The economy is tanking; unemployment claims have topped 30 million. So what’s happening with the housing market?
To wrap our minds around this rapidly-changing housing market, let’s break this down into three sub-questions:
- How strong was the housing market before the pandemic struck?
- What’s happening now?
- Where might it be going?
Here we go!
How strong was the pre-pandemic housing market?
Home values rose steadily after the Great Recession. From 2012–2020, home prices climbed 5.8% annually, according to the US Housing Market Health Check report from Thomvest Ventures. (All stats in this article come from that report unless otherwise indicated.)
Home values hit record-breaking new highs; the current national home price index is valued at 115% of the prior peak in March 2007.
Why did home values skyrocket in the last 8 years? There are many complex reasons, but three major factors include:
- Historically low mortgage interest rates. This makes monthly payments more affordable.
- Wage growth and consumer confidence arising from the 11-year bull market that just ended.
- Limited housing supply, fueled by a decline in new construction.
Let’s talk about that last point, because it’s crucial in understanding how the pandemic will re-shape the market.
In 2005, prior to the Great Recession, home values were skyrocketing and people across the country were drinking the Kool-Aid that says “your personal residence is an investment” (it’s not) and “home values never fall” (they do).
The rapid climb in home values – and ensuing demand from buyers who wanted a slice of the action – led builders to flood the market with a surplus of speculative new construction. Remember 2005 and 2006? You couldn’t blink without seeing a brand-new suburban subdivision arise of out nowhere, seemingly overnight.
The spike in housing supply started fifteen years ago with speculation, and continued through 2008 and 2009, as foreclosures flooded the market.
From 2010 through 2020, that supply has been steadily declining. Okay, fine, “declining” is a polite way to describe the reality. In February 2020, the government-sponsored entity Freddie Mac, an institution that’s not prone to hyperbole, stated the situation bluntly: “The United States suffers from a severe housing shortage.” They called this a “major challenge” and estimated that 2.5 million new housing units would be needed to bridge the gap between supply and demand.
What triggered this shortage? The multitude of reasons could fill an entire article, but one major reason is that the cost-per-square-foot of new construction is prohibitively expensive in some areas, particularly high-cost-of-living cities, squeezing margins so tight that many builders have decided it’s not worthwhile to construct new homes in those areas. As a result, new home construction has trailed household growth every year since the Great Recession ended.
During the last decade, supply has drastically sunk, while demand has steadily risen.
Recipe for a price increase, anyone?
Real estate analysts track a metric called “months of supply.” It’s a measure of how many months it would take for the current inventory of homes on the market to sell, at the current pace of sales.
Historically, six months of supply equals moderate price growth. Fewer than six months of supply, though, correlates with skyrocketing home values. Many sellers receive multiple offers; comparable sales figures climb as buyers attempt to outbid each other. The average-days-on-market shrinks.
If you’ve searched for real estate in the past couple of years, you may have endured the frustration of spotting an amazing listing – only to discover that it went under contract within 24–48 hours of its initial listing.
It was a seller’s market. And that’s now a relic of the past.
What’s happening now?
Cue the curtain for 2020.
As you might expect, both supply and demand have fallen off a cliff. Sellers aren’t selling (‘cuz duh, who wants to move in the middle of social distancing?), and buyers aren’t buying (for the same reason).
But here’s the thing:
Early data suggests that demand may have fallen significantly more than supply. For the first time in a decade, the tables have turned.
To be clear, supply is tighter than ever. Available homes for sale declined 25 percent year-over-year. Nationwide, one million homes were listed for sale in April 2019 vs. 750,000 homes for sale in April 2020.
But the drop in buyers may exceed the drop in sellers.
As early as January 2020, home showings had already dropped by almost half – it dropped 49% – as compared to January 2019. (And that was January!)
Of course, showings are a crude, imprecise metric. Many home buyers – even starting as early as January – began opting to tour homes through Facetime or Skype, or browsing 3D virtual tours.
So let’s take a look at a different metric: the number of people casually browsing home-buying websites such as Zillow or Redfin. Would you expect this number to rise in this work-from-home era? Stay the same? Dip slightly?
The answer: None of the above. The volume of visits to home-buying sites like Zillow and Redfin careened off a cliff after the pandemic struck, dropping an astonishing 40 percent.
