SAN DIEGO, CA – “Buy low, sell high” is a well-known adage attributed to legendary billionaire investor and philanthropist Warren Buffett. Looking at today’s super-hot residential real estate market, it’s hard not to wonder how much longer this madness will continue.
Buyers are in bidding wars to buy homes, multiple cash offers with no financing, no contingencies, sales prices tens or even millions of dollars above asking prices, double-digit annual home price appreciation, and inventory very low housing. on sale.
According to the Case-Schiller Home Index, the average annual home appreciation in the top 20 metropolitan areas was 14.6% year-over-year as of last May. Phoenix had the highest annual price increase at 22.3%, followed by San Diego at 21.6% and Seattle at 20.2%.
I vividly remember back in 2005-2006, at the height 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 least another ten years.
However, in 2007 home prices began to deteriorate and in 2009-2010 a wave of short sales and foreclosures dominated previously very hot markets. Hardest-hit places like Phoenix and Las Vegas had property values depreciated in some cases by more than 50%.
But this time it will be different… no. If there’s one thing true about real estate (and life in general), it’s that it’s cyclical. Every boom is followed by a bust, and every bust is followed by an eventual recovery and then another boom, and so on.
In the case of the real estate sector, the cycles are usually much longer than those of the general economy and last, on average, about 15 years. In this particular case, it is important to note that we are talking about a residential real estate cycle (homes), which can be quite different from a commercial real estate cycle (investment properties).
So where are we today? Interest rates, including mortgages, are at ultra-low levels. For example, our sister mortgage company recently closed 15-year fixed rate loans as low as 1.99%. This is quite remarkable given that the inflation rate is skyrocketing. Just last June, inflation jumped 5.4% year-over-year.
This was the largest increase in inflation since 2008. At this rate, the US is on track for double-digit inflation by 2023. Compare that to annual inflation rates of just 2.4% in 2018, 1, 8% in 2019 and 1.3% in 2020.
The money supply, the public debt and the public spending of the Federal Government are enormous. It seems that not long ago, when politicians discussed the federal budget, they talked about millions, or at most billions of dollars. Now, if it’s not a trillion, it doesn’t seem like much.
Unemployment in the US has been steadily improving since its peak of 16% in May 2020. In early June, the unemployment rate hovered around 5.9%. However, these numbers can be misleading, as they do not include people who are “underemployed”—for example, moved from a full-time to part-time job—or those who earn less now than they did before the pandemic.
In addition, they do not count workers considered “permanently unemployed” (unemployed for more than six months) and those who “stopped looking for work.” The “real” unemployment rate, or the so-called U6 unemployment rate, is around 9.7%.
So how does all of this translate to the residential real estate market? The real estate cycle today is about 15-16 years, which is worrisome, but basically, as long as money is so cheap, buyer demand is so high, and the supply of available homes for sale is so low, the “music goes on.” ringing”. .”
Also, we should not underestimate the “Covid effect” in housing. One of the reasons homes became so valuable was because of the lockdowns and paradigm shifts resulting from working from home, teaching from home, playing at home, and eating at home.
If cycles are the law of the universe, then it is safe to assume that this cycle must also change. When? No one knows for sure, as we realize that the cycle has changed only after it has already done so.
However, in my judgment, the catalyst for change will be a short-term rate hike by the Federal Reserve, which will have to happen sooner or later given high inflation.
Our real estate brokerage receives many inquiries from buyers and investors looking to purchase property. In our opinion, real estate buyers should proceed with extreme caution in such an overheated real estate market.
Double-digit annual price appreciation is absolutely unsustainable as real wage increases are in the low single digits. It is important to understand that real estate is not a very liquid asset and that there are substantial costs associated with its sale.
For most residential property owners, real estate should be a long-term game, and buyers should keep that in mind when considering property purchases. When the inevitable market correction hits, home equity can be greatly reduced or even wiped out in the case of heavily foreclosed homes.
In such cases, homeowners may find themselves “upside down” on their mortgages, meaning they will owe more than their property is worth. Short sales and foreclosures will once again be familiar terms.
On the other hand, those lucky residential property owners who currently own highly prized real estate assets may be in a perfect position to cash in their capital now that the market is hot and prices are high (remember what W. Buffett said).
Residential homebuilders, especially those building in the lower price ranges with projects already underway or about to go vertical and will deliver completed homes in the next 12 to 18 months, are in good shape because the current demand from buyers far exceeds supply.
Beyond that time frame though, it’s anyone’s guess. Exorbitant prices for materials, high land and labor costs, and onerous government fees make it difficult for builders to deliver affordable homes and turn a profit.
There could be another important consideration to sell sooner rather than later: Uncle Sam. The current administration is openly talking about raising taxes, and despite its election promises, it won’t hit just the “rich.”
For example, under his latest tax proposals, the capital gains tax break for homeowners when selling primary residences can be greatly reduced or even eliminated entirely. Oh, by the way, the capital gains tax rate is going to go up too.
Another significant tax change on the horizon for those who own investment property, even if it is a small rental home or condominium, is a proposal to reduce or eliminate the so-called “1031 Tax Swap” under which taxes on Capital gains can be deferred on investment properties, including small and large rentals.
Every situation is unique, but my general advice to Clients looking to buy real estate now is that there must be a compelling reason to do so. I recommend being patient and not falling into a frenzy, which sooner or later will pass.
Again, let’s remember what W. Buffett says about buying low and selling high, and he certainly has the track record (and the bank account) to show that he knows what he’s talking about.
For Clients who own real estate and want to keep it for the long term, I recommend that you review your mortgages and interest rates (if you have any loans on your properties).
If it’s beneficial, they should consider refinancing them, with or without cash out, to take advantage of these extremely low interest rates, which at this point are well below the rate of inflation, making them practically “free money.”
For Clients who are considering selling or have short-term property plans, this could be a great opportunity to review their property values and determine if selling now, while the market is very active and prices are very high, is a good opportunity. good idea
In conclusion, no one knows what the future holds, but a couple of things are certain: the real estate industry is cyclical and change is inevitable. The current cycle of the residential real estate market is ripe, prices are very high, and therefore it is reasonable to expect a change in the market.
