Is the Real Estate Market Going to Crash?
Over the past two years, we've seen massive supply chain issues, rising energy and food prices, sharply rising inflation, and fear of a recession on the horizon. Many are now asking, will any of these factors cause the real estate bubble to pop?
It's a sensible question, considering the run-up in real estate prices since the end of the pandemic. Is another 2008 housing crisis on the horizon, or will the Federal Reserve be able to thread a needle to create a soft landing for the housing market by removing speculator froth?
We discussed this very topic on Quiver Financial News. Below, you'll find a brief overview of what we learned during our talk. For a more detailed discussion of these ideas, you can view the video below:
What do we mean by "Real Estate?"
When we talk about the real estate market, we're speaking specifically about single-family homes. The current question is whether a confluence of rising home prices, affordability, and profitability could cause the housing market to drop or crash completely in the near future.
But Patrick Moorhead is quick to point out another reason why we're focused on single-family homes. "There are other real estate sectors that are booming right now and still gonna boom," he says. "Industrial is one aspect of it. I mean, industrial is blowing up."
This is thanks in part to a post-pandemic rise in online shopping and package deliveries. The companies who provide these services need industrial warehouses to help them house and ship a large amount of products daily.
The housing market in recent years
Since the pandemic, the housing market has moved in one direction: up. This is due to a few factors, but it all comes down to what Colby McFadden calls the "three-legged stool": interest rates, employment, and affordability. "It's been a one-way trajectory the last few years because interest rates have been going lower," says Colby. "Employment's been solid, even throughout the pandemic, because there was government money that came in, and so affordability was there."
There are some additional factors that helped drive the housing market. Mortgage rates dropped, which caused something of a chain reaction. This further increased the affordability of single-family homes, which increased demand. This saw home price increases early on in the pandemic and they've continued upward since.
Why are people worried?
Whenever any industry sees a continued bull market, some investors begin to worry that the prices might eventually drop out. In addition, a few things have changed since the beginning of the pandemic that could affect the current housing real estate market. Some important changes to consider are:
Wall Street and real estate
When worrying about a potential, looming recession, one might be inclined to look at the Great Recession of 2008 for guidance. Doing so can help us learn lessons about recession investing, but there's one big difference in today's real estate market: Wall Street.
Following the recession in 2008, many companies started buying single-family homes as money-making investments. The prices were low enough that they could purchase homes, invest in improvements, then rent them out in order to turn a profit. With the popularity of apps such as Airbnb and VRBO, the chances of profiting from owning residential homes have only improved.
In 2021, houses bought by companies accounted for 18% of single-family home purchases. This has caused a scarcity of potential properties for individuals and families looking to buy a home. And that's helped drive prices even higher.
Despite promising economic growth, the past year has seen the rate of inflation surge to 8.5%, well past the 2% price stability benchmark. This in itself caused increased costs universally. Oil prices shot up, which caused gas prices to hit worrisome numbers. Food and energy costs have skyrocketed. In addition, rising inflation can affect retirement.
But inflation hit the housing market twice. First, it led to rising costs. Then, to combat inflation, the Federal Reserve (the central bank of the United States) raised the Federal Funds rate. This benchmark rate caused interest rates to climb, which caused mortgage rates to go up, too.
These rising prices have affected the affordability of single-family homes. This is thanks in part to stagnant wages and an increasing wage gap. Without significant wage increases, it's become difficult for many millennials to purchase houses.
As Justin Singletary puts it in our video, "If housing prices come down, that's great. But if people still aren't making enough money, then[...]we still have a problem."
Will the real estate market crash?
Considering these factors, should we be worried about a looming real estate market crash? While it's important to remember that no one can predict the future, we can look at the above factors to see how long they might affect the market. Let's break them down:
Will interest rates stay high?
For now, it seems like interest rates have reached their highest point and are unlikely to continue increasing. According to Colby, "We're probably right at that line." This is good news because it can have a cooling effect on residential real estate prices. "I think if rates can cool here, and employment holds together, and Wall Street doesn't totally fall apart," Colby says, "I think things[...]stay stable."
Will Wall Street stay in real estate?
This is greatly dependent on how lucrative real estate continues to be for Wall Street investors, corporations, and other investment firms. As long as it remains profitable, investors will most likely continue to purchase residential homes. However, Colby considers that the opposite scenario is just as likely: "The moment that that portfolio starts to work against them," the company will find itself facing its responsibility to its shareholders. "In order to protect [their] shareholders, [they] actually got to sell and create cash, and get forced into selling at the bottom."
Will changes in employment affect affordability?
Because employment works so closely with affordability, it's important to look ahead at what might happen to the unemployment rate. As it stands, there's little reason to expect unemployment to go up in the near future. As Patrick says, "All the baby boomers are retired." This has left more than enough jobs open for millennials and Gen Z to fill. In fact, there are currently more jobs than workers.
Since the pandemic, there's also been an increase in work-from-home jobs. This has increased people's ability to find work. It's also helped some workers find two or more jobs they can comfortably do from their homes. And, because it's remote, they can choose to live in an area where they can more easily afford a home, regardless of proximity to an office.
The bottom line
There's always a possibility that the unthinkable can happen. Fortunately, there doesn't seem to be any immediate cause for worry. "If you have low unemployment and low-interest rates, there's really no reason to expect housing to crash," says Colby. "Because if people are employed, and they're working, and they can afford a house, they're gonna buy a house." That means "affordability becomes that real, real big factor."
We've still yet to see whether wages will increase to help improve affordability. But, like Colby says, "That's a whole 'nother show."
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