As I’ve been suggesting in my most recent posts, the real estate market of 2018 is showing sign of correcting. The funny thing, is that this curious correction looks different than any I can recall.
Maybe it’s just how corrections always are, and I frankly don’t remember their onset. Kind of like when your kid had colic as a baby, you vaguely remember the sleepless nights, but it’s usually part of some affectionate recollection rather than tacit unpleasant recall. As I suggested in my last post, it’s my supposition that you can’t have a strong economy with a weak housing market. Yet by all measures, we have a strong economy. Low unemployment, corporations flush with cash from the corporate tax cut and a booming stock market. Looking at the real estate market fundamentals, you’d have to think a slowdown isn’t likely.
Supply is low. Builders aren’t building enough to meet rising home buyer demand. They haven’t built enough to satisfy a growing population not since the Great Recession and they still aren’t. A shortage of buildable lots, available tradesmen, rising material costs and a general fear about over building are the common explanations. Part of the collective memory of an industry that exploded a decade ago I suppose.
Moreover, sellers in general aren’t selling either. This is for a variety of reasons not the least of which is they’ve got a super low interest rate on their current mortgage so any move up in price is exacerbated by higher borrowing costs and higher taxes. Senior sellers can’t find the one story they want, in the neighborhood they want to live and are choosing instead to put in lifts or move downstairs. More and more baby boomers are electing to die in their home rather than move too and that further constrains available inventory.
Then there’s the demand side of the equation. Millennials are just now starting family creation and beginning to purchase homes. Given this group is the largest generation on record, that’s a lot of buyers, a lot of demand. The booming economy means more people are working and one would think this would spur home buying as well and it has. Therefore, there will be a permanent shortage in supply of homes to sell and an ever-increasing demand from buyers wanting to buy. When taken in totality, there is every reason to believe that a down turn in the real estate market is a statistical impossibility. Still, the market is slowing.
When I began thinking about this conundrum, I looked back at previous bubble-corrections. They were all fueled by some sort of artificial demand component. Speculators artificially driving up prices, easy loans artificially propping up buyers etc. So that lead me to thinking about the appreciation we’ve had steadily since 2012. “Artificial appreciation, fueled by a shortage of available homes,” that’s it! No, that doesn’t make any sense. Supply and demand dictated the rise in prices: tight supply combined with low rates and a strong economy drove demand and that fueled that appreciation. Despite this, we are in fact seeing pressure on prices and a slowdown in sales activity. All this evidence is consistent with a market correction. Where does that leave us?
Here’s my belief: The unabated 6 years of appreciation and the rise in rates, coupled with stagnant wage growth, has caused the buyers to hit the ceiling of affordability. Most of the supply lies in price ranges that exceed the affordability for the buyer of that given type of home. In other words, buyers can’t afford what they want, and they don’t want what they can afford. As a result, they’ve it the ceiling, rebelling and refusing to buy. I tell my sellers all the time, a home is only worth what someone is willing to pay for it (Want to know what your home is worth check out my home valuation program ). If a buyer isn’t willing to spend $600,000 on a 3 bed, 2 bath, 60 year old, slightly improved home in Newbury Park, Ca then it’s not worth $600,000. If a buyer isn’t willing to spend $2M on a 3600 SF somewhat improved home in Westlake Village, Ca, then it’s not worth $2,000,000 (Check out my website for more local info ). Just because someone paid that much for a similar sized home in the same neighborhood, doesn’t mean that all homes in that neighborhood are worth that. There are factors like condition and turn key, that must be considered. In fact, turn key remains a big reason why some homes sell at outlandish prices. Most homes however, are far from turn key and therefore can’t command the turn key premium. One thing we know for certain, buyers today don’t want to do any work. If Millennials were like the first-time buyers before them, they’d buy older homes, improve them and build equity hoping to fuel their move up a few years and a kid or two, down the road. But they aren’t. Today, those buyers are often dual income, much older than previous generation first time home buyers and simply don’t have the time to remodel nor have the cash after buying to remodel, but they see remodeled homes online and on HGTV and that’s what they want. If they can’t get it in their price point, they won’t buy. There is a lack of incentive. Prices aren’t low and rates aren’t super low like they were, two big incentives for fueling our recent housing demand. Moreover, the discount or negative premium buyers today demand of under improved homes is substantial, which runs in contrast with the asking prices of those same homes following years of broad appreciation. (As opposed to the premium they’re willing to pay for turn key remodeled.) This problem is exacerbated by the home builder’s failure to build more entry and mid-level homes. Most analysts fail to consider the impact that new homes have on the overall health of real estate market. People sell their existing home to buy a new home. That existing home is then added to the supply of available inventory. If builders aren’t building where the demand is, then we end up with an over supply in homes people don’t want (or can’t afford) and a shortage of those people do. What happens when there is an over-supply of homes in a price range where there is a limited supply of buyers? That’s right, price corrections.
The real estate market correction that is just now starting, is fueled in my opinion, by a shortage of affordable supply, rising interest rates and stagnant wage growth. It should be very interesting to see how large the drop in home values has to be, before buyers jump back into the market? I personally don’t foresee a huge slide in home values, but there will be some – heck nothing goes up forever – at least not home prices, (that is unless everyone starts making a lot more money so they can afford what they want.) Thus a correction is always an inevitably; it’s not a matter of if rather, when. Then there’s the question of, how will a correcting real estate market affect the economy as a whole? Remember, I believe as the housing market goes, so goes the economy. Just look at how home builder related stocks have performed in 2018: the sector is down between 27-42%. Talk about a harbinger of things to come! If you’re looking for a crystal ball, look no further than that. The ripple effect of a correcting real estate market is felt across the entire economy. It affects incomes, confidence, the stock market which in turn affects, income, confidence and the stock market and so on. That ladies and gentlemen is how we end up in a recession. As I see it, the only way we stave off this inevitability is through substantial wage growth which offsets the rising cost of homeownership. Have any comments or questions? Feel free to send me an email, I always love to hear your thoughts.