less than what you owed, then hey, you’re off the hook.” But if it was a recourse loan, you are still on the hook for whatever was owed after the auction, which sucks because stuff never sells for as much at auction as much as it would sell for on the open market.
And then, if it doesn’t sell on the courthouse steps, then the lender or… What’s usually the case is the bank has to take the property back. It becomes a part of their portfolio. They take title to it, and it’s referred to as REO because it’s looked at as real estate owned on the bank’s books. That’s when a bank would go say to a real estate agent, “Hey, sell this thing. We don’t know what the heck to do with it,” right? Like when you hand a grown single man a baby and he’s like, “I don’t know. What do I do with this thing?” That’s how banks feel about taking properties back. So that’s where you can… You can find those properties on the MLS, but that’s a great explanation because people just throw the word foreclosure around.
And it’s confusing because not everybody understands that a foreclosure that’s listed on the MLS as REO is not going to be something you get a great deal on because all the other buyers see it, versus a foreclosure that you’re buying on the courthouse steps could be a great deal, but you’re going to have to have all cash. You’re not going to get a title check. You’re not going to get inspection, and then a foreclosure… In pre-foreclosure is something you actually probably could get a really good deal on because the person’s motivated to sell it. However, it’s hard to find them. Because you have to find the person that’s got the property. Okay, that’s a great explanation. Thank you for bringing some clarity there to all of our audience.

Dave:
Okay, so now that we understand the three different levels of foreclosure, the question is what does the current foreclosure landscape mean for your real estate investing strategy? We’ll get to that right after the break.

David:
Welcome back. We’re here with Rick Sharga, president and CEO of CJ Patrick. And he’s spelling out his company’s market intel on the state of foreclosures in the United States, as well as what that means for real estate investors.

Dave:
So, Rick, you mentioned that the early stages of the foreclosure process have started to tick up, but sales are not. And that is likely, from my understanding, because people are selling them earlier. Is that a consequence of all of the equity that the average American homeowner has?

Rick:
Yeah, that’s your spot on, Dave. There’s $31 trillion in homeowner equity out there. That’s an all-time record. And when I go out and talk to groups and I point out that there’s a lot of equity, the pushback I usually get is, “Well, yeah, but people in foreclosure don’t have equity.” Well, yes, they do have equity. In fact, according to some research from ATTOM DATA 80% of borrowers in foreclosure have at least 20% equity. I’ve seen some other reports from companies like Black Knight where that percentage is a little lower, but you’re still talking about close to 70%. So if you’re sitting on a 400,000-$500,000 house near 20% equity, that gives you 80,000-$100,000 cushion to work with. It also gives you the potential of losing 80 to $100,000 of equity if that property gets auctioned off in a foreclosure sale because the lender is going to sell it only for the amount still owed on the property, not for all of your full market value.
So intelligent people who have fallen on difficult times financially are leveraging that equity and selling the property off either at or close to full market value. But if you’re a savvy investor if you know how to work with borrowers in that kind of financial distress, you can usually find yourself a property, negotiate a deal that gets you something below full market value, but let that distressed homeowner walk away with some cash in their pocket and get a fresh start.
If you’re a rental property investor, you might have somebody who’s temporarily fallen on hard times recently got a new job, but just can’t catch up on payments. And maybe they become a worthwhile tenant. So you can buy a property with a built-in render right off the bat. So it’s a very different market dynamic than what we saw during the foreclosure crisis of 2008 to 2011, where the right strategy was to wait for the lender to repossess the property and buy an REO because the banks were selling them at fire sale prices just to get them off the books. And your average borrower in foreclosure was way underwater on their loan.
It’s just not the case anymore. In fact, some of the equity numbers would just blow people’s minds if they saw somebody in foreclosure who’s sitting on 70% equity. And there’s a question I do get periodically, which is, with all that equity, how they wind up in foreclosure? And the truth is that having equity doesn’t prevent you from missing payments, and that’s what gets you into foreclosure. So typically, it’s the same old things. It’s job loss, unexpected medical bills, divorce, death in the family, things like that that cause people to miss payments and go into foreclosure, but that equity provides them with a much better chance at a soft landing than what they had with no equity back in the day.

