The Scottsdale/ Phoenix area is clearly in a housing bubble.

My on-the-ground experience of watching the bubble begin to burst.

“Booms start with some tie-in to reality, some reason which justifies the increase in asset values, and then -- and this is the critical feature of speculative mood -- the market loses touch with reality.” - John Kenneth Gailbraith

As some of you may know, I enjoy the philosophy of the Stoics. If I could sum up my personal opinion of Stoic philosophy, it would be simply to state, “the obstacle is the way”. Essentially, the idea is to turn obstacles into opportunities. Well, I have stumbled upon one such obstacle and have attempted to turn it into an opportunity.

As it turns out, I have a rare genetic liver disease that causes pre-cancerous tumors to grow within my liver. Unfortunately, there is no cure for these tumors, except to perform a liver transplant before the tumors can turn cancerous. So, long story short, I had to take some time off from work and here I am in Scottsdale, AZ waiting for a viable liver to be transplanted into me. This article is about bubbles, so I will not get sentimental other than to simply say I am truly grateful and blessed for the ability to receive this life saving treatment.

Now, that is the obstacle, but what have I gained from this obstacle? Well I found on the ground evidence of a true housing bubble. One of the most impressive scenes in the movie, “Big Short”, is when Steve Carrell’s character goes to Florida to investigate the housing bubble and gather information with his own eyes. Yes, there is a lot of information to be gathered from charts, data, facts, and figures, but seeing the permeations of markets in physical form, especially real estate, truly gives you the “big picture”.

My realization of the enormity of the Scottsdale real estate bubble came from my adventures in renting a home here. I have a realtor friend in Scottsdale who helped me find a home to rent. My requirements were quite simple, I need a safe, three to four bedroom house within 15 minutes of the hospital. I would be renting for six months, which is considered short-term, so I knew I would be paying a higher price, however, I had no idea what I was in for.

The first obstacle I ran into was that almost none of the short term rentals were available when I needed to move in due to the superbowl. This is understandable, except landlords felt comfortable charging $20k+ for a one month rental of a three bedroom house for the month of February. However, landlords did not achieve their desired result. BusinessInsider posted an article after the Super Bowl, titled, “Phoenix Airbnb Manager Stunned by Empty Units on Super Bowl Weekend.” https://www.businessinsider.com/phoenix-airbnb-super-bowl-weekend-short-term-rental-market-2023-2 . Clearly, the demand for three bedroom houses being rented for nearly 1/3 the average American salary has wained, even for the Super Bowl.

After a few days of searching I finally found a house to rent. Three bedrooms, two bathrooms, in Scottsdale, near the hospital. The house was listed for sale, listed as a short term rental, and as a year long rental. I jumped on it quickly because it met my criteria and I needed a place to recover from a liver transplant. The house was listed for sale at $750,000 and listed for rent at $6200/ mo. Now, buying a $750,000 house at current mortgage rates would cost approximately $4,155.00 per month, with a 20% ($150k) down payment. During the lowest mortgage rates of 2020/2021, this house would cost approximately $2600/ month with a 20% down payment. Yet, the house is more expensive now, then during the 2021 real estate mania. Please explain how a house that costs the average family almost DOUBLE per month, can be MORE expensive now, than previously. Housing prices clearly need to come down, it is simple math.

I took another look at the listing, and decided to throw out a “low-ball” offer to rent the house as it seemed very over-priced asking $6,200/ month. I told the realtor to offer $5,000 per month for a six-month lease, with a one month penalty if I broke the lease early. I also wanted to bring my two large dogs and have the landlord cover landscaping. To my shock, the realtor called me back within two minutes and told me that the landlord agreed to my terms. I was completely in shock. My spider-sense began to tingle and I began to ask the realtor some back story on this landlord. The only caveat he put on our negotiation was that I pay the first month rent, security deposit, and pet deposit within 48 hours via wire. I immediately thought, “scam”, but the real estate agent assured me that he knew this landlord and there was no scam. It turned out, the landlord desperately needed the money, asap. After I thought about it, I assume this landlord needed my deposit to cover other debts that were mounting from his other homes and to cover carrying costs.