It’s not surprising, then, that by the first week of April, pending home sales fell 54 percent year-over-year.
Real estate commentators have differing views on the severity of the current demand decline, which is arguably harder to measure than supply. Housing supply can be tracked by metrics like new construction permits, renovation permits, and the volume of current market listings relative to the pace of sales (months of supply). Demand is estimated through stats like the pace of sales, the number of homes sold at or above asking price, weekly mortgage applications, and web traffic to search portals.
Many analysts view job growth and population growth as strong indicators of an uptick in demand. Job losses, therefore, predict a drop in demand. (Besides, banks don’t like to give mortgages to unemployed people.) And the U.S. is experiencing the worst levels of unemployment since the Great Depression.
For the first time in a decade, it looks like the supply-demand equation is flipped in the buyer’s favor.
“But wait! Are foreclosures going to spike again? Won’t those flood the market?”
It’s natural to expect the current recession to look like the last one. Since the Great Recession was characterized by a rash of foreclosures saturating the market, it’s natural to ask: “are we going to see a firehose of foreclosures flood the market again?”
The answer: probably not, for two reasons – (1) a decade of tighter lending criteria, resulting in highly-qualified borrowers with tinier debt loads, and (2) public opinion.
Let’s examine each one.
First, today’s borrowers are far more qualified than the borrowers of 2008.
Before the Great Recession, between 70–80 percent of mortgage originations were given to borrowers with less-than-excellent credit, defined as scores of 759 or less.
Today that metric has almost flipped. During Q4 2019, almost 66 percent of mortgage originations went to borrowers with excellent credit scores, defined as 760 or higher.
Before the Great Recession, homeowners could qualify for larger mortgages and easily borrow against their home equity through a cash-out refinance. As a result, in 2007, the ratio of mortgage-payment-to-income (the “front end ratio”) stood at 32 percent.
Today borrowers often qualify for smaller amounts (due to tightened lending restrictions) and are reluctant to borrow against home equity. At the start of 2020, the mortgage-to-income ratio was only 21 percent.
Let’s talk for a moment about borrowing against home equity.
In 2007, many borrowers were encouraged to cash-out refinance their home and spend this money on consumer purchases, such as discretionary home upgrades (e.g. building a backyard patio or installing a home theater system). They were advised that this would “boost their home value,” and they were not properly educated about the core financial literacy concepts that their personal home is not an investment and that relying on appreciation is speculation.
Unfortunately, those borrowers couldn’t liquidate their discretionary purchases when the recession struck. Their personal residence upgrades don’t provide a stream of passive income. They quickly found themselves underwater.
(That’s not the only reason many borrowers found themselves underwater in 2007, of course. Some borrowed to cover necessities, such as medical bills. Some found themselves blindsided by prolonged unemployment. Many were misled by lenders, who painted an unduly rosy picture and downplayed the risks of overborrowing. And many bought near or at the peak, such that when neighborhood home values declined, they found themselves holding a loan balance larger than their newly-depressed home worth.)
But the point remains – before the Great Recession, many people borrowed against their home equity for non-investment purposes.
Today that’s a distant memory. Cash-out refinance loans dropped 75 percent after the 2008 recession and remain at historically low levels today.
Foreclosures, bankruptcies and delinquencies are also at historic lows, as of the start of 2020. This January, only 3.5 percent of homeowners were late in paying their mortgage by 30 days or more, the lowest rate in 20 years for the month of January.
Finally, more people are mortgage-free today. In 2007, around 68 percent of homeowners carried a mortgage; by February 2020, that number had fallen to 62 percent.
Let’s review. In early 2020, at the start of the pandemic, the housing market was characterized by:
- Highly qualified borrowers
- Smaller loans
- Healthier debt-to-income ratios
- Fewer cash-out refinances or second loans
- Low delinquency / more on-time payments
That’s why this isn’t going to be a repeat of 2008. The conditions are different. The housing market entered the 2020 recession from a position of strength.
We’ll briefly touch on the second reason why there won’t be a rash of foreclosures: public opinion and organizational will.
We’re experiencing a loose patchwork of protections intended to protect homeowners (particularly owner-occupants) from facing foreclosure.