Dave:
Rick, I think that’s so important that the amount of equity that you have in your home and your ability to pay your mortgage are not the same thing. And you can have relative wealth in one area and still have negative cash flow as a household. And so unfortunately, people do fall on hard times even though they have positive equity. And I do want to get to talking about why people have so much positive equity, but I have one question. Someone on our podcast on the market recently, it may have been you, Rick, so please forgive me if I’ve forgotten, was telling me that the banks also now sort of have expanded their playbooks for how they can intervene in these unfortunate circumstances. It seems like back in 2008, they really didn’t know what to do with someone who stopped paying their mortgage. Are they more equipped to handle that now?

Rick:
Well, it was a bit of a perfect storm back in 2008. The banks didn’t have a particularly robust toolkit of ways to help borrowers who wound up in default. And they got overwhelmed with just the sheer volume. Again, we had four times the normal level of foreclosures, and they were all happening at once, and these loans that were just awful, awful loans that were written at the time. So in a lot of cases, there was very little the banks could even do.
So fast-forward 10 years to today, the loan quality of mortgages written over the last decade has been extraordinary, probably the highest quality in history. We’ve had an enormous amount of equity growth. And in the meanwhile, the mortgage servicers have really developed many more processes and tools they can use to help borrowers. In addition to that, we just went through this forbearance program that has been for my money, probably the most successful example of the government and the mortgage industry working together to achieve a positive outcome ever.
8.7 million borrowers took advantage of that forbearance program. There’s probably about 200,000 remaining in the program today. But of that 8.7 million, the people that have exited less than 1% have defaulted on their loans. So it’s just been a remarkable, remarkable success story. And what we’re seeing is the large entities that play in the mortgage space, Fannie Mae, Freddie Mac FHA, have kind of co-opted some of the techniques that we saw used in that forbearance program and are making those available to mortgage servicers to create loan modifications and loss mitigation strategies.
Fannie and Freddie have been instructed to make a similar forbearance program part of their ongoing loss mitigation activity. Ginnie Mae lenders have been given the option of extending the terms of a mortgage from 30 years to 40 years to get the monthly payment down again on distressed loans only not as a new loan.
And the FHA has a program where they can actually remove part of the mortgage loan and tack it onto the back end, so that you don’t owe any payments on maybe 10% of your loan until you either sell the property or refinance the loan at the end of the term, and that lowers their monthly payments.
There’s a lot more creative processes involved today and lost mitigation and loan modifications than what we saw 10 years ago. And candidly, the servicers are reluctant to foreclose on anybody. They’re not absolutely sure. They can’t help salvage because they don’t want the CFPB to come down on them with the wrath of God either. So there’s some motivation from that perspective as well.

David:
That’s a great insight into the history of foreclosures. And I do like that you mentioned the last housing crisis we had around 2010, ’11, ’12. It wasn’t just, “Hey, it’s a bad economy.” It was an absolute collapse of the housing market, which flooded the market with an insane amount of inventory at the same time that people were losing their jobs, and we went into an economic recession. So you had way fewer buyers to buy these properties, and in an outrageous amount of supply that hit the market, which led to an utter collapse of housing prices. And I think a lot of people feel like foreclosure is synonymous with buy it for 30% of what it’s worth, and that’s not the same. And I really love that you pointed that out.
Going into 2024, I think that just from what I see in the market, there’s a good chance that we’re going to have more foreclosures than what we’ve traditionally had. I don’t know it’s going to be an incredible spike like what we saw before. What do you think people should look out for or expect regarding foreclosure activity going into the new year?

