The Housing Market Is About To Flip
The 2021 housing market is, in a word, hot. Anecdotally, friends of mine looking to purchase a home for the first time are being priced out of the market, and are now expanding their searches further and further from Atlanta. One friend offered $35k over asking price with no contingencies one day after the listing hit the market, and his offer was ranked 4th. Of 38. This wasn't some mansion in the city's foothills. It's a home 40 minutes outside of Atlanta, built in the early 2000's and has little to no upgrades. He's not even the craziest story out there. A home-buyer in Bethesda, Maryland, noted in a written offer to the buyer a pledge to name their first-born child after the seller as part of the sale contingency.
Even in cities where inventory is high, like New York City and San Francisco, prices are accelerating higher and higher. Home prices across America rose an average of 24% year over year, but they're still selling for nearly 2% higher than their asking prices, both records. Not to mention the homes are selling in an average of 17 days, another record. The average first time home-buyer is getting priced out, and the refrain "oh we're just in a bubble so who really knows? I'll just wait until it bursts and then buy something cheap" is starting to get louder and louder from the current rental crowd. But are we in a bubble? If so, why? And when will it actually burst? Let's break it down:
1. Interest rates are at all-time lows
The 2020 COVID-19 pandemic threw the world into chaos. The world stood still for over a year as countries raced to quarantine and snuff out new infections. This resulted in historic economic contraction around the world. The way the United States deals with economic contraction is for the Federal Reserve bank to lower interest rates. This disincentivizes people to keep cash in a savings account because of the lack of return, and forces the hand of the consumer to invest their money into stocks, bonds or real estate. However, the Fed not having seen a world-altering pandemic coming, already had interest rates close to zero due to being at the so-called end of a short-term economic cycle. This forced the Fed to institute "quantitative easing," which is essentially a government bond buying program. So how does this affect mortgage demand?
When rates are low, it costs less to borrow. According to Bankrate, the average mortgage rate in 2018 was 4.7%. That means if you were to purchase a $350,000 house in 2018 at 4.7% for a standard 30 year mortgage, your monthly payment would be $1,815. That same house purchased in 2020 at a historically low 2.8% interest rate? $1,438, giving you a monthly savings of $377. Over a 30 year period of paying that mortgage down, you're essentially saving $135,000. This is why demand is so high to the normal person: people are looking to either buy a bigger home for cheaper, or another home.
2. Economic over-performance (e.g. Too Much Money)
Wait, wait, wait. "Another home?" Didn't we just come out of the year from hell where business the world over closed their doors and millions upon millions of people lost their jobs? Yes, but hear me out.
The recovery we're in at the moment is what economists refer to as a "K Shaped" recovery. That refers to the shape the recovery graph makes over time. The well off continue to grow wealthier, while the down-trodden continue to get kicked in the teeth. So why does this happen? Assets!
Look at any stock chart for 2020. You'll see a dramatic fall in March, typically somewhere around the 12th, which is when global stock averages suffered their largest single day percentage fall since 1987. Since that day? The S&P 500 returned a positive 45% from bottom to top.
So let's say you have most of your net worth in assets, like any good rich person, and you see a 45% historic return in 2020 and the trend continues in 2021 with the best first half return of the 21st century? You diversify! You pull some cash out of stocks and put it other assets, like real estate. You buy rental properties in upcoming desirable markets or a second home in the Hampton's to escape the riff-raff. This removes inventory from the market, and bada bing bada boom, you have a shortage, thereby driving the prices up further.
3. The cost to build is rising
This is the one item on this list that is starting to pull back slightly, but it's still a major factor in the near term. Overall, the prices of things are climbing in a phase the Fed calls "transitory inflation" and others call "the end times." We're seeing car prices, airline tickets, and most importantly home prices, climbing due to the rise in costs of goods and services. According to Bill Conerly of Forbes, lumber is typically more sensitive to inflation due to long production lead times in turning a tree into a 2x4 plank. What we saw in 2020 was people stuck at home and waiting to improve their little 30 year fixed term jail cell. They began home improvement projects en masse, building back decks and even entire new additions to their homes. Then, as the remote lifestyle began to set in, workers began to flee from big cities into suburban areas, or even completely different states (I covered this last week when discussing The Great Resignation). States with lower income taxes, like Las Vegas, Texas and Florida, saw influxes of new home-buyers at a 4:1 rate of incomings to outgoings.
