Greetings Clients, Friends, and Neighbors,
"Do you think housing prices will go down further? Why would I choose to buy now?"
I get asked this question almost daily, and you may be thinking it, too. These days the Bay Area housing market can feel every bit as spooky as your seasonal home decorations, but it may not be so scary when you remove the costumes and makeup. This month’s newsletter includes a lengthy finance-focused analysis. Given my wealth management background, and as one of the few (if not only) Bay Area realtors that is a CFA charterholder, I provide a unique perspective and insights during this pivotal market transition. While we all have our opinions and no one has a crystal ball, I hope my thoughts below will offer some valuable context to help you reach your own conclusions about how to best navigate the current market.
Since interest rates are the main factor here, let's dig in:
First, some quick math on the difference in a homeowner’s monthly mortgage payments between a 3% and 6% interest rate (assuming 20% down and 30-year fixed rate mortgage):
$2M purchase price @ 3% = $6,746/month
$2M purchase price @ 6% = $9,593/month
= 42% increase in a buyer's monthly mortgage payment
Mortgages behave like bonds in your asset allocation. For bonds, the prices go down when the yields (i.e., rates) go up. Per the example above, the correlation in mortgage rates is identical and it impacts buyer purchasing power, which translates to home prices. Afterall, the housing pyramid reflects the purchasing power pyramid. Looking forward to what is anticipated to be 2 to 3 additional interest rate hikes from the FED totaling 1.5%-2.0%, many assume additional drops in home prices are ahead.
On the upside, buying a home in a market with 6% mortgage rates has substantially less downside volatility risk than buying a home in a 2% to 3% mortgage-rate environment (as we have witnessed over the last 5 months). It is now likely that the home price volatility risk will be to the positive, and a home purchase now will have a price appreciation tailwind at the buyer’s back as long-term rates will likely be lower than current rates.
Second, while current average 30-year fixed mortgage rates nearing 7% are not necessarily high by historical standards, rates are still the highest they have been in over 20 years, and what is historically significant is how quickly they have increased. Mortgage rates have increased over 100% in less than a year (from 3.11% to start 2022 to nearly 7% today). This is a shock to buyers' purchasing power and sellers’ life plans, creating an immediate gap between buyer and seller expectations.
So, is now a good time to buy?
Given my financial services background, I, more than most, appreciate that this is always a subjective question. If you can comfortably afford to purchase a home right now, meaning you can forecast a 5+ year ownership horizon, I view this period as an optimistic time to buy. Here's why:
- The fundamentals of the current housing market are strong. Comparisons to the crash of 2008 continue to pop up in the headlines, but the precipitating factors of the 2008 crash – tens of millions of households talked into home loans they could never afford; expiring teaser mortgage rates sending buyers over an affordability cliff, forcing a tsunami of frantic sales (foreclosures, short-sales, etc.) – simply do not apply today. Mortgage payments as a percentage of income, and loan delinquency rates, are both close to all-time lows, and most homeowners' mortgages are held at historically low rates. Stock market declines, though substantial, cannot compare with those seen in 2008-2009, and employment rates remain very strong.
- Capital is plentiful and efficient. The investment environment today is significantly more attractive and encouraging than a year ago, when choosing how to invest your capital was like walking through a haunted house – you had nowhere good to turn. Equity valuations – what people are willing to pay for a dollar of future earnings – were sky high, bonds returned nearly nothing, cash literally returned nothing, and real estate prices where in the midst of a pandemic, “free money”-fueled rally that saw sale prices in many housing markets nationally increase over 40% in less than 2 years. San Francisco real estate had a notably lower percentage gain in price, around 20% for single family homes, although starting from a higher base price. Most capital was incentivized to be invested in the most volatile asset classes. In contrast, today investors are treated to enticing investment options in all asset classes. Bond and cash yields have returned, equity valuations have dropped approximately 25% year-to-date, and real estate is no longer hyper-frothy. This is a very healthy balance. There is substantial unallocated cash waiting on the sidelines, and cash holders will be able to allocate capital efficiently, preventing any one asset class from falling precipitously. Within real estate specifically, there are multi-billion dollar real estate investor funds that are spending down cash to buy swaths of U.S. real estate as prices retreat, and there is not a liquidity crunch that can fuel irrational price drops.
- Active buyers are finding deals. While we haven't seen a wild surge of desperate sellers in the Bay Area (the quantity of new listings is actually down from last year), I have spotted some very motivated sellers and helped buyers secure price discounts, paying the same prices as buyers paid in 2015-2017 for the same or similar properties. Why? Many buyers have “opted out” because they are fearful, lack clarity on affordability or “when this will end”, don’t want to “buy too early”, or logically assume further price drops are ahead as rates continue to rise. This lack of active buyer activity and competition is allowing for the contrarian buyer to acquire homes at purchase prices that have already built in some of these anticipated future price drops. Also, active first-time buyers get to stop paying rent and start building their equity now. If you take one thing from Warren Buffet, it is to be contrarian to the herd. When you see the light at the end of the tunnel, it is already “too late”, since real estate data is 4 to 6 weeks delayed and all the other sidelined buyers will see the light, too. The return of the sidelined buyers to the market in masse will create a rapid uptick in demand and prices, leaving a very short window that, short of dumb luck, is nearly impossible to time and capture.
- Housing inventory is down and likely to remain so. Housing inventory is likely to remain lower than average for a few years as sellers hang on to their mortgages in the 2 and 3% range, unless life circumstances dictate a need to change homes. Looking forward, the under-supply will stabilize home prices as buyer demand competes for fewer available homes and limits sizable price drops.
- A home purchase today is likely to have a price appreciation tailwind fueled by declining mortgage rates and increased purchasing power over time. Current mortgage rates of 6 to 7% are likely to settle long-term at lower percentages. Also, real estate has historically proven to be an excellent hedge against inflation. These are 2 key benefits to combat the current economic headwinds.
In sum, a reasonable interest rate + a great deal on purchase price, in a perpetually low-inventory, global market like San Francisco, equals a homerun in the long term. Even if a buyer does not get a mortgage rate below 6%, now can still be a great time to buy because of low buyer competition and available discounts on purchase price. The advantages of securing a low purchase price cannot be understated (don't forget you lock in a lower property tax payment, too!), and you can opportunistically refinance in the future.
If you are a buyer, now is the time to be pre-approved, in-sync with your agent about your specific needs and goals, and keeping your eyes peeled for the right opportunity to seize. Great opportunities are out there now, and I'll be happy to work with you to find them and win the right one.