Rick:
So I’ll answer that question, but I want to touch on something you said earlier because I think it’s critically important. We really did have a perfect storm back in 2008. We’ve never seen that set of dynamics happen at the same time. And what people don’t realize is right before the market crashed, we had about a 13-month supply of homes available for sale. In a normal market, you’re looking at about a 6-month supply of homes available for sale. In today’s market, you’re looking at about 2 1/2 to 3 months supply. So we’re dealing with an overabundance of inventory back then, right before everything started to go bad at from a lending perspective, and it built on itself. So that combination of more supply than demand plus distressed inventory coming to market really is what cratered home prices. And people were buying properties at 30 cents on the dollar.
Investors actually helped pull up the economy out of a recession by going in and starting to gobble up all that inventory. But last time, that big Great Recession, was the first time that I’ve ever seen where the housing market actually took the economy into a recession. Usually, the housing market helps the economy recover from a recession, but this time, we actually took it in because things were so bad. Not a replay of that at all in 2024. In fact, we ended 2023 with about 0.4% of loans in foreclosure, which again is way lower than normal. To put that in perspective, that means you’re looking at somewhere between 200 and 250,000 homes in some stage of foreclosure. And in a normal market, that number would’ve been more like 500 to 600,000. So just not a lot of activity. What continues to happen is that people get that first notice, and instead of going into hiding and denial, they’re acting quickly and selling off a lot of those properties. So that’s adding a little bit to the for-sale inventory but not really adding to distressed property inventory in the long run.
My most likely scenario for the balance of 2024 is we see a gradual return to pre-pandemic levels of foreclosure starts, but we will continue to see a lag in the number of properties that get to the auction. And we’ll continue to see fewer bank repossessions than we’ve seen in prior cycles. We probably don’t see those come back to normal levels at the earliest until 2025.

David:
Interesting. And what is it about 2025 that you think we’ll start to see that change?

Rick:
One of the reasons I think we’ll see a higher number of REOs in 2025 is simply the length of time it takes people to execute a foreclosure. So if you’re in states that have relatively high numbers of foreclosures starts today, like New York, and Florida, and Illinois, it takes 1800 days on average to finish a foreclosure in New York. So foreclosure start from 2023 probably won’t get all the way through the process until sometime in 2025. And so what I’m expecting is a lot of the activity that we’ve seen start in the last year doesn’t finish until we get through 2024 and into 2025.

Dave:
Rick, the New York Fed puts out some really interesting data about loan delinquencies. And if you look at other debt classes, like credit card debt or just consumer debt, auto loans, it does look like defaults are starting to tick up. Is there a reason they’re going up in those other types of debt but not for mortgages?

Rick:
It’s another reversal from where we were in 2008. Back then, people were paying their car loans but letting the mortgages go. And the running joke back then was you could sleep in your car, but you couldn’t drive your house to work. In today’s market, you’re absolutely right. What we’re seeing is an increase in consumer delinquencies, in credit cards, in auto loans in particular, in other consumer loans. Student loans haven’t started to go delinquent yet, but we’ve only just seen the payments start again on student loans after a hiatus of a couple of years. But mortgage delinquency rates have actually been going down. And part of me believes the reason for that is people realize how much equity they have in these homes, and they are protecting that equity even if it means they’re going to be a little late on some of some of their other credit responsibilities.
The other thing that’s probably worth taking a little bit more of a look at when you were talking about these trends is that a lot of the delinquencies in the other areas of consumer credit are only 30-day delinquencies. So somebody’s missing a payment or late on up payment, but they seem to be catching up pretty quickly after that. And even with the increases we’re seeing, the delinquency rates are still probably around half of what they were back in the Great Recession. So it’s not a crisis yet, but we do watch consumers for financial stress.
Last quarter, actually the third quarter of 2023, was the first time consumer credit card use had ever surpassed a trillion dollars. That’s a big number in and of itself. And it happened at a time when, because the Fed had continuously raised the Fed funds rate, credit card interest rates were on average at about 25%.
So we had a trillion dollars of credit card use at some of the highest interest rates ever. That could lead to some problems down the road. And in the auto market during the pandemic, we saw an awful lot of subprime lending in the auto industry so that people could sell cars, and a lot of those bad loans are simply coming home to roost, so it’ll be interesting to follow.
But the metric I would give people to watch, if you’re curious about mortgage delinquencies, is the unemployment rate. Very, very strong correlation between the unemployment rate and the mortgage delinquency rate. And if you look at late 2023 mortgage delinquency rates, they were at about 3.26%, while unemployment was at about 3.6%. So there really continues to be a correlation. If you see unemployment numbers start to tick up, you’ll probably see mortgage delinquencies start to tick up. But your question is great because, unless a mortgage goes delinquent, it’s not going to go into foreclosure. So if you’re looking at historically low levels of mortgage delinquencies, it stands to reason that we’re not going to see a huge wave of foreclosures until those numbers change.

Dave:
Thank you for answering that. That’s something I’ve been wondering about for a while.

