This is the question on everyone's mind. What is the real estate market going to do and how will interest rates affect things?
To start, anyone who follows this blog knows that the Fed's impact upon interest rates is misdiagnosed. Even the Fed itself admits there is no correlation between moves in the Fed Funds Rate (which the Fed set) and the 10 Year, the standard that the mortgage market tends to follow.
However, that does not mean that markets to not react to what the Fed says. Thus, we already see mortgage rates going up even though the Fed has yet to raise rates. It once again seems that the Fed's influence has an impact.
So how do we unwind all of this and how will it affect real estate?
Let us dive in.
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Increase In Rates Kill ReFi Market And First Time Buyers
If the Fed has no impact upon rates ultimately, how do we decipher which direction they will head. The reality is that, due to a variety of monetary and economic factors, rates cannot rise for an extended period. Rising interest rates is a sign of a healthy economy. What we are looking at is anything but healthy. In fact, it is easy to see how many are making the case that things are rather sick.
Therefore, we can expect the long-term trend, which was in place since the Great Financial Crisis to continue. We see an economy that is limping along, falling behind all longer term growth lines. Here is where we see rates turning downward again.
We also have evidence of this in both 2013 and 2018. Each time the Fed reversed course, it was bad news for rates. It is true they went up initially before the market realized what was going on. Anyone who looks at the charts sees he reversals were fierce.
Of course, the near-term rise in rates is what applies to real estate.
There is little doubt the downward trend that is in place. Look at this 30Y on over the last half century.
In other words, from a historical perspective, the cost of borrowing money is still very cheap. This is where the problem comes in. With a continue decline, the refinance market (ReFi) is about to get slaughtered.
Here is what is happening with mortgages already.
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This is going to have a major impact. We are seeing the ReFi business getting crushed since most people already refinanced their homes to lower rates. As rates go up, even if it is for 6-12 months, this stops a great deal of activity in the mortgage market.
It also impacts the first time home buyer. Higher rates do mean larger payments if the price of the home remains the same. Of course, it is likely to bring home prices down but that can take a while. The real estate market can be slow to move. Unlike the equity markets that simply collapse, real estate tends to be more of a process.
Watch for this to unfold throughout the year.
Rental Rates Get Crushed
What is often overlooked in the discussion is the fact that rents tend to drop as the values of homes go down. This is going to cause a world of hurt for those who got in later in the bubble (Blockrock?) and are fixed in trying to get their rate of return.
When things head south, those with a lower cost basis (or ones who join in as prices regress) can adjust their rents accordingly. The enables them to undercut the market while attracting the highest quality tenets. Since they are in a strong position on the cost basis, the cashflow is still present even at lower rents.
This simply is not the case with many of the other landlords. They have to try and get larger payments simply to stay in the green each month. Here we see where the problem can snowball.
As prices decline, newer people enter. Again, with a lower cost, they are able to operate with the present market conditions. This adds more pain to those who are just trying to hang on.
Of course, as the foreclosure process picks up, something that is starting, it ends up putting more inventory on the market. Savvy investors are able to hop on bank deals helping to reset the entire pricing structure for the area.
Markets Do Turn
Many people find it impossible for markets to turn. It seems they forget that there are two directions. Read the headlines of any economic numbers that are high right now and you will see how the sentiment is things will only go higher. Both inflation and real estate prices are only going to moon according to many.
This is absurd. One of the things that can alter a market is affordability. With real estate, this was an issue for a long time. Now, it is being compounded with the rise in mortgage rates. Since this will likely take much of 2022 to sort out, we can expect it to have an impact upon the price of homes. We can offer a simple guess which direction that will take prices.
Anyone with an ounce of sense know it is not a question of "if" the real estate market head south but "when". The same is true for the equities market. Nothing goes in one direction.
Real estate carries a lot of pain with it. To start, it is leveraged. Hence, when things turn, the effects is much greater than if everyone paid cash. Also, it is a major part of the economy. This means the impact is felt outside the real estate industry itself.
Now that we know the real estate market will turn, the big question is when? That is tough to say. Since it is a process, instead of looking for a collapse, try to find some cracks. Mortgage applications, pricing in certain areas, and the exiting of real estate agents are all good barometers to seek out.
The latter is very interesting. During the run up before the GFC, it seemed like every 3rd person was a real estate agent. There were women who were married to attorneys who were pulling down $4K-$5 per month, part time. Of course, when things turned, they went back to doing whatever.
What we know is things leveled off starting in June of last year. This is a normal topping pattern for real estate. What happened in 2006 is not typical. It is a pattern.
