When the real estate market begins to change, seldom is it an avalanche. As one who’s been doing this for nearly 3 decades, I have been through my share of market downturns. Some, like 2007, started like the scene in Indiana Jones and the Temple of Doom, where you heard a low rumble and seconds later there was a wall of water coming down the tunnel. Obviously, that crash, more violent than any before burned brightest right before it flamed out. Most other times it’s just a gradual sort of slow down and then nothing. The market just dries up and everyone stares blankly at each other and wonders aloud, “Market’s slow, I wonder how long this will last?” I believe this is that kind of market we find ourselves in today.
A couple days ago the new home data was released and it showed fewer sales, fewer contracts, fewer permits pulled and fewer homes being built. This was attributed to a variety of reasons. A lack of buildable lots, shortages of labor, tariffs (rising material costs), rising interest rates and perhaps most importantly, price fatigue for today’s buyers. Oh yeah, and not enough entry level homes where the demand is greatest. Tuesday, Case-Shiller reported numbers that show sales (monthly closed transactions) were down and price appreciation is slowing dramatically in all but a few markets. Yesterday, the National Association of Realtors put up their pending sales numbers and as expected, they are similarly uninspired. Sales are down month over month for the 7th straight month in every region and price appreciation while still a thing, is declining year over year. The thing to understand when looking at year over year appreciation numbers, is that as a market tops out and the subsequent months go up less and less, this year’s price starts to look a lot like last year’s price and the spread between the two narrows. If that trend were to continue indefinitely, you’d end up with a graph that is just a flat line, ie: August’s median price last year was $750,000 and this year’s is too.
For those of you who are old enough to remember Johnny Carson, I am going to put on my turban and play Canrac The Magnificent and make my prediction. (If you are unfamiliar with Carnac, google it. It’s funny stuff.) Before I do, let me offer a little perspective.
The first thing to know about the real estate market is that it is never stagnant. It’s constantly in flux. Going up, going down, every home is different so it’s always doing something. Right now it’s slowing. It’s not grinding to a halt, plenty of homes are transacting, but it’s not as it was. Let’s look to my local market as evidence (Thanks to my friend Chuck Lech of TheLechReport.com for the data.) In August the Conejo Valley sold 12% fewer homes than they did last August. 12% is not an insignificant decline. Inventory is 15% higher too. Declining sales plus rising inventory means more competition for the same buyers. Interestingly however, the median price is still up 4%, but that is a shrinking number as the year over year price begins to look the same and the curve flattens. Property appreciation has been directly attributable to the shortage of available homes for sale. However, if inventory continues to rise, prices will by necessity come down as more and more sellers find themselves sitting on the market. And that ladies and gentlemen, is what we call a correction.
Prices need to find an equilibrium that spurs increased interest from buyers. The thing to bear in mind is that real estate always adheres to the basic economics of supply and demand. Prices go up when demand goes up and when demand declines prices follow. Naturally demand is affected by affordability which factors in the cost of borrowing money (interest rates) and the strength or lack there of in the economy. When it comes to supply, things like speculation and the ease and availability of financing are big considerations. In the bubble of 1989, there was plenty of new construction going up but speculators were buying and flipping driving up prices more than the actual market would have otherwise supported. In the bubble of 2006, financing became so easy, anyone could get a loan to buy, falsely inflating demand.
The strength in the economy is a big factor on the demand-side. When people are feeling good, working and making money, they buy houses. The economy is also a big factor on the supply side. If the economy is doing poorly, people don’t buy homes and often times are forced to sell homes, increasing the supply. So one could say, as goes the economy, so goes the housing market; or is it, as goes the housing market, so goes the economy? This begs the question: Can we have a strong economy when the housing market is in correction?
According to everyone you listen to, the economy is humming along nicely and there are no signs of a slowdown or recession. GDP is up 4.2% and that’s the strongest it’s been in 4 years. We are also at or near full employment: everyone is working and making money. If we accept the premise that the economy is in great shape, then we can safely say the real estate demand component should remain strong and builders should continue to press forward, boosting production in an effort to increase supply. Buyers having steady employment, will feel good about making a home purchase. If this is the case then, the slowdown we are experiencing is almost certainly attributable to normal seasonal components rather than anything else. Ie: August is the slowest month of the year (it is); parents are taking their last vacation and preparing for school to start back up (they are) and as has been the case as long as this Realtor has been in business, the pattern of a slow end-of-summer continues. The thing is, that does not explain why the number of sales are declining 7 months in a row. This suggests something else is at play.
If you don’t subscribe to the “Economy is humming along” school of thought, then you might say the slowing trend is only a precursor of things to come; that a slowing real estate market foreshadows a slowing economy. I believe you can’t have a strong economy without a strong housing market.
We know that after 6 years of rising home prices and rising interest rates, affordability has declined. The only way affordability improves is either prices come down or we make more money. Formerly unemployed people are making more money, but wages are not increasing at the pace of inflation. When our wages are growing slower than the prices of the goods we purchase (like a home), our confidence gets eroded. Since consumer spending represents 2/3 of our GDP, confidence is king to a growing economy. The failure of salary growth to keep up with inflation reduces confidence, which leads to slower homes sales and eventually declining home sales prices which is what? Another confidence shaker. So which is it? Are we in a good economy where everyone is sharing in the spoils of growth and prosperity or is the prosperity largely limited to the most wealthy? Carnac here is in the latter camp. I think the tax cuts and budget deficit spending are primarily helping a small group of Americans and for this reason, I predict a correction is afoot and a recession on the horizon. I don’t however see a major recession or housing correction coming (To share your thoughts with me click here). For housing, we simply are not building enough homes for our growing population. This will keep inventory tight and that puts a floor on home values. And as for a recession, there’s always a recession coming, it’s just a question of when and how bad. As for my guess on home values? I am predicting a 5-8% adjustment but that’s just a guess. So, what does a home buyer or seller do? If you’re thinking of selling, sell now because you’re not leaving much money on the table and be a little more aggressive on price than your competition. If you’re thinking of buying, buy now because prices may decline some but not collapse and nothing like 2009 (search for homes here ). Just be a little more aggressive on your offer, especially if the property you like has been sitting.