David:
This is such great context for all of our listeners. And I imagine many of our listeners want to know if these foreclosure trends will lead to more supply. We’ll get Rick’s answer to that right after this break, and stay tuned to the end as we answer a listener question on our Seeing Greene segment. My favorite part of the show.

Dave:
So it sounds like, Rick, at the top of the show, I mentioned that foreclosures are pretty important to the housing market because it is one channel by which supply enters the housing market. It sounds like you don’t believe, and the data seems to show that foreclosure is probably not going to add a lot of supply next year. So, Rick, let me ask you, do you think supply will increase in the housing market in the coming year and help thaw the market a little bit? And if so, where could that supply come from?

Rick:
So supply almost can’t help but go up a little bit in 2024 because it’s been so, so low in 2023, almost the lowest levels in history. And that was certainly true for a while in the new home space, where we had just almost no supply of completed homes available for sale. I don’t expect to see a flood of existing homes listed for sale next year. In fact, I don’t think we can expect to see a whole lot of those homes listed until we see mortgage rates drop down into the fives.
Right now, you have 70% of borrowers with an active mortgage who have a mortgage payment of 4% or lower, and the math just doesn’t work. It’s not that they’re being picky and don’t want to sell, it’s they can’t afford to. You sell a house with a 3% mortgage. You buy another house at exactly the same price, and you’ve effectively doubled your monthly payments. Most people simply can’t afford to do that. So that’s going to continue to suppress the number of existing homes that are listed.
You will see people who need to sell their house continue to list their homes, and that’s people in foreclosure, people that get a job transfer, people that have a kids or get married, or there’s a death or divorce. So you’ll see that. But where I do think we’ll see an increase, and we started to see indications along those lines, is in the new home market. We saw housing starts for single-family owner-occupied units jump up pretty significantly in November, which is the most recent month we have those numbers for. And the builders seem to be trying to take advantage of a market where their prices are almost at a parity level with the median price of existing homes being sold and where they’re offering concessions and buying down mortgage rates for their buyers.
So in some markets, it’s actually a better economic decision for a buyer to buy a new home than it is to buy an existing home. And I’ve actually seen some investors take the tack of targeting new home builders in their markets and looking for kind of the builder-close act deals. So you go to a Pulte, or a Toll Brothers, or some other builders and a development. And they have two homes left on the lot. And they want to close out that development, and reliquidate or recapitalize, and move on to their next project. So it’s a time when investors looking for the best deals really, really do have to be pretty creative in their approach. And in some of those markets, those properties represent good deals for rental property investors. Tough to get them to pencil that for a flipper, but for a rental property investor, there might be an opportunity there.

David:
One of the things I liked that you mentioned, Rick, is that foreclosure activity is related to economic activity, right? A big piece of it is recognizing that if there’s equity in the home, you’re way less likely to get a foreclosure because the seller is just going to sell it even if they fall behind on their payments. But the other ingredient in the recipe of foreclosure is you can’t have equity, and you have to not be able to make your payment, right? So what are some of the economic indicators that you pay attention to, or you think that real estate investors should be paying attention to, that aren’t directly related to foreclosures, but sort of are the lead into towards them?

Rick:
Yeah, you just tapped into the biggest one, David. The unemployment rate is huge. I’m still among what’s probably a minority of people right now who believes that the country will see a bit of a recession this year. Not a particularly severe one, not a particularly long one, but something of an economic downturn. I think the consumers pretty much tapped out at this point. And if we do see consumer spending come down, it accounts for 70% of the U.S. GDP. And theoretically, at least we could see a bit of a recession. If that happens, we’ll see unemployment numbers go up. If we see unemployment numbers go up, we’ll see mortgage delinquencies go up, and more people either having to sell off these properties or wind up in foreclosure. So that’s the biggest number I look at. And in a lot of markets, your national numbers are almost meaningless, so you really have to be looking at what’s going on in your neck of the woods.
The other number that really is important for investors to keep an eye on if we’re talking about foreclosure potential is sales volume and prices. If you’re in a market where prices are going down, it’s that much more difficult for a borrower who’s kind of marginal in terms of their equity to be able to avoid a foreclosure. So if you’re in the Pacific Northwest, if you’re in coastal California, particularly some of the higher-priced areas, if you’re in Austin or Boise, some of the markets that were just soaring during the pandemic, you’re likely to be seeing prices come down a bit. On the other hand, if you’re in the Southeast or the south, huge swaths of the Midwest, we’re seeing prices go up over 5% year over year. So you’re looking at the number of jobs created. You’re looking at unemployment. You’re looking at sales volume. You’re looking at prices. And a combination of those that looks negative tends to lead to more foreclosure activity.

