What is the Real Estate Market Going to do?

This is the question I have heard most the last year or so. I have given some form of the same answer each time I have been asked. But I have heard so many different responses from other people in the industry. So what is the market going to do?

Well, I no more have a crystal ball than the next person. In all reality who wants to answer this question in black and white? It is much easier to deny making a statement or even remember wrong, but words become immortal when published. I have seen countless articles and internet posts talking about the strength of the real estate market, and how there is no way the market could crash again, I simply had to add my overpriced two cents worth.

Are we in a real estate bubble? YES, absolutely. Does that mean the bubble is going to pop soon? No, but that doesn’t mean it won’t. We are in an everything bubble. Stock market bubble… equities bubble… you name it, it’s a bubble, or at least overinflated. Bubbles do pop, or at least bubbles must have some pressure released.

Is the market the same today as 2006? Yes and No. First, lets talk similarities. Prices were high in 2006, and prices got to a point where with the then current interest rates, the average person could not afford to buy a house. The market was run up by investors, AND by us normal folks not wanting to “miss out”. Investors have had a hand in this run up too. The investor was more of a little guy last time, and now tons of properties are being purchased by huge corporations or conglomerates like Blackrock, Invitation Homes, Progress, American Homes 4 Rent, Tricon, Zillow, OpenDoor, etc, etc, etc. These groups have cash; and lets be real, if the elite have tons of cash (or have access to tons of cash), and the stock market is “iffy”, why not put $$ into real estate? I often hear comments like, “Those greedy pigs are killing us working class” and such. Which is true – their greed is hurting the masses. But at the same time, it is us “working class” that keeps choosing to sell to them as opposed to a fellow working class person. Why are we selling to them? Greed. We sell to them because they will pay more; and then we complain how our children are not going to be able to afford to stay in our state. Well, we have some of the blame. We, the “working class” have also been taking homes to live in off the market by turning them into (and using on our travels) vacation rentals. These homes are no longer available as a primary residence. The real estate market did get crazy in 2006, with home prices and interest rates (about 6% in 2006) got to an unsustainable level before the last crash. Not a whole lot different today.

Now lets chat a little about what is different. Loans are different today. There are less “questionable” loans being made. Back then they were giving mortgages to anyone with a heartbeat. If a buyer had a job making $14 per hour, he/she could somehow buy a home for $450k. Made zero sense. That is not happening today. Back then, we had all kinds of adjustable rate mortgage loans, we had interest only loans – heck we had adjustable rate AND interest only loans being made to investors with only 10% down. Back then they made borrowing money super easy. Today, much of that does not exist. Perhaps the biggest difference today verse 2006 is two-fold. I saw a stat a month or so ago in an article (can’t remember which article) that stated 84% of US mortgages were at a 4% interest rate or below. This means the vast majority of homeowners have “affordable” house payments. Heck, my loan is at 2.5%. I am not moving anywhere even if I wanted to. Why on earth would I sell my home with a 2.5% rate so I could go buy a home with a 5.5% rate. Heck the payment almost doubles if I buy a home with the same loan amount… No thanks. I’m staying put. The next huge difference today verse 2006 is that there is a greater percentage of homeowners that have a bigger chunk of equity in their home. When things started going south in 2007, and job losses started happening, people would walk away from their home because they could rent the same home for half the monthly payment. Then after a few people foreclosed, the neighbors ended up being under water, so they too stopped making payments and moved to a rental for 1/2 price (or some bought another home, then stopped making payments). Today, there is no benefit to “jumping ship” on your home. Heck most people’s mortgage payment is considerably less than their house would rent for. BUT, far too many of us are using equity in our homes to enhance our lifestyle.

The home my wife and I owned back in 2006 peaked with a value of about $440,000. Say a buyer put 5% down to buy the home, and got an interest rate of 6% – his/her payment would be about $2900 per month (back in 2006). That is a nice chunk of money today, but it was a boatload then. Especially when the same home would rent for about half that. In January 2022 that same house was probably worth $600k. If a buyer bought the home in January for $600k and put the same 5% down payment, and got a then available 3% interest rate, guess what their payment was? Yep, about $2900 per month. That same home continued to go up in value for another couple months. So today it would be maybe $630k at say 5.5% interest rate, the payment is now a whopping $3900 per month. That is absolutely insane.

Now I want to chat a bit about the economy. We have hefty inflation right now. The government has been spending money like it only has a few months left to live (one can hope…), which has helped push inflation higher. The federal reserve holds significant blame for our current housing prices. Mortgage rates were low enough before March of 2020 (some virus or something), but the federal reserve decided to drop rates even more to stimulate the economy AND they started purchasing mortgage backed securities to free up more money for banks to lend on homes. Having mortgage rates go from 4.25% to 2.625% in a few short months is like offering ice cream to a fat kid. We have lift off! Now they realize things got a little too hot, and they now have to cool things off, so they start jacking rates up.

We are seeing inflation in everything that we need. Home prices, interest rates, gas and energy prices, food, medical services, etc. We are seeing increases in pay – but that does not come close to covering even the extra household costs excluding mortgage or rents. The average US household is getting pinched. As a general rule, when rates are going up, companies and businesses stop investing in growth, and they start “tightening their belts”. We then see company layoffs, and slow hiring practices. We see contraction in the GDP (which we have already had). IF this continues, we will see more layoffs and further strain on household budgets. If/when the economy starts to slow (I believe it already has), we will start seeing less travel and less use of people’s vrbo properties. This could lead to some to choose to either rent their home out as a normal rental or sell the property. The number of active listings in the Phoenix metro area has doubled in the last eights weeks. It will continue to go up. Yes, this time of year we generally see more listings, but we also see more pending sales. We are not seeing more sales, but less.

About a year ago, the Phoenix metro area ranked 1st in the country for multi family construction units (mostly apartment complexes), and we see tons of them under construction currently. Throughout the next year, the valley will see thousands of new units available for rent. This may help ease pressure on rents; and if rent pressure decreases while home prices and interest rates are high, demand for housing to purchase will decrease more.

While I still believe buying a home, if one can afford the payment without being too risky and uncomfortable, is far better than renting. We are now at a point where house payments do not make sense. If I was a 20 something and faced with renting an apartment for $2200 per month, or renting a small house for $2500 per month, or buying a starter home for $3000 per month, I’m not so sure I would even stay in Arizona. Our current market is 100% unsustainable. If interest rates do not go back down, or if household incomes do not go up, we will see significantly fewer house sales in the valley… and that will continue until rates go down, or pay goes up, OR home prices go down…. My guess is the vast majority of people will choose to stay where they are. No sense in giving up a low house payment to get a high one. The bread and butter of real estate, which is the “sell a small home and buy a bigger one” segment will not exist for a few years. That will leave us with cash buyers, people moving from pricier markets, and first time home buyers.

We all know something doesn’t feel right. We don’t need the media to tell us that (same media that lied to us in 2006 about the real estate market saying that “all is well”). Household savings rates have dropped to the lowest level since 2008. We see equity in our homes which gives us comfort (and maybe a false sense of security), but we also see the costs of things rising quickly. As we see more layoffs, our comfort level will decrease. While I do not believe we are in for a housing crash like 2007, I do believe realtors will be fighting over fewer deals, making less money, and many will be looking for jobs outside of real estate.

Now is a time to be smart.