If you’re like me you are listening to the prognosticators making their predictions for 2019. Not one to be left behind, here are my predictions on what you can expect from real estate and the economy at large in 2019.
Starting with what I know best, let me speculate of real estate first. (Contact Tim Here)
- I think real estate pricing will be down a little as the effect of higher rates and lack of income growth conspire to keep buyers on the sideline and push sellers to lower their prices if they want to sell.
- Inventory will stay on the market longer actually giving buyers better selection than they’ve had these past few years, but the total number of units for sale will remain historically low.
- I think transactional volume will continue its slightly downward trend as owners with low rates and/or low property taxes, choose to stay put keeping inventory low, which in turn forces many sellers/buyers-to-be to wait when hopefully selection improves.
- I expect rents to remain flat to slightly lower. That said, the ripple effect of the loss of units due to the California Fires could force rents higher in fire affected areas but I think flat is the more general scenario.
- I believe mortgage interest rates are going to stay flat from here and may even go down should the Fed cut rates instead of raise as they’ve indicated they are leaning towards.
- I think the stock market will continue to trend lower as the global economy slows and the effects on consumer and business owner confidence becomes more unsteady.
- I see a 50/50 chance of a recession in 2019 (Negative growth for 2 successive quarters). I think either way, it will feel like a recession because the decline in growth in domestic GDP from 2018 is going to scare people into more conservative behavior. Slowing spending as the wealth effect or lack thereof enters the psyche of business owners and consumers alike.
If you only wanted my predictions stop reading here but if you want to understand my reasoning, keep going!
The backdrop is that rates shot up in 2018 following 4 Fed hikes and The Fed’s simultaneous shrinking of their balance sheet. This was like a double, triple or quadruple whammy. It’s the shrinking of the balance sheet along with the largely ineffective yet very expensive tax cut, that is the fly in the ointment of the whole economy and why equities have been so volatile and why the economy is not on stronger footing. Let me explain…
Following the financial crisis, the Federal Reserve began a course of aggressively stimulating the economy to avoid a depression. They did this by reducing the rates banks charge one another for short term borrowing (The Fed Funds Rate) and what they charge banks to borrow directly from the Fed (Fed Discount Rate) down to zero. Unfortunately, the economy was in such a free fall that that strategy proved insufficient in both stimulating the economy and adding liquidity. Liquidity is a word used to describe how much cash is floating around for lending and borrowing. The lack of liquidity was the result of the vast amounts wealth that evaporated when housing market crashed, and trillions of dollars of equity vanished. To combat the lack of liquidity The Fed began a process of buying debt (Mortgage Backed Securities, US Treasury Bonds and Mortgages from Freddie Mac, Fannie and Ginnie Mae). This they called, Quantitative Easing or QE for short. Historically the Fed had always maintained some balance of debt that they owned and in 2008 that amount stood around $1 Trillion. When QE still wasn’t enough to stave off the economic free fall, The Fed embarked on additional rounds of easing monetary policy by buying more debt (QE II, III and IV) adding several more $ Trillion to what they owned. By 2018 that amount stood at $4,000,000,000,000.
Now you’re probably thinking, “So what? What’s the significance of The Fed buying and holding debt? The significance is that by being a buyer of debt they effectively created artificial demand. They were buying huge amounts of debt so the price they paid went higher and higher. Basic Econ 101 tells us that as demand goes up, so do the prices. In the case of bonds, when the price goes up, the yield goes down and thus rates came down (the whole point). This stimulated the economy, the recovery in housing (Search listings here) and saved us from a repeat of the 1930’s. Phew!