David:
Great stuff there. This is awesome, Rick. I really appreciate you sharing this, especially because foreclosures are such an interesting topic in the world of real estate investing, but there’s a lot of misinformation out there. And a lot of people that have the wrong impression about how these things actually work.

Rick:
Just one thing I’d like to add, if you guys don’t mind. I still see an awful lot of people talking about the pending and impending housing market crash. None of the data supports that at all. One of the things that could precipitate a foreclosure cycle is a housing price crash. And I still see a lot of people trying to sell stuff on YouTube purporting this impending doom. None of the data supports it. And even if we did have home prices come down, much, much more than they’re likely to anywhere across the country, that doesn’t necessarily mean somebody goes into foreclosure. It just means they have less equity. Again, we have $31 trillion equity cushion right now, which is just the highest it’s ever been. So I just encourage investors not to buy into the hype, not to buy into the people that are selling services to get you ready for that foreclosure tsunami that’s about to hit. There’s just nothing in the real numbers out there that suggests any of that stuff’s going to happen.

David:
I appreciate you saying it because I say it a lot, and people get upset. So now I don’t have to be the only one that’s sort of carrying that torch. It’s very easy to scream. We’re going to have a crash, especially because the last one was so traumatizingly horrible. Everyone sort of got it in the back of their mind if they were there. So even hinting that that might happen again will just elicit this very strong fear response. That’s how you get views. That’s how you get clicks. That’s how you get likes, but it’s not how you actually run a successful portfolio.
Thank you, Rick, for being a light in this dark and scary world of foreclosure night in the real estate investing realm. We will see you on the next one.
All right, let’s jump into the next segment of our show, Seeing Greene. As a listener to this podcast, you are a part of the growing and thriving BP community, and we love you. And this segment is where we get to connect with community members like you directly by answering listener questions that everybody can learn from.
Today’s question comes from Nelson in Northeast Pennsylvania. Nelson writes, “I’m a big fan of the podcast and enjoy listening to every episode. Thanks for all the wise advice and amazing work that you and the BP team do. I purchased a triplex in 2015 and house hacked it, and the property value has roughly tripled leaving me with about $300,000 in equity and great cash flow. For my next investment I’m looking for something priced around 300 to 500,000, but I’m not sure what’s the most optimal way to apply my new equity. Currently, I’m looking into getting a HELOC but would also consider a cash-out refinance if needed. My question is how would you recommend that I use the equity in a case like this? Should I purchase a $300,000 property in cash giving me additional buying power and leaving only to HELOC to pay down, or should I use this equity to put 25% down on a more expensive property and pay a separate new mortgage? I’m not averse to taking risks, but I just want to be careful about over leveraging myself.”
Great question here, Dave. What do you think should be considered?

Dave:
Well, first of all, thank you for allowing me to be a part of Seeing Greene. This is quite an honor. I feel like I’ve made it in my podcasting career now that I get to be on this segment. It’s very fun. This is a great question from Nelson, because I think a lot of people face this. You find one deal. It sounds like Nelson’s had a ton of success here, which congratulations, and you try and figure out what to do next. And I feel like I always give boring advice here because it really does depend on your personal goals and what you’re trying to accomplish. But I do think the question is about really where Nelson finds himself in his investing career, because buying a property in cash does feel appealing. I think for a lot of people right now, if you have that ability because mortgage rates are so high, but you have to remember that that is going to eat up some of your appreciation potential because you won’t have leverage on the property.
And just to remind everyone, leverage is a benefit you get when using debt because, proportionally, when your property goes up in value, you earn a higher rate of return. And so generally speaking, for most people, and I don’t know Nelson’s specific situation, I think that if you’re sort of earlier in your investing career, I think taking on at least some debt is appropriate because you’re going to get the benefits of that over the long run. Plus, the benefit of buying in cash is better cash flow. And if you’re continuing to work and have a full-time job, you might not need that cash flow right now. That’s sort of how I see it, David. What do you think?

