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Is The Next Housing Market Crash Coming?
SAN DIEGO, CA – “Buy low, sell high” is a well-known adage attributed to legendary billionaire investor and philanthropist Warren Buffett. Looking at today’s super-hot residential real estate market, it’s hard not to wonder how much longer this craze will last.
Buyers are in bidding wars to buy homes, multiple cash offers with no financing, no contingencies, sales prices tens or even hundreds of thousands of dollars above asking prices, double digit annual price appreciation housing and a very low housing inventory. for sale
According to the Case-Schiller housing index, average annual home appreciation in the 20 largest metropolitan areas was 14.6% year-over-year last May. Phoenix had the highest annual price increase at 22.3%, followed by San Diego at 21.6% and Seattle at 20.2%.
I vividly remember that in 2005-2006, at the height of that last very hot residential real estate market, many were saying that the market would continue to boom and that prices would rise for at least another ten years.
However, in 2007 home prices began to deteriorate and in 2009-2010 a wave of short sales and foreclosures dominated the previously overheated markets. Hardest-hit places like Phoenix and Las Vegas saw property values depreciate in some cases by more than 50%.
But this time will be different… no. If there’s one thing that’s certain about real estate (and life in general), it’s that it’s cyclical. Each boom is followed by a rejection, and each recess by an eventual recovery and then another boom, etc.
In the case of real estate, the cycles are usually much longer than those of the general economy and have an average duration of about 15 years. In this particular case, it is important to note that we are talking about a residential real estate cycle (homes), which can be quite different from a commercial real estate cycle (investment properties).
So where are we today? Interest rates, including mortgages, are at very low levels. For example, our sister mortgage company recently closed 15-year fixed rate loans as low as 1.99%. This is quite remarkable considering that the inflation rate is skyrocketing. Last June, inflation increased by 5.4% year-on-year.
This was the largest increase in inflation since 2008. At this rate, the US is on track to have double-digit inflation by 2023. Compare that to annual inflation rates of just 2.4 % in 2018 and 1.8% in 2019 and 1.3% % in 2020.
The federal government’s money supply, public debt, and public spending are enormous. It seems that not too long ago, when politicians were discussing the federal budget, they were talking about millions, or at most billions of dollars. Now, if it’s not a billion, it doesn’t seem like a big deal.
Unemployment in the United States has steadily improved since its peak of 16% in May 2020. At the beginning of June, the unemployment rate was around 5.9%. However, these figures can be misleading as they do not include people who are ‘underemployed’, for example, who switched from full-time to part-time work, or those who earn less now than they did before pandemic
In addition, workers considered “permanently unemployed” (unemployed for more than six months) and those who “have stopped looking for work” are not counted. The “real” or so-called U6 unemployment rate is around 9.7%.
So how does all this translate to the residential real estate market? The current real estate cycle is about 15-16 years, which is a concern, but basically, as long as money is so cheap, buyer demand so high, and the supply of homes available for sale so low, the “music continues to play”. .”
Also, we should not underestimate the “Covid effect” in housing. One of the reasons homes became so valuable was because of the lockdowns and paradigm shifts of working from home, learning from home, playing at home, and eating at home.
If cycles are the law of the universe, then it is safe to assume that this cycle must also change. when? No one knows for sure, as we only realize the cycle has changed after it has already done so.
However, in my estimation, the catalyst for change will be an increase in short-term interest rates by the Federal Reserve, which will have to happen sooner or later given high inflation.
Our real estate brokerage receives many inquiries from buyers and investors who want to buy property. In our opinion, real estate buyers should proceed with extreme caution in such an overheated real estate market.
Double digit annual price appreciation is absolutely unsustainable as real wage increases are in the low single digits. It is important to understand that real estate is not a very liquid asset and that selling it has substantial costs.
For most residential property owners, real estate should be a long-term play and buyers should keep this in mind when considering property purchases. When the inevitable market correction comes, home equity can be greatly reduced or even wiped out in the case of highly mortgaged homes.
In these cases, homeowners can find themselves “upside down” on their mortgages, meaning they owe more than their properties are worth. Short sales and foreclosures will become familiar terms again.
On the other hand, the lucky residential property owners who currently own highly appreciated real estate assets may be in a perfect position to cash in their capital now that the market is hot and prices are high (remember what W. Buffett said ).
Residential homebuilders, especially those building in the lower price ranges with projects already underway, or about to go vertical and delivering completed homes in the next 12 to 18 months, are in good shape because current buyer demand far exceeds supply.
However, after this period of time, no one would guess. Exorbitant material prices, high land and labor costs, and onerous government fees make it difficult for builders to deliver affordable homes and make a profit.
There could be another important consideration for selling sooner rather than later: Uncle Sam. The current administration is openly talking about raising taxes and, despite their campaign promises, it won’t just affect the “rich”.
For example, under his latest tax proposals, the homeowner’s exemption from capital gains tax on the sale of primary homes may be greatly reduced or even eliminated entirely. Oh, by the way, the capital gains tax rate is also going up.
Another major tax change on the horizon for owners of investment property, even if it’s a small rental home or condo, is a proposal to reduce or eliminate the so-called “1031 Tax Exchange “, under which capital gains taxes can be deferred. investment properties, including small and large rentals.
Every situation is unique, but my general advice to clients looking to buy real estate now is that there needs to be a compelling reason for them to do so. I recommend being patient and not buying into the frenzy, which sooner or later will pass.
Again, remember what W. Buffett says about buying low and selling high, and he certainly has the track record (and bank account) to prove he knows what he’s talking about.
For clients who own a property and want to hold it for the long term, I recommend reviewing their mortgages and interest rates (if they have loans on their properties).
If it is beneficial, they should look into refinancing, with or without repayment, to take advantage of these extremely low interest rates, which are currently well below the rate of inflation, making them practically “money free of charge”.
For clients who are considering selling or have short-term ownership plans, this could be a great opportunity to review their property values and determine whether to sell now, while the market is very hot and prices are very high. it’s a good idea .
In conclusion, no one knows what the future holds, but there are a couple of things that are certain: real estate is cyclical and change is inevitable. The current cycle of the residential real estate market is mature, prices are very high, and therefore it is reasonable to expect a market change.
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