You’re probably wondering at this point, where did the money come from to buy that debt? Simple, they printed more money and all that money improved liquidity and in turn all that extra money helped us climb out of the Great Recession and helped the DOW Jones Industrial Average go up from a low of a 6,500 in March 2009 to over 27,000 in October 2018. However, by inserting themselves into the daily functionality of the market place, they warped the market. They weren’t alone either. Central banks around the world did the same and this massive world wide debt is contributing in part to the global economic slowdown we are experiencing now. At some point all “good things” come to an end and as the U.S. economy strengthened The Fed announced in June 2015, an end to QE. They stopped being a buyer. By October 2017 The Fed began the process of “Unwinding” the balance sheet (selling off their debt) $75B at a time. But this amounted to the equivalent of many rate hikes. Remember, as the Fed became a seller not a buyer of debt, the demand for debt decreased. Again, Econ 101 teaches as demand wanes for a good or service, prices decline. Since interest rates move in the opposite direction of prices, by backing out Quantitative Easing, the Fed caused rates to rise. As a result a 30 mortgage went from about 4% to over 5% by fall 2018. And while the rates have recently come down as investors are betting we are now closer to a recession than an economic expansion, the cost to borrow is still .5-.75% higher than it was. This has lead to a decline in real estate affordability and that has turned into a decline in demand for homes. I maintain this axiom remains true: Housing is the engine of the economy and you can’t have a booming economy with a contracting real estate market. It is for this reason that I am leaning towards a Fed that keeps on pace in reducing their balance sheet of debt, but holds rates steady or if need be, even lowers them in 2019. In the absence of inflation, (inflation is still running below The Fed’s stated optimal annual inflation rate of 2%) there is little justification to continue a path towards raising rates. Rates are raised to stave of the danger of inflation which once accelerating, is very hard to slow down – think the late 1970’s. No significant inflation, no need to raise rates. That said, The Fed cut rates to zero and then added debt with the QE’s. To walk that back, I believe they should have accelerated the unwinding component and then raise rates; think about Jack Nicholson chasing the boy in The Shining where the little boy had to walk backwards in his footsteps and then hide. Walking back in his footsteps happened before the hiding part. The Fed probably should have gotten rid of more debt first and waited to raise rates, letting the market place return to some form of normal.
As for the 2018 tax cuts, the Federal deficit has now ballooned an additional $1.5T. And what happens when supply is greater than demand? Prices decline and then rates go… up. In this case that means the amount of money the Federal Government must pay in interest payments goes up because there’s so much debt and only a limited amount of countries buying it (ie: China and to a lesser extent Japan.) That means rates have to go up on the debt to attract buyers and that makes paying off the debt that much harder. The corporate tax cut to 20% was supposedly designed to spur economic expansion through investment by corporate America, as well as increase wages since profits would be higher with a lower corporate tax rate and employers would pass some of that profit to workers in the form of higher pay. And since they’d have to compete for workers in a tight job market, historically wages went up. We got the tight labor market, but wages haven’t gone up. Too much global competition. Unfortunately then, the predictable happened which was that instead of getting pay raises, some employees got one-time bonuses while most didn’t even get that. Amazon made headlines for example by raising the minimum wage to $15 but then cut other perks like stock options. Meanwhile, instead of using the windfall of cash on capital expenditures, Corporate America engaged in massive stock buyback programs the likes of which has never been seen before, fattening the pocket books of the shareholders. Said another way, Corporate America used the money to buy back stock boosting the stock’s value by tightening supply rather than by improving actual capacity, making capital improvements or increasing Research and Development which ultimately contributes to economic expansion. Capital investment and R & D lead to far greater economic growth, job creation, income and prosperity, than stock buybacks which tend to boost the stock price for benefit the very few rather than the many and accomplishes very little else. Sadly, the President and Congress awarded massive corporate tax-cuts without any strings attached linking the cut to desired behavior, ie: investment. Some of you won’t agree with my assessment especially on the effectiveness or lack thereof of the tax cut, perhaps pointing to a timeline down the road not yet visible, but I’m pretty sure I’m right on this and 2019 and 2020 will bear that out.
So that’s it. It’s going to be a continued year of volatility in equities and housing. If there’s a take away for real estate it’s this: as home prices give back a little of the 2012-1018 gains and interest rates drop due to a slowing economy, there’s going to be an opportunity to “buy the dip.” And because supply is still very low and demand is only going to increase in the years to come with the bulk of the Millennials just now beginning their household formation home buying cycle, 2019 is going to prove a great year to buy real estate.
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