Today’s Market: November 2022

Context > Headlines

The first step to understanding this market is to come to terms that today is not 2008. Bill Parcells, the two time Super Bowl winning coach, once instructed his staff to “un-prejudice yourself”. His meaning behind this phrase was to drop any preconceived notions that one may have over a player or team from last year and look at them today. Players get better and players get worse and therefore their teams get better or worse. The economy is the same way. Context changes; what caused the fall of Rome did not cause the great recession. So let’s un-prejudice ourselves from comparing this bull market run and pending demise from the great financial crisis of 2008. 

Real Estate Fervor

Home prices have been hitting record highs each of the past 16 months for year-over-year growth compared to 2005. The historically low rates have put more people in a position to purchase a home than ever before.  Almost everyone you know is talking about real estate in one way or another whether it’s an HGTV mania fan or your cousin at Thanksgiving talking about real estate investing. (Personally I miss Judge Judy playing in the waiting room. The verdict was so much more dramatic than the “big reveal”, which is usually just more shiplap and exposed brick features, but maybe that’s just me. Did ER doctors actually watch ER? Perhaps not. I digress.) It is easy to compare today with pre-2008 due to the hyperbolic hype and how quickly valuations have moved. But what has caused this bull run in housing and why will history not repeat itself this time? Well, there are three main factors that are large contributors to the unique circumstance we find ourselves in: Affordability, Reality, and Market Demand.

1. Affordability 

Rising Mortgage Rates

The greatest impact in the real estate market over the last 12 months – and what is dominating the headlines – is Affordability. Mortgage rates have risen this year as the Fed works to combat inflation. The speed and the extent of the rising rates is what is making headlines. To combat inflation the Fed has stripped away 13 years of economic easing by moving the benchmark rate an unprecedented 300 basis points higher since the beginning of the year. The last time 30 year fixed mortgages were at 7% was March of 2002 when Dr. Phil first aired. Catch me outside, how bout dat? 

How Far Does Your $$ Go?

To put this into perspective, if you were looking to buy a home in October of 2021 and you wanted to keep your monthly principal and interest payment to around $2,000 that would have put you in a position to look at homes selling for around $600,000, provided you put a 20% down payment on the purchase ($120,000). With the available rate of 7% interest today, that same $600,000 home is going to give you a monthly payment of about $3,200 before taxes and insurance. Wage growth has grown in the past 12 months nationally but not as much as inflation so that bump in pay probably doesn’t apply to your budget much if you still want to maintain that $2,000 monthly mortgage payment. Well now you’re shopping at a different store or in a different zip code altogether with the change in affordability.

Another Way to Look at It:

Assuming you still use the same down payment of $120,000 that you originally planned for with the $600,000 home purchase, you’re now shopping for a $410,000 home to maintain that monthly $2,000 payment. Woof! Feel the burn? That’s the affordability aspect and why the sky seems to be falling, but there is a broader reality as to why valuations won’t be plummeting with the deterioration of affordability.

Stricter Underwriting

Thanks to the Dodd Frank Act of 2010, underwriting for home mortgages has become much more scrutinized since the collapse of Lehman Brothers. Back in 2007 I probably could have gotten my dog pre-approved for a loan if I showed them his number of instagram followers (@hankhoundstl where likes equal pets). Nowadays they check and double check your income, your debt, and your employment status before agreeing to lend you those dollar dollar bills, ya’ll! And not just the day you apply for the loan, but on the day they are lending you the money you can expect your superior to receive a phone call verifying your employment. Maybe it seems a little intense, but it’s all in an effort to prevent defaults.

Different Loan Types

The biggest difference though are the loans themselves. Not only do they bear more weight in the quality of the borrowers, but they are also at fixed rates where the repayment amount doesn’t change over time. Back in the early 2000s the predominant loan programs were 2/28s and 3/27s that came with an adjustable rate mortgage. This means the interest rate would change over the course of the loan. The initial two or three years would be very low, even sub-market interest rate, but after that period your rate would adjust twice a year to the “floating rate” causing payments to balloon beyond the debtor’s ability to pay.  Since then, it’s been mostly fixed rate mortgage products. Current estimates show that 90% of residential loans out there right now are at fixed rates. So while inflation affects everything from chicken wings to beer cans your monthly mortgage payment and a hotdog at Costco will remain the same this time around. 

Demand Wins

This week in my real estate world I saw four, six, and nine offers on homes priced between $200,000 and $500,000 even as interest rates are breaking 7%. Which indicates that demand still seems to be holding steady; it’s not just another short lived TikTok craze. 

That 70s Show?

For more historical perspective to plan your pretty picnic and predict the weather, the last time rates jumped like this was in the late 70’s. In February of 1977 30 year fixed rates were at 8.65%. Three years later by 1980 they were at 16.25%. Oil Shock! A year later on Wednesday October 21, 1981 rates hit an all time high of 18.39%. In that timespan from 1977 to 1987 the median home price in the US went up 111%. Whatchu talkin’ ‘bout Willis?! Yes, and who do we have to thank for that? It’s not president Ronald Reagan (wait, the actor?). It’s millennial babies! So are we talking Diff’rent Strokes or are we talking reality TV? 

Generational Traffic Jam

Even in the early 1980s when rates jumped to over 18% on a 30 year fixed, home prices did not wane, they only continued to climb at a steady pace. So why is it that when affordability has deteriorated so much today that there is still so much demand? Well, It’s a generational fight worse than debating who played the best Batman (who we all know is Michael Keaton). Currently one in three homes in the US are owned by someone age 65 or older, mostly Boomers and the Silent Generation. Those two generations combined account for approximately 92 million people asking the 138.4 million Millennials and Gen Xers how to change their smartphone settings. Besides the technological divide between the generations, millennials today are ages 26 and up. Even the youngest of their generation is starting to “settle down” and find more stable living arrangements, like the houses that older people are still living in. Boomers and the Silent are living longer than their parents and they are doing so by living longer in their own homes than their parents did. This has been coined “aging in place”.

Priorities Evolve, Demand Stays Steady

So how much demand can possibly wane when we are already grossly underserved structurally and we don’t see new inventory hitting the market? The answer is… I don’t have an answer. However, this is the question we should be looking into more and the answer will only come in time. Overall, there is still a strong demand for housing as Americans still desire homeownership. The pandemic has changed the priorities of homebuyers. A two bedroom one bath used to be standard starter home criteria, but with hybrid work here to stay home office space has become an essential need and not just a desk in the corner.