SAN DIEGO, CA – “Buy low, sell high” is a well-known adage credited to the mythical billionaire investor and philanthropist Warren Buffett. Looking at today’s super-hot residential real estate market is hard not to surprise how much longer this craziness will continue.
Buyers are in bidding wars to buy homes, multiple all-cash offers with no financing, no contingencies, sale prices tens or already hundreds of thousands of dollars above asking prices, double-digit annual home price appreciation, and a very low inventory of homes for sale.
According to the Case-Schiller Home Index, the average annual home appreciation in the 20 major metropolitan areas was 14.6% year-over-year as of this past May. Phoenix had the highest annual price increase of 22.3%, followed by San Diego’s 21.6%, and Seattle at 20.2%.
I vividly remember that back in 2005-2006, at the peak of that last super-hot residential real estate market, many were saying that the market would continue to thrive and prices would go up for at the minimum another ten years.
in addition, by 2007 the home prices started to deteriorate and by 2009-2010 a wave of short sales and foreclosures dominated the before super-hot markets. The hardest hit places like Phoenix and Las Vegas had character values depreciated in some situations by over 50%.
But this time it will be different… not. If there is one thing certain about real estate (and life in general), it is that it is cyclical. Every expansion is followed by a bust, and every bust by eventual recovery and then another expansion, etc.
In case of real estate, cycles are usually much longer than those of the general economy and they last, on average, about 15 years. In this particular case, it is important to observe, that we are discussing a residential (homes) real estate cycle, which can be quite different from a commercial (investment similarities) real estate cycle.
So, where are we today? The interest rates, including on mortgages, are at ultra-low levels. For example, recently our sister mortgage company closed a 15-yr fixed rate loans as low as 1.99%. This is quite exceptional given that the inflation rate is sky-rocketing. Just this past June, the inflation jumped by 5.4% year-over-year.
This was the largest increase of inflation since 2008. At this speed the U.S. is on the trajectory to have a double-digit inflation by 2023. Compare that to annual inflation rates of just 2.4% in 2018, and 1.8% in 2019, and 1.3% in 2020.
Money supply, government debt, and the public spending by the Federal Government are enormous. It seems that not too long ago, when the politicians were arguing about the federal budget, they were talking about millions, or at the most billions of dollars. Now if it is not a trillion, it does not seem to be a big deal.
The U.S. unemployment has been steadily improving since its peak of 16% in May, 2020. As of early June, the unemployment rate was around 5.9%. However, these figures can be misleading as they don’t include folks who are “under-employed,” e.g. went from a complete-time to a part-time jobs, or those who earn less now than pre-pandemic.
Additionally, they don’t count workers deemed “permanently unemployed” (unemployed for more than six months) and those who “stopped looking for work”. The “real,” or the so called U6 unemployment rate, is around 9.7%.
So, how all of this translates into the residential real estate market? The current real estate cycle is about 15-16 year old, which is worrisome, but basically, as long as the money is so cheap, buyer need so high, and supply of obtainable homes for sale so low, the “music is nevertheless playing.”
Furthermore, we should not underestimate the “Covid-effect” on housing. One of the reasons why homes became so valuable was because of the lockdowns and the resulting work-from-home, teach-from-home, play-at-home and eat-at-home paradigm shifts.
If the cycles are the law of the universe, then it is safe to assume that this cycle must change too. When? Nobody knows for sure, as we realize that the cycle has changed only after it already did.
However, in my estimation, the catalyst for the change will be an increase of the short-term interest rates by the Federal save, which sooner or later will have to happen given the high inflation.
Our real estate brokerage receives lots of inquiries from buyers and investors wanting to buy similarities. In our opinion, real estate buyers should proceed with extreme caution in such an over-heated real estate market.
The double-digit annual price appreciation is absolutely unsustainable as the 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 substantial costs associated with selling it.
For most residential character owners, real estate should be a long-term game and buyers should take that under consideration when considering purchasing similarities. When the unavoidable market correction comes, home equity can be greatly reduced or already wiped out in case of highly-mortgaged homes.
In such instances, character owners can find themselves “upside down” on their mortgages, meaning they will owe more than the values of their similarities. Short-sales and foreclosures will become familiar terms again.
however, the lucky residential character owners who currently own highly-appreciated real estate assets, maybe in a perfect position to cash out on their equity now when the market is hot and the prices are high (remember what W. Buffett said).
Residential home builders, especially those who build in the lower price ranges with projects that are already going, or about to go vertical and will deliver completed homes in the next 12 to 18 months, are in good shape because the current buyer need far exceeds the supply.
However, past that time frame, it is anybody’s guess. expensive prices of materials, high costs of land and labor, and onerous government fees make it hard for builders to deliver affordable houses and make a profit.
There could be another important consideration for selling sooner than later: Uncle Sam. The current administration openly talks about increasing taxes and in spite of of their election promises, it is not going to be affecting only the “high.”
For example, according to their latest tax proposals, the home-owner exemption from the capital gain taxes when selling dominant residences, may be greatly reduced or already thoroughly deleted. Oh, by the way, the capital gain tax rate is also going up.
Another meaningful tax change on the horizon for those who own any investment similarities, already if it is a small rental house or condominium, is a proposal to reduce or eliminate the so called “1031 Tax Exchange” under which capital gain taxes can be deferred on investment similarities, including small and large rentals.
Each situation is rare, but my general advice for Clients who want to buy real estate now is that there needs to be a powerful reason for them to do so. I recommend being patient and not buying into the frenzy, which sooner or later will pass.
Again, let us remember what W. Buffett says about buying low and selling high, and he certainly has a track record (and the bank account) to prove that he knows what he is talking about.
For Clients who own real estate and want to keep up it for a long-term, I recommend that they review their mortgages and interest rates (if they have any loans on their similarities).
If advantageous, they should look into refinancing them, with or without a cash-out, to take advantage of these extremely low interest rates, which at this point are way below the inflation rate, which makes them nearly a “free money.”
For Clients who are considering selling or have shorter term ownership plans, this might be a great opportunity to review their similarities’ values and determine if selling now, while the market is super-hot and the prices are super-high, is a good idea.
In conclusion, nobody knows what the future has in store, but a associate of things are certain: real estate is cyclical and change is unavoidable. The current residential real estate market cycle is mature, prices are very high, and consequently it is reasonable to expect a market shift.