The backstory of this landlord was that he was originally from the east coast, but moved out to Scottsdale in 2019 as a real estate “investor” and began to buy up homes to flip. The modus operandi of this investor was to buy up homes in Scottsdale/ Phoenix, put some work in to “re-model” them, re-finance the home at a higher valuation and then sell the home. This model generally tends to work when home prices are consistently climbing, it works especially well during bubbles as we saw from 2003-2007. This investment model can also work if you are adding real value to the home, refurbishing the home, adding on to the home, etc. However, during real estate bubbles, home flippers tend to throw some slabs of paint on the house, fix some dry-wall, landscape the backyard, and then call their appraiser friend to re-value the house at a 20% higher price than six months prior. I call these flips “paint-throw flips”. These flips tend to work in a market bubble as demand for houses continually rises past any fundamental reasoning and into silliness.

The home I am currently renting is clearly a “paint-throw flip”. Although, in a very desirable location in Scottsdale, AZ, the house was clearly renovated for as cheaply and a quickly as possible. The floors squish under your feet as you walk and are clearly uneven, the cheap countertops are coming up in the corners and you can see the glue, the doors are uneven and some cannot lock without serious force, the hot water heater is 22 years old, the closet doors are extremely cheap and don’t fit on the tracks, about 1/3 of the electrical outlets do not work and some are painted over, some windows do not open, the windows still contain stains from the manufacturer stickers, etc. The list goes on and on. Now, I am not saying this to complain, but rather I am pointing out that this house was listed for 3/4 of a million dollars, this house flipper really expected someone to pay $750,000 for this shoddy house! It defies all common sense and logic.

I did some basic research and found out this house was purchased for $169,000 in the year 2000. My landlord purchased this house for $650,000 (pre-renovation) in July 2022, and is trying to flip it in January 2023 for $750,000. I would estimate about $25,000 of renovation went into this house. The fact that the seller thinks he can get anywhere near $750,000 for this house, with mortgage rates at 7% is completely mind-boggling. The fact that he paid $650k for this house before any of these renovations, is even more stunning. The couple that bought the house for $169k in 2000 made out like bandits. That couple made a 384% return on their primary residence even though they bought at a market peak as well.

It is quite obvious to me that this house flipper bought this house at a ridiculously inflated price, thought he could throw some paint on the house and flip it as he had done very easily the past few years. Well, it seems as if the house was not selling at the price he needed to be profitable, could not sustain the carrying costs, and got desperate for money so he threw it on the market as as rental in the hopes to stop the bleeding for a few months and pray the market recovers. These are the first signs of a housing bubble popping. A house-flipper clearly would rather sell the house, take out their profit, and run. Rather, my guess is that he is renting this house to me out of desperation. Remember, bubbles are often easy to spot, but often last much longer than anyone expects because people will claw, beg, and borrow to keep themselves afloat even if the endgame is obvious.

Now, lets be clear, there is real reasons for the Scottsdale market to have done well. There is a mass exodus from California into Arizona, relatively cheap taxes, business friendly environments, and previously cheap housing. Additionally, the weather, golf, recreation and amenities are top notch. This is clearly true. However, although there are legitimate reasons for homes to have appreciated in value, the level to which they have accumulated is clearly not sustainable.

After I am healed and ready to head back to New Mexico, I will be watching this house on the market, I am very curious to see what will happen here. If my suspicions are correct, the owner of this house will likely sell for less than he bought it for, which means the bubble has officially began to pop. The soft sounds of the bubble slowly deflating are getting louder and louder.

-Russell

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**As Always, this article was not financial advice. For financial advice, please consult with a licensed financial advisor for your particular financial situation.**