David:
When prices and rents were… They’re never guaranteed, but as about as close to a guarantee as you can get the last eight years or so that they were going to go up. I leaned more towards erring on the side of boldness. I think you should borrow more. I think you should buy more. And I made it clear that my stance on that was because the government was creating so much money. There was so much stimulus going on that all the winds were at your back and pushing you forward. Now, does that guarantee a deal’s going to go wrong? No, but it definitely puts the odds in your favor.
In the market we’re in right now, we’re sort of in a stalemate. It’s not a bad market where we think prices and rents are going down, but it’s just not as likely to go up. We sort of got opposing forces. They’ve got everything locked into one place. So I would still say buying is a good idea, but I wouldn’t say buying aggressively is as good of a plan.
I would like to see Nelson probably take out the HELOC, buy something in cash, use that extra cash flow from the property that doesn’t have a mortgage to pay off that HELOC, which theoretically means every payment he makes on it is going to be less than the last one was.
Now, the reason that I like that is it covers him on the downside because he’s paying off his mortgage. It’s a safer way to buy, but it also gives him upside potential if the market does turn around. If rates drop back down to something in the mid-fours or something, or we get another round of stimulus and like, “Oh, here goes the party again. Prices are going up,” he can always throw a mortgage on the new property, put more debt on it, and now he’s got that capital to go play in the game when the odds are on his favor.
So you have to… There’s no guarantees. You have to put yourself in the position where you’ve got flexibility in different areas. I think with the market we’re at right now, but of a stalemate, he’s got some upside. He’s protected against some downside. It’s sort of right down the middle. What do you think about that?

Dave:
Yeah, I think that’s a very good and defensive strategy, and generally agree with that approach in this type of market is definitely not leveraging yourself. One thing that I’ve been considering for deals is sort of taking the middle road and maybe putting 40% equity into a deal instead of what is usually the minimum for an investor of 25%. Would you ever consider doing something like that, David?

David:
This is a funny thing that you’re asking me that. So I was talking to Jay Papasan. He’s the author of The One Thing with Gary Keller as well as a lot of the other Keller Williams books. And he said something that made me feel really stupid. I was saying, “Yeah, there’s not much cash flowing right now.” And he goes, “Unless you want to put 50% down.”

Dave:
Yeah.

David:
That’s a great point. We just sort of assume 20% down is the only way to get cash flow. So we analyze a deal. It doesn’t work at 20% down. We go, “Oh, there’s no cash flow. There’s no point of buying real estate. I’m just going to sit over here and sit on my thumbs.” That’s not true, though. If you have more money to put down at will cash flow, you’re just going to get a smaller ROI because the capital investing is greater.
And so I think what you’re saying is a great point. If you’ve got more money, you still can buy real estate, and you’re not taking on additional risk because it is going to cash flow. You just can’t buy as much of it, which is one of the reasons that I continually give advice that we need to be saving our money and making more money, not just thinking about real estate investing. When real estate is doing awesome, of course, all we talk about is how to buy more of it, how to acquire it, how to build value in it. But when it’s not doing awesome, it’s just doing okay. You can still do awesome with the other two pillars of defense and offense, which I covered in my book, Pillars of Wealth, and you can get that on the BiggerPockets bookstore as well as your book, David. Do you want to share where people can get your new book?

Dave:
Yeah, thank you. It’s right behind me. I just got it for the first time, actually holding it in my hands. It’s called Start with Strategy. You can find it at biggerpockets.com/strategybook. It’s all about how to individualize your approach to real estate investing based on your own goals, risk tolerances, and circumstances in life.

David:
All right, so do you ever want to Dave and I visit your house at the same time? Go to the BiggerPockets bookstore, buy each of our books, put them on the shelves next to each other. It look like we’re holding hands, and you can tell your friends that you’ve been visited by David Greene and Dave Meyer at the same time.
Dave, thanks for joining me on the podcast and on Seeing Grain. Awesome doing a show with you as always. Hope to see you again on our next joint venture. And if you didn’t know, Dave is a huge aficionado of sandwiches. His Instagram is TheDataDeli, so go check him out there and let us know in the comments on YouTube what your favorite sandwiches because we want to know.
This is David Greene for Dave’s Strategy and Salami Meyer signing out.