Escalation Clauses in a Tight Market

photo by Jeramey Jannene (CC BY 2.0)

I spoke with Business Insider about the use of escalation clauses in hot housing markets.  The article (behind a paywall) opens,

With people around the US competing in a tight housing market, many are turning to a unique strategy: escalation clauses.

Escalation clauses are meant to help buyers beat the competition for an in-demand property. When would-be buyers put an offer on a home that they anticipate will have other offers, it automatically increases the buyer’s original offer by a specified amount in an effort to outbid everyone else.

Whether the buyer is notified before a seller applies an escalation clause depends on the particular contract terms, according to David Reiss, a law professor at Brooklyn Law School specializing in real estate. Some real-estate agents encourage clients to use escalation clauses, though not every state or seller allows them.

These clauses can give you a fighting chance by allowing you to skip some of the negotiation and back-and-forth, but can be harmful in that they show sellers how much buyers are willing to spend.

Insider spoke with several home buyers who used escalation clauses to understand the risks and rewards they come with.

Supply and Demand in a Hot Market

photo by Subman758

The Asheville Citizen-Times quoted me in Apartment Occupancy Dropping, but Rents Not Budging Yet. It reads, in part,

Tell Marie Kerwin the city’s apartment vacancy rate has dropped a few notches – meaning a lot more units should be available – and she may beg to differ.

“There’s not a lot of options,” said Kerwin, “It took me months to find an apartment. I actually was calling every complex, every day.”

Kerwin and her husband, Christian, relocated to Asheville a year ago from Jacksonville, Florida, both taking jobs with the Earth Fare supermarket. Kerwin said they “got lucky” in finding a place at The Palisades, a 224-unit complex off Mills Gap Road in Arden that opened last summer.

For renters like the Kerwins, it might not seem like it, but the city’s apartment vacancy rate — famously pegged at 1 percent in a consultant’s report published a year-and-a-half ago that looked at Buncombe and three other counties — is dropping, meaning more units are available. That also should mean, theoretically, rents will decline, but that hasn’t happened.

A tight apartment market has dominated local discussions about affordable housing and livability in the Asheville area for nearly two years. But while that vacancy rate is dropping to a more livable range of around 6 percent, rents likely won’t fall over the next couple of years, experts say.

‘A very tight market’

“Typically, Asheville is a very tight market,” said Marc Robinson, vice chairman of Cushman & Wakefield, a global company that tracks apartment trends, including occupancy and rents.

Whether rents will drop with new apartments being built is “a hard call,” he added, “because on the one hand there is a supply entering the system, and that market has really seen lot of supply at one time — more supply than it would have historically seen. But in many markets, including Raleigh, Charlotte and Atlanta, absorption (of new units) has been better than expected.”

Robinson’s company, Multi Housing Advisors, now part of Cushman & Wakefield, issues quarterly reports on the apartment market. Its “MHA Market Insight” first quarter report for Asheville noted:

• “Properties built from the 1980s to the 2000s are maintaining an average vacancy rate in the 6 percent range, compared to 3 percent for properties built in 1970s or earlier.”

• “The average vacancy for properties built after 2009 is approximately 19 percent, which is skewing the vacancy rate upward,” in part because in a smaller market “additions to supply have an amplified effect.”

Robinson said his company’s figures from about two months ago show the Asheville area has “about a 3 percent vacancy, and in real time it may be a little higher.” In North Carolina, the rental vacancy in the first quarter stood at 8.2 percent, according to U.S. Census data.

By some estimates, the Asheville area, including surrounding Buncombe County and Fletcher, has had or will have in coming months about 2,200 new units coming online, well short of the 5,600 units the consultant recommended be built to meet demand.

“The pipeline of new construction (of rental properties) over the next three to five years will still not meet the forecasted demand so for the short-term we can expect to see the rental rates remain high, vacancy rates to remain at record lows,” said Greg Stephens, chief appraiser and senior vice president of compliance for Detroit-based Metro-West Appraisal Company.

Several firms track such information, including Real Data, a Charlotte-based real estate research firm. Using market surveys rather than sample data to compile its statistics, Real Data found the vacancy rate among apartment complexes with at least 30 units in Asheville, Buncombe County and Hendersonville was 6.9 percent in December.

Theoretically, all this should mean rents will come down, as people move from older apartments to newer ones, and apartment companies have to make concessions, such as lowering rents.

Apartments under construction has been a common sight in the Asheville area in the last two years, and that has eased vacancy rates some, experts say. This complex, the Avalon, went up in 2014 off Sweeten Creek Road and is now open.

But this is Asheville, where millennials keep moving in and retirees are drawn to great weather, arts and restaurants. From March 2015 to March 2016, Asheville saw the highest spike statewide in the average cost of renting an apartment, a 7.6 percent jump.

For the first quarter of 2016, MHA Market Insight found the average rent for one-bedroom apartments in Buncombe, Henderson, Haywood and Madison counties was $821, representing a 6.2 percent one-year growth in rent. A two-bedroom went for $964, 4.3 percent growth.

Kerwin said she and her husband are paying $1,095 a month for their two-bedroom, two-bath, 1,125-square-foot apartment. In Florida they paid $1,100 a month for an 1,800-square-foot three-bedroom.