Some banks are offering mortgage forbearance programs. Some states are instituting eviction and foreclosure moratoriums. Unemployment payments are fueled with $600 per week in additional benefits, and businesses with PPP funding must keep their workers on the payroll.
While these efforts are far from perfect, they’re – at the moment – adequate to prevent a huge volume of foreclosures.
So far, so good. Current data reflects no significant rise in delinquencies (late payments). If this number starts to spike in the summer or fall, there’s a reasonable chance that public opinion will pressure lawmakers and institutions to offer more protections to homeowners.
Where’s the housing market headed in the next 6-12 months?
Here’s what we’ve learned:
- Home values are at historic highs. They’ve climbed steadily over the last decade.
- Mortgage interest rates are at historic lows, continuing their pattern from the past decade.
- Borrowers are well-qualified, and the likelihood of a 2008-style glut of foreclosures is slim. We’re unlikely to see a housing crash.
- Housing supply has been tight for the last decade, but now the supply/demand balance appears to be tilting in favor of buyers.
If you want to buy a property, the next 6–12 months might be an excellent time to become a buyer.
(And if you want to sell a property, wait. Hold for now.)
The pandemic may be ushering in a new era. Buyers might feel like it’s 2012 again: they can negotiate hard, offer significantly less than asking price, and not worry about getting outbid. They can ask the seller for repairs, concessions, and closing costs. Ahh, the good ol’ days.
Of course, there are people who disagree. Demand was high before the pandemic struck. As a result, some analysts have floated the idea that once mandatory social distancing restrictions loosen, buyers will unleash pent-up demand.
But if the lack of customers flooding back into restaurants, bowling alleys and tattoo parlors in Georgia is any indication, the housing analysts who dream of “unleashed pent-up demand” are … well, they’re dreaming.
When the economy tightens, people tend to become more cautious with their spending.
In the midst of a deep recession, with more than 30 million unemployment claims and a national mood of restraint, I find it unlikely that a huge volume of aspiring first-time homeowners will be eager to spend six-figure sums.
This means the brave buyers who pick up properties at this time may enjoy finding deals and negotiating from a position of strength.
Is it wise to buy in 2020?
In an unstable economy, many people are reluctant to make big-ticket purchases such as cars or homes.
And rightfully so.
Let’s turn this conversation to you. You might be wondering, “is it wise to buy a home in 2020?” – regardless of whether it’s a personal residence or an income property?
The answer: ONLY if you’re starting on a strong financial foundation.
First – If you don’t have an adequate emergency fund, focus first and foremost on building at least 3–6 months of rainy day reserves. If you think there’s a decent chance that you might get laid off or furloughed, or if you’re self-employed, extend this to 6–9 months of expenses.
Even if you’re a relentless optimizer, DO NOT invest this money. Keep this in a high-yield savings account (CIT Bank* is currently paying up to 1.25% APY on savings). Resist the temptation to throw it into the stock market, no matter how much you want to “buy on the dip.”
You can buy on the dip with a different bucket of funds. Don’t gamble with your emergency fund.
Second – If you’re carrying high-interest credit card debt, this is not the time to distract yourself with a home purchase. Crush your credit card debt first. Transfer your balances to a zero-interest card, and live on a strict budget that allows you to chip away at these balances before the teaser rate expires.
Third – If you anticipate any major big-ticket expenses (for example, if your car is 25 years old and the engine is sputtering, and it’s only a matter of time before replacing it transcends from “someday” to “urgent”), set aside enough cash to cover this cost.
Fourth – This is such a “duh” that I hope it goes without saying, but if you get a company 401k match, contribute at least enough to your retirement accounts to take full advantage of the match.
Fifth – Take stock of your dreams and goals. Everything is a trade-off. Don’t buy a home just because you think “this recession might be a great opportunity!” – that’s not a good enough reason if your heart isn’t authentically excited about it.
If you’re starting from a strong financial foundation AND this is your genuine goal, then 2020 might be the year that you, as an aspiring buyer, have been hoping to find.
(And if you’re selling a home … wait until 2021.)
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Unless otherwise indicated, all research and data conducted by and attributed to the US Housing Market Health Check report, released by Thomvest Ventures and written by Nima Wedlake, Principal.
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