SAN DIEGO, CA-“Buy low, sell highis a well-known adage attributed to legendary billionaire investor and philanthropist Warren Buffett. Looking at today’s super-hot residential real estate market, it’s hard not to wonder how much longer this craze will continue.

Buyers are in bidding wars to purchase homes, multiple all-cash offers with no financing, no contingencies, sales prices tens or even millions of dollars above asking prices, double-digit annual home price appreciation, and poor inventory. very low housing. on sale.

According to the Case-Schiller Home Index, the average annual home appreciation in the top 20 metropolitan areas was 14.6% year over year as of last May. Phoenix had the highest annual price increase at 22.3%, followed by San Diego at 21.6% and Seattle at 20.2%.

I vividly remember back in 2005-2006, at the height of that last super-hot residential real estate market, many were saying that the market would continue to thrive and prices would go up for at least another ten years.

However, in 2007 home prices began to deteriorate and in 2009-2010 a wave of short sales and foreclosures dominated previously very hot markets. Hardest hit places like Phoenix and Las Vegas had property values ​​depreciated in some cases by more than 50%.

But this time it will be different… no. If there’s one thing true about real estate (and life in general), it’s that it’s cyclical. Every boom is followed by a bust, and every bust is followed by an eventual recovery and then another boom, and so on.

In the case of the real estate sector, the cycles are usually much longer than those of the general economy and last, on average, about 15 years. In this particular case, it is important to note that we are talking about a residential real estate cycle (homes), which can be quite different from a commercial real estate cycle (investment properties).

So where are we today? Interest rates, including mortgages, are at ultra-low levels. For example, our sister mortgage company recently closed 15-year fixed-rate loans as low as 1.99%. This is quite remarkable given that the rate of inflation is skyrocketing. Just last June, inflation jumped 5.4% year over year.

This was the biggest rise in inflation since 2008. At this rate, the US is on track for double-digit inflation by 2023. Compare that to annual inflation rates of just 2.4% in 2018, 1, 8% in 2019 and 1.3% in 2020.

The money supply, the public debt and the public expenditure of the Federal Government are enormous. It seems that not so long ago, when politicians discussed the federal budget, they talked about millions, or at most billions of dollars. Now, if it’s not a billion, it doesn’t seem like a big deal.

Unemployment in the US has been steadily improving since its peak of 16% in May 2020. In early June, the jobless rate hovered around 5.9%. However, these figures can be misleading, as they do not include people who are “underemployed” — for example, moved from a full-time job to a part-time job — or those who earn less now than they did before the pandemic.

Also, they do not count workers considered “permanently unemployed” (unemployed for more than six months) and those who “stopped looking for work.” The “real” unemployment rate, or the so-called U6 unemployment rate, hovers around 9.7%.

So how does all of this translate to the residential real estate market? The current real estate cycle is about 15-16 years, which is worrying, but basically, as long as money is so cheap, buyer demand is so high, and the supply of available homes for sale is so low, the “music goes on dreaming”. .”

Also, we should not underestimate the “Covid effect” on housing. One of the reasons houses became so valuable was because of the lockdowns and paradigm shifts resulting from working from home, teaching from home, playing at home, and eating at home.

If cycles are the law of the universe, then it is safe to assume that this cycle must also change. When? Nobody knows for sure, since we realize that the cycle has changed only after it has already changed.

However, in my opinion, the catalyst for change will be an increase in short-term interest rates by the Federal Reserve, which will have to happen sooner or later given the high inflation.

Our real estate brokerage receives many inquiries from buyers and investors who want to purchase properties. In our opinion, real estate buyers should proceed with extreme caution in such a heated real estate market.

Double-digit annual price appreciation is absolutely unsustainable as real wage increases are in the low single digits. It is important to understand that real estate is not a very liquid asset and there are substantial costs associated with its sale.

For most residential property owners, real estate should be a long-term game, and buyers should keep that in mind when considering property purchases. When the inevitable market correction hits, home equity can be greatly reduced or even disappear for heavily mortgaged homes.

In such cases, homeowners may find themselves “upside down” on their mortgages, meaning they will owe more than the value of their properties. Short sales and foreclosures will once again be familiar terms.

On the other hand, the lucky homeowners who currently own highly appreciated real estate assets may be in a perfect position to cash out their equity now that the market is hot and prices are high (remember what W. Buffett said).

Residential homebuilders, especially those building in the lower price ranges with projects that are already underway or about to go vertical and will deliver finished homes in the next 12 to 18 months, are in good shape because the Current buyer demand far outstrips supply.

However, beyond that time frame, it’s anyone’s guess. Exorbitant material prices, high land and labor costs, and onerous government fees make it difficult for builders to deliver affordable homes and turn a profit.

There could be another important consideration to sell sooner rather than later: Uncle Sam. The current administration is outspoken about raising taxes, and despite its election promises, it won’t just affect the “rich.”

For example, under its latest tax proposals, the capital gains tax exemption for homeowners when selling primary residences may be greatly reduced or even eliminated altogether. Oh, by the way, the capital gains tax rate is going to go up, too.

Another significant tax change on the horizon for those who own investment properties, even if it’s a small rental home or a condominium, is a proposal to reduce or eliminate the so-called “1031 Tax Exchange” under which taxes on Capital gains can be deferred on investment properties, including small and large rentals.

Every situation is unique, but my general advice to Clients looking to buy real estate now is that there must be a compelling reason to do so. I recommend being patient and not falling into a frenzy, which will pass sooner or later.

Again, let’s remember what W. Buffett says about buying low and selling high, and he certainly has the track record (and the bank account) to show that he knows what he’s talking about.

For Clients who own real estate and want to keep it for the long term, I recommend that you review your mortgages and interest rates (if you have any loans on your properties).

If it’s beneficial, they should consider refinancing, with or without cash out, to take advantage of these extremely low interest rates, which at this point are well below the rate of inflation, making them virtually “free money.”

For Clients who are considering selling or have short-term property plans, this could be a great opportunity to review their property values ​​and determine whether to sell now, while the market is very active and prices are very high, it is a good opportunity. good idea

In conclusion, no one knows what the future holds, but a couple of things are certain: real estate is cyclical and change is inevitable. The current cycle of the residential real estate market is mature, prices are very high, and therefore it is reasonable to expect a change in the market.

Leave a Reply

Your email address will not be published. Required fields are marked *