SAN DIEGO, CA-“Buy low, sell high‘ is a well-known saying attributed to legendary billionaire philanthropist Warren Buffett. Looking at today’s blisteringly hot housing market, it’s hard not to wonder how much longer this madness will continue.
Buyers are in bidding wars to buy homes, there are multiple cash offers with no financing, no contingencies, sale prices tens or even hundreds of thousands of dollars above asking prices, double digit annual home price increases, and a very low inventory of homes for sale.
According to the Case-Schiller Home Index, the average annual home value appreciation in the 20 major metro areas was 14.6% year over year as of this past 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 back in 2005-2006, at the peak of that last super hot housing market, many saying the market would continue to thrive and prices go up for at least ten more years.
But starting in 2007, home prices began to deteriorate, and from 2009 to 2010 a wave of short sales and foreclosures dominated previously sizzling markets. The hardest hit places like Phoenix and Las Vegas have seen property values drop by over 50% in some cases.
But this time will be different… not. If real estate (and life in general) is one thing for sure, it’s that it’s cyclical. Each boom is followed by a bust, and each bust is followed by an eventual bounce and then another boom, and so on.
Real estate cycles tend to be much longer than the broader economy, averaging around 15 years. In this particular case, it is important to note that we are talking about a residential (home ownership) cycle, which can differ significantly from a commercial (investment property) cycle.
So where are we today? Interest rates, including mortgages, are at ultra-low levels. For example, our sister mortgage company recently took out a 15-year fixed rate loan with a low interest rate of just 1.99%. This is quite remarkable considering the inflation rate is skyrocketing. Only last June did inflation rise by 5.4% year-on-year.
This was the biggest spike in inflation since 2008. At this rate, the US is on track to post double-digit inflation by 2023. Compare that to annual inflation rates of just 2.4% in 2018, 1.8% in 2019 and 1.3% in 2020.
Money supply, national debt and federal government spending are enormous. It seems that not so long ago, when politicians were arguing about the federal budget, they were talking about millions or at most billions of dollars. If it’s not a trillion now, it doesn’t seem like a big deal.
US unemployment 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 numbers can be misleading as they do not include people who are “underemployed”, e.g. For example, those who switched from full-time to part-time work, or those who are now earning less than they did before the pandemic.
In addition, they do not count workers who are considered “permanently unemployed” (unemployed for more than six months) and those who “have stopped looking for work”. The “real” or so-called U6 unemployment rate is around 9.7%.
How does all of this translate to the housing market? The current real estate cycle is about 15-16 years old, which is worrying, but fundamentally, as long as money is so cheap, buyer demand is so high, and supply of homes for sale is so low, the “music is still playing.”
In addition, we should not underestimate the “Covid effect” on housing. One of the reasons housing became so valuable was the lockdowns and the consequent paradigm shifts of working from home, homeschooling, homeplay and homeeating.
If cycles are the law of the universe, then it is safe to assume that this cycle must change as well. When? No one knows for sure as we realize the cycle has only changed after it already has.
In my opinion, however, the trigger for the change will be an increase in short-term interest rates by the Federal Reserve, which will have to happen sooner or later in view of the high inflation.
Our real estate agency receives many inquiries from buyers and investors who want to buy real estate. We believe property buyers should exercise extreme caution in such an overheated property market.
The double-digit annual price increase is absolutely unsustainable given that real wage increases are in the low single digits. It is important to understand that real estate is not a very liquid asset and there are significant costs associated with selling it.
For most residential property owners, real estate should be a long-term game and buyers should keep this in mind when considering buying real estate. When the inevitable market correction comes, home equity can be severely reduced or even wiped out for highly stressed homes.
In such cases, homeowners can leave their mortgages “upside down,” meaning they owe more than the value of their properties. Short sales and foreclosures are becoming familiar terms again.
On the other hand, the lucky homeowners who currently own highly valued real estate investments may be in a perfect position to cash out their equity now when the market is hot and prices are high (remember what W. Buffett said) . .
Residential home builders, particularly those building in the lower price brackets with projects that are already going up or about to verticalize and will deliver finished homes in the next 12 to 18 months, are in good shape given current buyer demand who deliver.
After this time frame, however, it is unclear. Exorbitant material prices, high land and labor costs, and onerous government fees make it difficult for builders to deliver affordable homes and turn a profit.
There could be another important consideration for the sale sooner or later: Uncle Sam. The current government is open about tax increases and, despite its election promises, will not only hit the “rich”.
For example, under their latest tax proposals, the homeowner’s capital gains tax exemption on the sale of primary residences can be greatly reduced or even abolished altogether. Incidentally, the capital gains tax rate also increases.
Another significant tax change looming for those who own 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 are deferred investment property, including small and large rental properties.
Every situation is unique, but my general advice for clients looking to buy property now is that there must be a compelling reason for doing so. I recommend being patient and not getting into the frenzy that will pass sooner or later.
Recall what W. Buffett says about buying low and selling high, and he certainly has a track record (and the bank account) to prove he knows what he’s talking about.
For clients who own real estate and want to hold it for the long term, I recommend checking their mortgages and interest rates (if they have loans on their real estate).
If it makes sense, they should try to refinance them with or without a payout to take advantage of these extremely low interest rates, which at this point are well below the rate of inflation, making them effectively “free money”.
For clients considering a sale or who have short term ownership plans, this could be a great opportunity to review the value of their properties and determine if selling now while the market is super hot and prices are super high is a good idea.
In summary, no one knows what the future holds, but a few things are certain: real estate is cyclical and change is inevitable. The current residential real estate market cycle is mature, prices are very high and therefore a market shift is to be expected.