CA, SAN DIEGO – The famous maxim “Buy low, sell high” is credited to philanthropist and billionaire investor Warren Buffett. It’s difficult not to question how long the current madness in the residential real estate market will last when one looks at how heated it is right now.
Multiple all-cash offers without financing or caveats, bidding battles amongst buyers for houses, selling prices that are tens of thousands of dollars or even hundreds of thousands of dollars over the asking price, double-digit yearly home price increase, and a very small supply of available properties all contribute to the current real estate market.
The average yearly house appreciation in the 20 main metropolitan regions was 14.6% year over year as of this past May, according to the Case-Schiller house Index. Seattle had a 20.2% yearly price rise, San Diego had a 21.6% increase, and Phoenix had a 22.3% increase.
I still clearly recall that many people predicted that the residential real estate market would continue to prosper and prices would rise for at least another 10 years back in 2005-2006, during the height of the last really hot residential real estate market.
However, by 2007, house values began to decline, and in 2009 and 2010, a wave of short sales and foreclosures took over the once-hot markets. Property values in some of the hardest-hit cities, like Phoenix and Las Vegas, plummeted by over 50%.
However, this time things won’t be different—at all. Real estate (and life in general) are cyclical, if there is one thing you can count on. Every boom is followed by a bust, every crash is followed by a recovery and then another boom, and so on.
Real estate cycles often continue significantly longer than those of the overall economy, at around 15 years on average. In this scenario, it’s crucial to keep in mind that we’re talking about a residential real estate cycle, which might be very different from a commercial real estate cycle (which deals with investment buildings).
Where are we now, then? Mortgage interest rates are also quite cheap right now. For instance, a 15-year fixed rate loan with a low as 1.99% was recently finalized by our sister mortgage business. Given the skyrocketing inflation rate, this is rather astounding. The inflation rate increased by 5.4% year over year in only June.
Since 2008, this was the inflation rate’s biggest rise. At this rate, the United States will experience double-digit inflation by 2023. In contrast, the annual inflation rates in 2018, 2019, and 2020 were only 2.4%, 1.8%, and 1.3%, respectively.
The federal government’s public expenditure, debt, and money supply are all considerable. It seemed like just a short while ago, when legislators were debating the federal budget, they were discussing millions, if not billions, of dollars. It does not appear to be a huge concern now if it is not a trillion.
Since reaching a peak of 16% in May 2020, the U.S. unemployment rate has been gradually decreasing. The unemployment rate was approximately 5.9% as of the beginning of June. These statistics, however, may be deceptive since they exclude those who are “under-employed,” such as those who switched from full-time to part-time employment, or those who earn less now than they did before the epidemic.
Additionally, they exclude people who have “stopped looking for work” and those who are considered “permanently unemployed” (unemployed for more than six months). The “real,” or so-called U6 unemployment rate, is close to 9.7%.
What does this mean for the residential real estate market, then? Although the fact that the present real estate cycle is around 15 to 16 years old is concerning, the “music is still playing” as long as money is so cheap, buyer demand is so great, and there are so few properties on the market.
Furthermore, the “Covid-effect” on housing should not be understated. The lockdowns and the subsequent paradigm shifts that allowed people to work from home, educate from home, play at home, and dine at home were among the factors that contributed to homes being so expensive.
It is reasonable to anticipate that this cycle will alter as well if cycles are a universal rule. When? Nobody can say for sure since we only become aware of the cycle’s shift after it has already occurred.
My prediction is that the Federal Reserve will raise short-term interest rates, which will eventually have to happen given the rising inflation, and this will act as the impetus for the shift.
Many questions about buying homes are sent to our real estate agency by buyers and investors. In such a hot real estate market, we believe that purchasers should proceed with the utmost care.
Due to the low single-digit real wage growth, the double-digit yearly price rise is utterly unsustainable. Real estate is not a highly liquid asset, and selling it entails high fees, which are crucial to comprehend.
Real estate should be a long-term investment for the majority of residential property owners, therefore purchasers should keep that in mind while looking at homes. Home equity can be significantly decreased, or in the case of highly-mortgaged properties, entirely eliminated, when the inevitable market downturn occurs.
Property owners may be “upside down” on their mortgages in such circumstances, owing more than the worth of their houses. Foreclosures and short sales will return to common usage.
The fortunate residential property owners, on the other hand, who now hold highly appreciating real estate assets, may be in a fantastic position to cash out on their equity now while the market is strong and prices are high (remember what W. Buffett stated).
The present buyer demand outpaces the supply, which is excellent news for residential house builders, especially those that construct in the lower price ranges with projects that are either moving or about to go vertical and will deliver finished homes in the next 12 to 18 months.
After then, though, no one can say for sure. It is challenging for builders to provide inexpensive homes and turn a profit due to exorbitant material costs, high land and labor costs, and onerous government taxes.
Uncle Sam can be a crucial factor in your decision to sell sooner rather than later. Despite their electoral pledges, the present government openly discusses raising taxes, which won’t just hurt the “rich.”
For instance, their most recent tax plans would significantly cut or potentially abolish the homeowner exemption from capital gains taxes when selling main properties. Oh, and the capital gains tax rate is also increasing.
A proposal to reduce or eliminate the so-called “1031 Tax Exchange,” which allows capital gains taxes to be deferred on investment properties, including small and large rentals, is another significant tax change that is on the horizon for those who own any investment properties, even if it is a small rental house or condominium.
Although every case is different, my general counsel to clients who wish to purchase real estate now is that they should have a strong justification for doing so. I advise being patient and not getting caught up in the excitement since it will eventually go down.
Remember what W. Buffett said earlier about buying low and selling high? He definitely has the track record (as well as the bank account) to back up his claims.
I advise my clients to check their mortgages and interest rates (if they have any loans on their houses) if they own real estate and want to retain it for a considerable amount of time.
They should consider refinancing them, with or without a cash-out, if advantageous, to take advantage of these absurdly low interest rates, which are now well below the inflation rate and effectively amount to “free money.”
For clients who are thinking of selling or who have shorter-term ownership intentions, this might be a fantastic chance to examine the worth of their homes and decide if it makes sense to sell now, when the market is quite hot and prices are extremely high.
In conclusion, no one can predict what the future holds, but two things are for sure: real estate cycles and change are unavoidable. Given the maturity of the present residential real estate market cycle and the high prices, it is realistic to anticipate a market change.