That said, things can go on for months without a major change. We could see the leveling off continue well into the Summer. Of course, it is helpful to keep in mind that, the longer things go, the closer it gets to the Boomers unloading. Do not forget, the largest generation in terms of size is going to be downsizing. This could put markets such as the Northeast in a world of hurt as these people finally unload their properties and move to someplace warm.
Therefore, in conclusion, the time is coming near. Over the next 12-18 months it is likely that we see a large pullback in the real estate market. This likely will not be a crash like in 2006 but a grind down. Some areas are going to get crushed while others will hold up well. Nevertheless, the cleansing is not far off.
This is how markets work. Over time, excess gets washed out. And right now, real estate has a lot of excess in terms of market valuations.
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I know that in my country, there will be major inflation when it comes to real estate, been noticing the trend for a while now and it is crazy.
Price are going up in most places. The question is it a bubble? We are going to see some massive pullbacks in some areas.
Nothing goes up forever.
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Well, hopefully, it goes back down because most people are ending up homeless.
Prices going down, at least in the US, ends up costing people their homes. When they cant use the home as an ATM, they end up in trouble.
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There is always an advantage and a disadvantage but I don't think that would be the case here at least, the advantages would be way more.
I agree. The slowing down will be a long grind. The interest rate discussion has already impacted the house buying decisions for folks here in Toronto. There will be a pocket in markets like Toronto where the rate will dampen the spirit but won't change much. Apart from rate, there is an issue of high demand. High demand and low inventory were the two variable that kept the real estate market booming for the last two years. Going forward, the demand will stay high unless there is an immediate policy bomb the government explodes.
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Certainly real estate is local and that can never be overlooked. Not everything is going to experience the same market moves.
In the US, I predict the Northeast is screwed starting in the next couple years. This is because the Boomers are going to be moving out and they do not capture the younger people.
Warmer states, since Boomers do not want to shovel snow, are going to see an influx.
So that will add some stability to those areas.
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Agree. There will be pockets of cities and neighbourhoods that will go anti-current.
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This is so true. Clueless people I know literally try to tell me word for word "real estate always goes up", they actually said that to me. We are at the top of the market, and a friend of mine wont stop buying, they are going to get totally REKT...and even worse, they took out massive DEBT to buy at the top!
People's egos and thinking they are geniuses because they bought a few properties, slapped a coat of paint of them and made some cash, is going to be their undoing.
I know that from experience. In the US boom the last time, I got caught up in the FOMO. The "professional" real estate investors were sitting on the sidelines starting in 2003. The cost ratio simply was not there for them to have positive cashflow.
Me, I was buying and I had two houses on the market when the reversal in June 2006 hit. Guess who got crushed and who did not.
It is the same story over and over.
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The fact that were both humble and honest enough to recognize and admit your mistake, means you are already light years ahead of most other investors these days. I currently know maybe 7 or 8 investors, and with the exception of one (the one who was actually successful and now owns 3 condo complexes with over 20 units), they ALL invest blindly, without so much as 30 minutes of research. Not a single book read. Zero strategy or due diligence. Zero discipline and infinite ego. Success or failure, they do not learn anything. They are just like the kids that invest in coins with cartoon dogs on them, same mentality.
The friend of mine who wont stop buying and going into massive debt, he is actually a close friend and I am very sad at the destructive financial path he has chosen, though there may be hope for him because he does do some minimal research and more importantly his ego never grew once he owned multiple properties, and he is actually willing to listen. I think he is finally coming around a bit and is starting to see his errors, but...I fear it may be too late for him, I think unless he sells multiple properties soon, he is done once the market crashes. I can only hope that it takes the market a few more years to drop, as he does pay the houses off very aggressively (he tries to pay them off in 4-6 years), and perhaps that way he can be saved.
Sorry if I went off the deep end there and went overboard on the negativity man, it has just been an emotionally stressful past few years, seeing the economy get decimated, seeing my good friend march toward financial destruction, taking business losses myself, and seeing more dead people the past year than I have the rest of my life combined, including some of my family members, was all just really heavy shit and I needed to get some frustration out there.
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Has the foreclosures started? I don't really think I have heard anything about it. Do you think the government will start to step in once the market starts to tank?
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Yes the forebearance ended so there were a few starting in January. Keep in mind this is state run, with each having different laws. The ones with court ordered foreclosures, like Florida, will take a while since it has to go through the court system.
The government is going to have a tough time doing anything. There is a lot of division right now and they are being led to believe everything is rosy. The problem is things can start moving rapidly.
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It seems normal that the real estate market remains stagnant for a while due to the little economic movement, but surely when it will be activated little by little and you have to be patient.
We are expecting another rate hike being the second of the year and we have only had 2 months.
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Very wise observation you’ve I must say. Honestly real state business is not something I'm really very knowledgeable but many industrialist getting rich for this in my network by doing this business.
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