Updated: Apr 21, 2020
I saw a Facebook post that said "Well, this can’t be good for the housing market." and then had a link to the CNBC story with a head line "JPMorgan Chase to raise mortgage borrowing standards as economic outlook darkens". I was tagged in the post and was asked my opinion.
I figured this would be the perfect item to discuss for my first blog post on this new site.
My clients almost always ask me...
"How much do you think my home will be worth next year / 5 years from now / in 10 years.
"Do you think that this market will readjust?"
"Is now a good time to Buy / Sell?"
It's like I have a crystal ball that I can peer into and see the future of real estate! NO! I don't and neither does anyone else.
What determines the value of my home?
Real estate acts like other assets...stocks, bonds, savings, CD's, etc. The value of these assets is dependant upon the supply and demand for the asset. "If demand increases and supply remains steady, then this leads to higher prices and quantity of the asset. As demand decreases and supply remains unchanged, then this leads to lower prices and quantity of the asset. " Real estate is the same way: with higher demand, prices go up. With lower demand, prices go down.
The supply of homes is the # of active listings and the demand is the # of closings by the buyers. These variables dictate whether or not prices will increase or decrease. Either or both of these variables can go up or down. Lets review some of the different things that can happen to real estate supply and demand and resultant effect to the values.
Supply vs. Demand scenarios to consider and how real estate value increase or decrease.
Listings are steady but a lot of buyer demand.
Prices will increase in this scenario. The increased demand could be due to the following reasons.
1. More buyers move into Phoenix. Think about all the Californians leaving CA for cheaper real estate, less traffic and a better lifestyle.
2. More companies relocating to Phoenix. As more companies move to AZ, better job prospects and a resulting influx of people moving to AZ.
3. A new category of buyers such as Institutional buyers and AirBnB investors increasing demand for homes. This would be the New Colony Homes and other hedge funds who are buying homes for the goal of leasing them out.
4. Trend of Americans moving from the midwest to warmer climates in the Southwest. This would be winter residents but also full time residents that just don't want to deal with the cold.
5. The transition from renters to new home buyers. Think about the millennials who are making more money, able to finally afford a new home and moving out of their parents' home.
6. Increased liquidity in the mortgage market. Better access to mortgages for buyers with lower credit score, lower down payment requirements and additional creative financing for business owners and investors.
7. Lower mortgage interest rates making it possible for tenants to afford a mortgage due to the lower mortgage payments.
Listings decline (less sellers putting their homes on the market) but demand stays steady.
Prices should increase. This decline of listings could be due to the following reasons
1. New home builders can't build homes quick enough for the demand. It takes years to purchase , rezone, plat, permit and then build homes. For a few years, the builders were scared to build in AZ due to the 2008 recession and housing collapse. Lack of raw land, raw materials and construction workers exacerbate the problem.
2. No catalyst for sellers to move from their existing homes. Many clients have equity in their homs but then ask "Where am I going to move"? In this case, most sellers will just remodel resulting in low listings.
Listings decline and demand increases.
Prices should increase and very quickly. This is what happened in 2005-2006 and over the past 2 years. The reasons for this are very different though. Today, builders can't build homes fast enough, existing home owners don't want to move and buyer demand increased as noted above. In 2005 demand increased due to fradulent lending practices and over leverage by everyone.
Listings Increase and demand decreases.
Price should fall and this is what we saw in Great Recession of 2008.
This is a double whammy. Sellers can't afford their home due to over leverage, homes go into foreclosure, this snowballs to the financial markets causing additional job losses. Sellers who weren't highly leveraged have to sell because of a financial emergency or job loss compounding the listing inventory increase. Sellers stop making payments on their mortgage, default rates increase and lenders dump their REO listings on the market. Listings increase and by a lot! At the same time, demand drops quickly. Lending guidelines tighten making mortgages harder to obtain. With falling real estate values, buyers wait fearing that the market will drop further.
This is the perfect storm of increasing listings and decreasing demand and you have a run away prices on the down side. I lived this in 2008. It was UGLY and I still have nightmares!
Listings Decline and Demand Declines:
The real estate prices should stay the same. At equilibrium,the # of listings coming on the market is same as listings that go under contract. Net new listings are zero.
Looking into my crystal ball...there are a few possible outcomes.
COVID-19 is a short term hit to the economy.
COVID-19 deaths are less than expected. Social distancing is in place and when people do get sick, they get treated without too much stress to the healthcare system.
Businesses start to reopen slowly but on a consistent basis. Small businesses come back on line thanks to the Federal and State government stimuli. Employees who were furloughed (not laid off permanently) are employed again. Long term job losses are minimal, unemployment decreases, confidence returns in the economy and we start spending money again.
Economy improves, lenders feel more comfortable making mortgages with looser lending guidelines, buyers are able to get mortgages and we should see buyer demand increase. Real estate is an inelastic investment i.e. not easy to sell, so values shouldn't drop too quickly. With less leverage in the real estate market, less home owners will just walk away from their homes.
This small blip might help to cool off the hot housing market making sellers more reasonable and give buyers a chance to make a better decision when making an offer on a house. Economists would call this is a V shaped recovery.
In hot markets such as Phoenix, we might see small price drop but if Phoenicians can get back to work, the market should bounce back.
COVID-19 is a longer term hit to the economy
In this case, COVID-19 effects business activity for greater than 90 days. Small businesses are forced to not just lay off employees but businesses shut down due to inability to pay their fixed overhead costs (leases, business insurance, capital expenses).
Demand side effects could be as follows:
Banks fear that the economy will fall into a recession. They only lend to A+ borrowers. Banks decrease liquidity (increased down payment requirements, higher credit score requirements and creative financing gets curtailed) for extended time period.
Buyers are scared to buy a home due to the fear that the real estate market will drop
Buyers stop viewing homes for fear of spreading the Virus.
Investors stop buying homes due to dropping prices.
All of these will decrease the demand for real estate and supply will increase leading to lower prices.
I'm going out on a limb but I think we won't have a wholesale foreclosure mess or a corresponding rapid drop in real estate values. The demand side will drop but I don't see a dramatic increase in supply. I'm optimistic that if we can get people back to work, it won't be like 2008.
We also don't have the same amount of leverage by the homeowners so they are more likely to do everything possible to stay in their homes. The banks and financial institutions are in much better shape to be able to weather this COVID-19 storm. The economy was in a strong shape before the pandemic. The government response has been very good. Everyone is working at light speed and both political parties understand that this problem needs a quick response. Lastly, the COVID-19 pandemic worst case scenarios haven't come to fruition.
We could have 5-10% drop in real estate values if the COVID-19 pandemic has longer term effects as noted above.
I want to stress that this is just an educated guess on my part. No one knows ultimately what will happen but if you want to know how I feel about the real estate market future.
We are in uncharted territory with COVID-19 pandemic so anything is in the air right now. We have to get everyone back to work! I know this seems heartless but we should be able to do this with proper testing, isolation and government support for those who do get the virus.