Inflation, geopolitical instability, economic insecurity, market correction, etc. Are locusts just around the corner?
It’s not been much fun reading the news of late, with the constant barrage of negativity weighing on emotions and sentiment about investments across asset classes, including real estate. The impact is clear in the number of homes going under contract which, by mid-year, is off last year’s torrid pace by between ten to fifteen percent overall in the market with the figure proving higher in the luxury tier.
When markets shift, the level of uncertainty leads many to temporarily hit the pause button for fear they may be investing in a declining value environment. Others perceive an opportunistic window opening, allowing them to enter a market where discounting is possible. History suggests both may be mistaken.
Inflation looms large in any discussion at present, with worries that the real rate of return (adjusted for inflation) on investments will turn negative. The point is valid among many asset classes, yet real estate has proven incredibly resilient and a strong performer during inflationary times. In fact, from 1970 through 2021, a period of 51 years, the median price of housing has risen faster than the rate of inflation in all but four years, three of which were tied to the great recession which was an anomaly due to irresponsible lending guidelines not existing today. In approximately 10 of the last 50 years, the inflation rate rose to 5% or higher. In every one of those years, median home prices rose faster. In some cases, double the rate of inflation.
The lesson is clear: Sitting on the housing market sideline during inflationary times results in ultimately paying a premium for hesitating.
Now, there are some for whom inflation’s impact on mortgage rates renders a home purchase challenging, if not impossible. Affordability is a constant concern expressed in these articles. Yet others who qualify simply don’t wish to purchase with a mortgage rate essentially double that of the prior year. Understandable, of course, yet here too the economic assumptions are often misguided.
Since 1990 there have been seven periods when interest rates rose at least 1%, with the average duration of 13 months before returning to the previous rate. And while a direct correlation exists between the number of home sales in the country and interest rates, it isn’t the same for prices. In fact, in six of the seven interest rate rise periods, median home prices continued to climb at an average rate of 5%. The second lesson is the economic benefit gained from waiting for mortgage rates to return to the former level in interest charges is generally offset by the increase in the home purchase price paid.
In the recent world of 2.5-3% fixed, 30-year mortgages, the public and even the real estate industry have forgotten the creativity and options utilized in similar environments of the past. Five- or seven-year arm mortgages, almost nonexistent in recent years, are making a comeback to obtain an initial lower rate for those with confidence that rates will, over time, decline and allow refinancing within the window. And for most who itemize their taxes, the ultimate rate is lower when adjusted for mortgage interest deductibility.
Fear of a recession is another reason why some would hesitate to jump into the market, and indeed many signals are present despite low unemployment and strong balance sheets. This concern, as it relates to housing, is the likelihood of falling prices. Including the downturn of 2020 tied to the pandemic, there have been a total of six recessions since 1980. In 1991, prices declined by 2% and, during the great recession of the early 2000s which will not be repeated, prices fell by almost 20%. Overall, in four of the six recessions housing prices continued to climb. In fact, if one ignored the early 2000s, the average appreciation rate during these recessionary periods exceeded 5%. Statistics are against someone who is waiting on values to drop due to a temporary macroeconomic setback.
The second buyer profile referenced was those who feel the current environment of declining sales presents an opportunity of a discounted purchase price. Not so fast. While the number of sales is admittedly down year over year, the median price last month was up approximately 30% with the average price up over 15% versus last May. Sales have indeed declined, so inventory is rising yet the level remains far under what would be considered a balanced market where a buyer would be advantaged. We are heading into a period of decelerating rather than depreciating prices, merely returning to a healthier and more sustainable rate of appreciation seen in prior years.
Yet another influencer of resale home prices is the cost of new home alternatives. With continued supply chain challenges driving up the cost of construction materials and labor on top of escalating land prices, causing some homebuilders to reduce new permitting, the resale market will continue to be attractive in relation to new homes.
We’ve all heard a million times that one may not time the stock markets. Day traders would perhaps argue, yet for most of us, it’s true. I would submit it’s also the same with real estate. Ultimately, the decision to buy should be based on the fundamental reasons of shelter, lifestyle, security, a change in circumstances, etc. Waiting to invest with the goal of an economic advantage has proven, at least in my career, a largely unsuccessful strategy.