Updated: Apr 28, 2020
I was talking to a business associate about today's market, similarities to the 2008 crash and trying to think about different outcomes for the real estate market. I've talked at length about the potential downside to real estate with this pandemic. We realized that there was a potential for the real estate market to do the opposite and actually have double digit growth due to the COVID-19. Let me layout the scenario.
The U.S. housing supply is far lower than it was during the 2008 financial crisis. Back in 2004-2007, the housing market had a massive supply glut that ultimately led to severe price depression. People who should of never be buying a home were doing so. Many were buying multiple homes as investment properties with the goal of flipping them.
COVID-19 is going to slow the housing industry. It just has to. Americans are getting furloughed, unemployment rates will increase, this uncertainty will lead to Americans conserving cash. This will result in lower demand for homes and falling or stagnant real estate prices. I don't think anyone can argue this for the short term.
But, if the recession isn't too long and protracted, we may be setting up for the exact opposite with crazy appreciation in real estate values - at least in Phoenix, AZ.
Real estate has been on fire for the past 4-5 years. This was driven by low interest rates and new buyers entering the market (iBuyers, millennials, looser lending guidelines allowing for more buyers, influx of residents moving from California). This is the demand side of the equation.
But, the Supply (or lack of ) might be the real reason why real estate values increase in the double digits. Supply of homes has been very low to the point of ridiculously low. This was due to the following reasons.
Existing homeowners can't move because home values have increased to the point of being unaffordable (incomes aren't keeping up with the real estate values).
Scottsdale is the most profitable AirBnB investment and the State of AZ passed a law making it difficult for cities to regulate this investment. Larger investment groups came in and started to purchase homes as long term, AirBnB investments.
There aren't enough new homes being built. Construction labor market is very tight, building materials are scarce and it takes a long time to find, plat and rezone land for new home communities. You can't just "flip the switch" and add new homes to the market.
Our regional builders were gobbled up by the large national builders. The decision on how much to build in AZ is being decided in other parts of the country. The national builders don't understand the pent up demand in Phoenix (my builder VP's are telling me this). The national builders are also scared about the "Boom and Bust" of the Phoenix market.
Most of the infill land has already been purchased and redeveloped into apartments, small townhome communities, higher end condominiums or smaller single family communities. The infill land is easier to rezone and build upon so the lower hanging fruit is gone. Now, the builders have to purchase, rezone and replat larger pieces of dirt. This takes a long time and limited the supply of homes.
Uncertainty surrounding the pandemic’s impact on the economy has led sellers to begin pulling their homes off the market, but relatively stable mortgage application data indicate that demand has not tailed off enough to put downward pressure on prices in the near-term. In other words, buyers still want to buy a home when things clear up a bit. This may change though if the economy takes a longer term hit.
What happens to the Demand when the economy stablizes a bit?
I don't see the interest rates increasing anytime soon. Interest rates will stay low for a very long time to come (I'll talk about why in a future blog post). Lower interest rates means more buyers can get approved to purchase a home. Interest rates may even drop to the 2% - 3% range.
The iBuyer craze is here to stay. A few iBuyers won't make it. Actually, most won't make it. But, the ones that survive will be able to grow exponentially. There will probably be one big player and a second smaller player.
California buyers will continue to move to AZ - that state has way too many structural problems. Demand from California buyers should stay strong.
I also don't see how the Supply can increase quickly when we get past this COVID-19 shut down. The only way to increase supply is with new homes and you can't just turn a valve and build new homes. It takes time and this time lag may cause for an even more extreme housing shortage.
So, Demand will increase again and supply will stay constrained!
I don't think this will be like 2008 recession
Unlike the 2008 financial crisis, the housing market is not flush with underwater loans, leverage due to risky loans (neg-am loans) or other pressures that force sellers to drop their prices.
The average U.S. family with a mortgage ended 2019 with $177,000 in home equity wealth. Also, only 3.5% of all mortgaged properties had negative equity (CoreLogic). This is a good sign that homeowners won't be motivated to dump their homes.
Homeowners who are worried about the future can do a cash-out refinance with even lower interest rates to pull that equity out for an emergency fund. Even if they don't do a cash-our refi, they may be able to get a conventional refinance to help them lower their monthly payment by reducing their interest rate and/or lengthen their loan term.
Job loss victims will struggle to have a refinance application approved, but they have more access to mortgage forbearance programs and other government support to help them keep their houses. There just seems to be quicker and larger programs for stimuli.
So if this is true, Phoenix housing may come back even stronger after this COVID-19 shut down.
Let me know your thoughts.