“It’s definitely more expensive to live here,” she said.

Rising vacancy rates combined with rising rents is a national phenomenon, said Jonathan Miller, the New York-based co-founder of Miller Samuel, a residential real estate appraisal company, and the commercial valuation firm Miller Cicero.

“New development that skews to high-end rentals has been overplayed,” Miller said. But moderate rental development stock “has remained largely static.”

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Solutions far off

That is not what some members of Asheville City Council want to hear right now. Councilman Gordon Smith, who’s on the city’s Housing and Community Development Committee, said the city has formulated a comprehensive affordable housing strategy and has talked about an “all of the above approach.”

That includes increasing zoning density to allow more units per acre and encouraging developers to use city-backed incentives to build apartments.

The city is also in the midst of calling for a voter referendum on a $74 million bond issue, with $25 million of that potentially earmarked for affordable housing. If passed, it could include a $5 million addition to the existing revolving loan fund for private developers to build affordable rental housing, and $10 million for land banking or repurposing city-owned land, which would involve offering that land to developers for construction of affordable housing.

Rusty Pulliam heads Pulliam Properties, a commercial real estate firm that has become active in the apartment industry in recent years, building the 280-unit Weirbridge Village in Skyland and the 180-unit Retreat at Hunt Hill. This year the company also received approval to build a 272-unit complex on Mills Gap Road in Arden, which will include 41 units designated as “affordable,” a number Pulliam agreed to bump up at council’s urging.

Pulliam said he can still make money at the Mills Gap site because demand is so high that he can build a “premium complex” and charge high enough rents to make it work. But in the long run, he said, solving the apartment crunch does not require a Ph.D.

“If we were building middle-of-the-road apartments, we couldn’t do it. But until we put out there, as the Bowen report stated, 5,600 units in the marketplace, I don’t see that rents are going to come down, especially when see we’ve got a (3.5) percent unemployment rate and rents went up 7.6 percent, even when a lot of units did come on line.”

Unemployment in Buncombe County dropped to 3.5 percent in May, the lowest in the state.

People have always loved moving to Asheville, a trend that essentially never abates. Our region continues to grow not because of the birth rate but because of in-migration.

The U.S. Census Bureau projects Buncombe County’s population to grow to 300,000 by 2030, up from 253,178 in 2015. While the mountains are known as a retirement haven, millennials are coming here, too, with growth in that segment over the past five years outpacing that of baby boomers, people of ages 50 to 69, and Generation X, which includes ages 35 to 49.

In short, that’s a lot of apartment demand.

Other cities the challenge facing Asheville, said David Reiss, a professor of law and the research director at the Center for Urban Business  Entrepreneurship at Brooklyn Law School in New York.

“During the Great Recession nothing got built,” Reiss said. “The same thing happened in New York.”

Some economists believe that “when vacancy rates are below 5 percent, you have the ability to raise rents significantly,” he said.

The MHA Market Insight first quarter report noted that “fewer than 700 units are currently under construction at five properties” in Asheville, so we’re still a long way from that 5,600 units figure.

Reiss said a full-court approach such as the one Asheville is taking can be useful, but he also urged caution.

“Whatever they decide the solution is, it takes years to implement those ideas,” Reiss said. “Whether it’s a developer or the city government, it takes a long time to get a solution in place.”

Buying in a Boom

Marcin Wichary

TheStreet.com quoted me in How Consumers Can Buy Houses in a Booming Market. The story reads, in part,

Home prices have also risen compared to last year as the number of homes sold rose in all parts of the country except for the Midwest, according to a recent report from PNC, the Pittsburgh-based financial institution. The median sale price for an existing single-family home was $288,300 in July, up from $279,700 in June.

“The housing market continues to gradually recover from the Great Recession, supporting economic growth,” Stuart Hoffman, chief economist for PNC. “Stronger demand and good affordability are supporting home sales and pushing up house prices.”

Many economists are predicting that home prices will continue to increase this year. PNC said prices will rise by 3.7% in 2015 and 2.7% in 2016, down from 6.6% in 2014.

“This year we [saw] inventory continue to grow in August and while overall demand is strong, the trend in median days on market is suggesting that the market is finding more of a balance,” said Jonathan Smoke, chief economist of Realtor.com, the San Jose, Calif. real estate service company. “This bodes well for would-be buyers who have been discouraged by the inability to find a home to buy this spring and summer.”

Consumers who are still eager to purchase a home still have many opportunities left to negotiate a deal within their price range. While it is tougher to buy a house in a tight market, here are some tips to give homebuyers a head start.

Looking for a house in the fall is generally a better bet. Even though there are fewer homes on the market right now, there are “definitely less buyers, so there’s less competition,” said Mark Lesses, a broker with Coldwell Banker in Lexington, Mass.

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Renters Who Wait Can Benefit

Buying a house during a tight market could prove to be an expensive endeavor. Staying out of the market might be a good option, because housing prices could level off and decline, said David Reiss, a law professor at Brooklyn Law School in N.Y.

“Sometimes it is cheaper to rent,” he said. “Don’t try to time the real estate market. Look at your needs and what you could afford, and consider if it is a good choice.”