2023 Look Ahead
As a realtor, finding the right balance to educate buyers without sounding too pushy in this period filled with uncertainty is definitely an art that is mastered by few. I believe most people go along with popular mainstream media information and opinion, because that seems like the easy thing to do. But remember — the media thrives on provoking and clickbait headlines, most of which often lack proper context. My opinion on real estate in 2023 may be an unpopular one, but I will unpack how I arrived at my views in short blurbs and hopefully my readers find insights and new perspectives.
With creative financing, between now and summer 2023 could be a good time to purchase real estate — whether as primary residence or as an investment.
I could be wrong, of course. But I’m happy to exchange a different perspective backed by logic rather than superficial opinions and speculations.
A Tale of Two Halves
The 2022 bay area housing market has been a roller coaster ride to say the least. We saw home prices shot up to all time high, followed by rapid normalization after the interest rate spiked up aggressively. Homes that consistently got 10+ 20% over asking offers now just get a couple of offers at or below asking in a matter of months. The inflation and interest rate has come down from the recent highs, but a slew of mixed economic signals still leave many people scratching their head s — where are the rates and home prices headed?
Mortgage Interest Rate
Historically, mortgage rate fluctuation (orange) tends to align with CPI movements (blue). The lag between the two is usually small until last summer, where the Fed decided not to act when July 2021 CPI went over 5% YoY. The mortgage shot up after the Fed finally decided to raise rates but mortgage rates likely have peaked just like inflation did.
As most of you have probably felt / read already, inflation is slowing down (particularly in energy prices), per the most recent CPI report. When we roll into 2023, the Dec 2022 and Q1 2023 MoM CPI will be replaced by the high MoM CPI we saw in early 2022. We should expect the YoY inflation number to come down drastically next year.
The spread between the 30 year mortgage rate and the US 10 year treasury is historically between 175 to 200 basis points (1.75% to 2.00%). At the time of this writing, the spread is at 300 basis points (3.00%) and is bound to normalize to the historical spread. As economic outlook worsens, investors tend to move their money to safe heaven (aka T-bills). This drives the demand for T-bills up and drags the T-bill yield down, along with the mortgage rate.
That’s great news! But wait! The core-CPI (CPI less energy and food) is still at 6%, the same level when CPI peaked at 9% in July! There’s evidence that inflation is still sticky and will take more time to come down.
Looking back 1 year at MoM core CPI, even if we assume the core CPI maintains the current level (0.2% MoM), YoY core CPI won’t come down as quickly as the CPI since there will be a smaller spread between 2022 and 2023 Q1 core CPI.
The stickiness of core CPI means inflation will be around for a while, but it’s not unreasonable to expect the CPI to drop quickly to 6% in Q1 2023 but takes more time to get down to the 5% and the 4%. As a result, the national averaged mortgage rate could see the 4% handle pretty soon. In fact, some lenders in the bay area are already quoting low 5%’s for those with excellent credit scores.
Bottom line — taking consideration of the factors and historical trends above, we could expect mortgage interest rate to normalize quickly in the first half of next year.
Supply and Demand
As I have written in my July article, US housing inventory remains under supplied for the years to come. Inventory continues to flatten as home builders pull back on new construction.
Meanwhile, US household formation is not slowing down…
… and the millennials are at the prime age of forming new households and drive the demand.
The bay area housing inventory recovered from a crazy low level (< 1 months!) but still sits at around 2 months. Despite the amount of price normalization seen in the past few months, this MSA is still not even close to reaching a more balanced supply/demand level (around 4 months of inventory). When the rates eventually come down (and may come down sooner than expected), expect buyers to flock back to the market to prop the home prices up.
Also — most people have locked in rates between 3 to 4% and this further chokes the inventory, as they have very little reasons to sell in exchange for a higher interest rate mortgage.
Bottomline — the supply and demand are still off-balance and supply scarcity will provide price support until buyers return to the market.
So How is the Economy Doing?
Unfortunately not everything is all sunshine and rainbow looking ahead. The December FOMC minutes revealed concerning economic outlook, mainly in sharp cut in 2023 GDP forecast. PCE is also revised upwards and the Fed remains firm on their long run 2% inflation target.
The Fed plans to hold the Fed funds rate between 5.0% to 5.25% for most of 2023. While the Fed funds rate does not directly affect the 30 year fixed mortgage as indicated before, it should impact the US economy significantly and really makes one second guess on the possibility of a soft landing. If you haven’t heard already, the Fed has repeatedly stated that they are willing to inflict short term pains for the greater long term stability of the economy.
Yes, tech companies are laying off large number of employees and there’s no way to downplay it. But what is the real effect on the local economy? Santa Clara county unemployment rate ticked up from 2.2% in October to 2.4% November. One thing of note is the number of jobs added MoM is quickly approaching zero and there is 0 net gain in the higher paying jobs from the Professional & Business Services industry. In comparison to last month’s report, there is clearly softness in the labor market. While the unemployment rate is still at a historical low level, its trend will be something for home buyers and investors to monitor closely.
Always zoom out to see the big picture. Given how much the tech companies have grown during COVID, it is not surprising to see companies that grew too quickly to start trimming the fat to prepare for economic uncertainties. Unless layoff becomes widespread to across industries (have not seen signs yet), the bay area should be able to sustain economic output and prevent mortgage delinquency rates to increase. Most bay area home owners have built a significant amount of equity over the past few years and mass foreclosure is not a likely scenario in the near future.
If recession is worse than expected (i.e. more job loss), then we can expect inflation rate to drop further as households cut back on spending. Again, as inflation rate lowers, mortgage rate will follow.
Bottomline —the bay area economy does not show major weakness so far but near term local employment reports will verify the health of the local economy.
The Verdict
While it is anybody’s guess when the mortgage rates will come down to affordable levels, I think there is enough evidence that we could affordable rates (in the 4's) before summer 2023. Bay area home prices have already seen a good amount of normalization (-18% from 2022 highs) and price cuts have decelerated already. Unless job loss becomes widespread or inventory spikes up (no signs for either yet), home prices should continue to follow the fundamentals and find support at the current level. The same thought applies to the national level. Once inflation and interest drops further, more buyers will re-enter the market and good deals will become harder to find.
With creative financing, between now and summer 2023 could be a good time to purchase real estate — whether as primary residence or as an investment. There is much more room for negotiation with the seller nowadays and the interest rate won’t stay high forever.
Buyers should be cautiously optimistic heading into 2023 and keep a watchful eye on the fast changing economic conditions.
On the multifamily side — operators who took a floating rate debt without rate cap will see their operating cash flow eroded by higher interest rates. This could force some to run for the exit and picking up distressed assets at discount prices presents rare opportunities for long term profits.
Admittedly, the above projection are very fluid and could change with economic reports.
Let’s chat if you see an alternative scenario or are interested in making a move in real estate!