This sent the home-builders into overdrive, ordering more and more lumbar from a supply that had already been stressed from that summer's home improvement bonanza. This caused another supply issue, meaning that it cost the builders more to build new constructions, in-turn driving prices higher. Couple this with the labor shortage we're experiencing due to federal unemployment checks being greater than wages received at many of these lumber mill and truck driving jobs, and you have a supply chain bottleneck that is crippling home-builders.
This one is a little smaller reason, but could have far-reaching implications for the future of real estate. The 2020 pandemic again allowed workers to spend time at home and work remotely. This opened up the opportunity for more free time, and further assessment of what makes them happy. A result of this forced reevaluation is a dramatic uptick in real estate agents across the country. In January of 2021, there were officially more real estate agents than home listings in the U.S. And this rush of real estate agents looking for a new living has led to a rush of offers on homes. A 2021 Redfin study of 2,000 home-buyers showed 63% of them had offers in on homes they hadn't actually seen yet.
The Bottom Line
Do you jump in to purchase something now, while the market is insane, hoping to catch the upward wave? Or are you afraid of buying at the top and getting stuck holding the bag when the market crashes, so you bide your time? These are the questions plaguing the modern-day home-buyer. And these questions would eat away at any generation of first-time home-buyer, but even more so today as the generation buying homes are millennials. Millennials were between the ages of 11-27 when we experienced our first earth-shattering economic disaster when the housing market collapsed in on itself like a dying star made of money and investment bankers. We saw homes foreclosed on, we saw parents and loved ones lose jobs, and many of us were spit out into the repercussions of the collapse, a horrendously weak job market. So excuse us for not wanting to dive in with both feet into the second earth-shattering economic disaster where we saw parents and loved ones lose jobs and homes foreclosed on.
The good news for our generation is that the home prices look to be cooling off slightly. As mentioned before, lumber prices are starting to come down as production is starting to meet demand. Many companies are also returning to work from offices, or at least in a hybrid model, slowing down the demand for continued home renovation work. Many states are also ending unemployment benefit increases early due to the number of available jobs thanks to high vaccine rates and reopening businesses, which should hopefully spur employment in the sectors required to create, transport and utilize building materials, driving prices back down.
Finally, interest rates. I mentioned earlier that economic contraction = lower interest rates. But does economic expansion = higher interest rates? Yeah, kind of. While the Federal Reserve believes that this period of inflation we're in is transitory due to factors like semiconductor chip shortages, worker shortages due to unemployment boosts and raw material price increases, there is a strong chance that they're wrong. Fed Chair Jerome Powell was the subject of a piece from MarketWatch during the writing of this article that cited multiple U.S Senators in their criticism of how he's handled inflation and interest rates, among other issues.
The Fed has also stated that they are looking to raise interest rates in 2023 based on their transitory inflation-theory, though that number could be moved up should inflation persist or get worse. This would drive home prices lower due to decreased demand, as it will be more expensive to own a home.
Of course, all of this is just rampant speculation backed up by economic theory and socioeconomic factors revealed over the past 17 months since the start of the pandemic. Could interest rates go negative and then you'd actually potentially be paid by the bank to take a mortgage? Theoretically, yes. Practically, no. Look, it's up to you when you buy (or even if it makes sense for you to buy at all!). I'm just some guy on the internet laying out the facts. Whatever your decision, I wish you the best, brave millennial house hunter.
Did you buy a home during the pandemic? Did you avoid it? Why or why not? How was the experience? Let me know in the comments below! And don't forget to sign up for my email list so you can get these in your inbox a soon as they're posted. Thanks for reading!