Up, Down, or Sideways?
“Price Dropping!”, “Housing Crash is Coming!”, “Sky High Interest Rates Will Crash the Market!”, “Sell NOW!”, “These Markets Will Crash!”
You’ve probably seen many similar headlines above at some point in the past few months as many speculate where the housing market is headed. It’s easy to just take the news headline at its face value and go with whatever seems to be the popular opinion. After all, nobody will blame a housing crash advocate when home prices keep rising. Home buyers and real estate investors should really look at historical perspective and dissect the elements that move the real estate market:
The Banks Made Sure You Can Pay
High foreclosure rates in an area mark the beginning of a local housing market crash. Mortgage delinquency is a leading indicator that shows the amount of homes at risk of default. Back to the mid 2000’s subprime mortgage loan days, many borrowers were able to take out loans they should not have been qualified for. Many bankers called those the NINJA mortgages, aka “No Income, No Jobs or Asset”. This reckless lending practice planted the seeds for disasters that left long lasting scars on the economy and many households.
Today’s mortgage approval process is stricter and underwriters do way more diligence before approving a mortgage. Most recently, PennyMac even began to audit past loans to ensure the risk of default is well understood. Healthier lending practice is shown in the mortgage delinquency rate of 2.13% as of Q1 2022 compared to 4% at the start of the 2008 crisis. The delinquency rate went as high as 11% during the 2008 crash.
Many under-qualified buyers who did not have sufficient financial strength were hurt when they did not have enough disposable income to pay down the debt. Before the GFC, the averaged household debt service payment accounted for 13% of the disposable income. In Q1 2022, this number has dropped to 9.5%, indicating stronger financial strength across the US households.
Higher quality loans combined with stronger household financial strength makes spiking mortgage delinquencies less likely compared to the mid 2000s. Furthermore, most homes have gained a significant amount of equity in the past couple of years and should provide extra padding for home owners.
We Need More Homes!
Anyone can say anything about where the housing market is headed but real estate really comes down to a simple concept: supply and demand.
After the 2008 GFC, new home construction practically grind to a halt for several years. Just as the country gradually climbs back towards normal level of new housing construction rates, COVID 19 threw us a 100 mph curve ball.
Although housing starts recovered quickly and continued to rise, the pandemic induced supply chain shock has made it extremely difficult for builders to complete projects on time. BUT the number of people seeking new homes has not diminished and we’re still years from getting out of this nation wide housing shortage. FreddieMac estimates the housing deficit has grown from 2.5 million in 2018 to 3.8 million units in 2020!
The millennials have recently overtaken the boomers as the largest generation in the US. Most of the 72 million millennials are at the age where they either start to form families or gets tired with having roommates. The natural progression in this life stage is typically buying a house and that’s where a large portion of demand comes from.
Strong housing demand from the millennial population coupled with years of tight housing inventory has created an unbalanced market supply and demand, thus driving the home prices up. Housing demand may lessen due to higher interest rates but the housing supply gap cannot be closed in a matter of months.
Interest Rates
The days of 3% interest rate is long gone and we might not see this level of interest rate in our lifetime. The media and youtubers can rave about rate spike all they want, but the current rate is merely returning to normal levels after over a decade of low interest environment as the nation recovers from the 2008 scars.
The Fed isn’t planning to hike rates to levels seen in the 80’s (well, hopefully not) as indicated in their June FOMC Dot Plot. By front loading rate hikes in 2022, they give themselves more breathing room to adjust monetary policy in 2023 and beyond. It can be inferred the Fed funds rate (hence the mortgage interest rate) could peak sometime in early 2023 and starts tapering down in the second half of 2023.
What’s Happening In Bay Area?
Mortgage delinquency in Santa Clara county is around 0.2%, well below the % seen during the GFC. We are not yet close to seeing the start of something that can create a spiraling effects on the local housing market.
Housing inventory in Santa Clara County stands at 1.6 months, up from 0.4 month in December 2021. By the way, this is how the media / youtubers are able to write clickbait headlines like “the housing inventory is up by 300%! Is a crash imminent?”.
A healthy housing supply is typically around 4 months. When the housing supply is less than 4 months the market condition can be called the seller’s market. Vice Versa, buyer’s market emerges when the supply is greater than 4 months. While the inventory has indeed growth by 300% to 1.6 months, Santa Clara County is still far from being a buyers market. All the buying frenzy we saw in the past years, even before COVID started, was due to extremely low housing supply.
Based on available data, what we are seeing in the Bay Area is a healthy market correction rather than a looming housing crash (6.5% correction from peak for Santa Clara County). The housing market is given some breathing room to catch up with demand as more buyers take a breather on the sideline. Home prices may see continued short term headwind as inflation continues to stay elevated, forcing the Fed to keep raising rates aggressively. However, as buyers eventually realize a 5% mortgage interest rate is the new norm, demand and competition should resume to support the home prices. In the long run, bay area home prices should continue to enjoy higher than national average appreciation due to concentration of high paying jobs and relatively few land to develop.
Closing Thoughts
I just don’t see a market crash in the Bay Area or at the national level based on housing fundamentals but can foresee more price reductions in the near term. There could be markets that are truly at risk (perhaps Boise, ID?) since real estate is very much local oriented.
A lot of the above can change with inflation data and company Q2 earnings report / full year outlook. My advice to buyers is keep your feet wet in the market and get the necessary paperwork lined up. Home prices may continue to be depressed and there will be an opportunity to strike a deal before more buyers rejoin the market. The focus should be on finding the home that works for your finances rather than trying to time the market. Time in the market will beat timing the market most of the time. For sellers that must sell, pricing the home that reflect the current market condition is absolutely critical. Letting your home sit on the market for too long will hurt your profits.
The best time to buy real estate is 20 years ago. The second best time to buy real estate is right now.
Let’s chat if you have any questions in your real estate journey!
P.S. Please do not consider any of these as financial advice as these are my personal opinion on the current market condition. Do your diligence as you are responsible for your financial decision.
