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Market Risk Focus | International Residential Real Estate Investors Association
Monday September 25th 2017

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Market Risk Focus

The economy in general faces major challenges.  As I see it, our  industry faces several key risks including:

  • Interest rate risk,
  • Inflation risk,
  • Price pressure for certain key  commodity inputs, and
  • Shifts in the housing paradigm in general and renting in specific

Over the past few weeks, I’ve highlighted census information showing substantially higher vacancies in luxury rental units.  This is further supported by clear substitution issues in major markets.

Next, since last summer the threat of rising rates has ebbed and flowed as with economic news.  While the effect has been muted and spreads have slowly began to close, the latent threat of higher rates seems likely  to become a growing reality if economic recovery  remains on track globally and especially if and as the U.S. economy gains momentum.

Next, the growing economic momentum of the emerging markets is beginning to take slack out of the commodity markets.  This combined with a still falling dollar implies likely price pressure and growing inflationary threat.  More specifically, our industry relies heavily on petroleum based products for roofing and paving and on metals (especially copper) for air conditioning, appliances, and wiring where pressure is likely to be more acute.

Investors should consider these points as they establish due diligence plans.  These considerations can be included in plans as:

  • Upward pricing bias on expenses for appliance repair, roof repair, vinyl flooring, paving, and air conditioning;
  • Increased capital reserves per unit per year;
  • More conservative loan to value; and
  • Increased long term capitalization rates

Positively, I believe we will continue to see muted pricing pressure for items produced in domestic supplies and for labor.  These areas are likely to be relatively flat for the foreseeable future.

I believe these considerations will affect asset classes until slack is taken out of the housing market as follows:

  • Class A properties will face weak demand and will need solutions to increase their value premise.  Positively, new inventory will be very limited on the rental and homeownership side of this equation leading to a more rapid recovery.
  • Class B & C properties face headwinds from the traditional renting base as the down turn has caused greater losses in the lower end of the income spectrum, but this should be more than made up for by consumers looking toward these properties as a cost saving alternative.

While these are relatively broad considerations, including these in plans is a prudent and potentially profitable exercise for the investor.

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