Are We Headed Towards Another Housing Crash?
Background
Since the start of the Covid pandemic in March 2020, home prices are up a staggering 45% – according to the National Association of Realtors. Sellers have enjoyed a wildly imbalanced market for the past couple of years, while buyers have been forced to offer well over asking price and waive all contingencies in order to have a competitive offer.
The last time the real estate market was this hot was in 2007, just before the real estate bubble burst – triggering a foreclosure crisis and a global recession. With soaring inflation and another recession looming, homeowners and investors are all asking the same question.
Are we headed toward another real estate crash? The short answer is no.
Rising interest rates have started to slow the record-breaking market, but today's real estate market is fundamentally different from that of 2007 in a few key ways.
Housing Shortage
The most significant factor driving home prices up is the simple fact that we have a shortage of homes available. The National Association of Realtors recorded a home shortage of 5.5 million in May, a gap they say would take over a decade to close.
In a perfectly healthy market, economists estimate that there would be about a 6 month supply of homes. Meaning it would take 6 months for all the homes on the market to be sold. Throughout the past couple of years, supply has been closer to 1.5 to 2 months.
With a lack of existing homes, the simple supply/demand imbalance is going to prevent a significant fall in home prices.
Why is there such a shortage of homes?
Building Costs and Delays
After the Great Recession of 2008, many home builders pulled back production levels significantly. When the covid pandemic began, most industries came to a screeching halt, resulting in long delays for materials like steel and lumber and skyrocketing costs.
According to the Bureau of Labor Statistics, overall construction prices are up over 35% since the start of the pandemic. Additionally, while the construction industry was on pause, many out-of-work contractors transitioned to more stable industries to find work and have not returned. It's hard to build homes if you can’t get the materials you need or the labor to work. Builders are generally over budget and behind schedule on existing projects, so lack of inventory will continue to be a problem.
Type of Loans
The lead-up to the housing crash of 2007-08 was fueled by the infamously loose lending practices of the early 2000s. Thanks to complex financial engineering and predatory lending practices, lenders offered mortgages to almost anyone – regardless of down payment or credit history.
Today, buyers must meet strict requirements to qualify for a loan, and those who are getting loans have record-high credit. Only 8% of loans today are adjustable, compared to 37% in 2007, which left borrowers open to jumping payments and eventual foreclosures.
Following the crash of 2008, foreclosures flooded the housing market diluting home prices even further. Today, most homeowners have a large equity cushion and foreclosure rates remain low – hitting an all-time low in 2020 with only 0.16% of homes reaching foreclosure.
Buyer Demographics
Work from home policies, restricted international travel, and general pandemic policies all encouraged home buyers to look for larger and nicer homes and increased demand for vacation and second homes. The pandemic also coincided with a large portion of the population, millennials, coming into prime home-buying years.
The National Association of Realtors estimates that about 31% of home purchases are first-time homebuyers, most of which are under 40. Even if homebuilders can increase production in the next few years, Gen Z buyers will soon be entering the home buying market increasing the buyer pool even further. This growing block of young homebuyers will continue to be a high floor for housing demand and a buffer of home values against a struggling economy.
Conclusion
Despite waning buyer demand – the current housing shortage, inventory backlog, strength of loans, and forecasted amount of future buyers will continue to be a hedge against a market crash. Even while national housing trends weaken, growing markets like Chattanooga and Nashville will likely be insulated from the harshest adjustments coming.
So, while competition for homes may be beginning to rebalance, don’t expect to see home values retreat to pre-pandemic prices – especially here in Tennessee.
Do you agree? What would you add to this list?
@Andrew Austin The simple fact that we are, as a general market review, short on the housing supply AND that the loans on the houses purchased since 2009 were underwritten with stricter guidelines mean a housing crash is highly unlikely.
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Nah.
- Real estate will be less liquid. The number of transactions will decrease. When rates are sexy, it's no big deal to sell your house with a crummy kitchen in order to buy a house with a nicer kitchen, but one fewer bedroom, as a lateral move (sell a $500k home you don't like any more, to buy a $500k home you do like, equity from one is down payment on another, monthly payment ballpark unchanged). Now, in mid/late 2022, that would mean swapping out your 2.75% rate for a 5.XX% rate, the payment will be $1200/mo higher. Suddenly you don't hate your kitchen so much after all. Supply and demand are unimpacted by this, since it's 1 fewer seller AND 1 fewer buyer, but there are 2 fewer transactions (times however many million). So, as stated, liquidity will be down. Less houses will swap hands. People will do more staying put.
- Rent will be going up faster than real estate for the next couple years. All the would-be FTHB deterred by the higher rates still gotta live somewhere. That would-be FTHB isn't leaving the rent treadmill, but young people are still aging out of college and their parents house, they need to hop on that treadmill too, so the treadmill is about to be more crowded. Rent bidding wars wouldn't shock me, basically rent in 2023 doing what real estate did in 2021 (go bonkers).
- Because of the lack of liquidity in bullet point 1, demand for home renovations will be up. To any general contractor out there worried about the lack of flippers hiring you moving forward, worry not, that person in paragraph 1 needs to redo their kitchen, and as long as the cost (amortized either in a personal loan or credit card) is less than the $1200/mo bump she was otherwise looking at, she will conclude that the new kitchen renovation is a good deal. Rates follow inflation up, and will follow it back down, but in the meantime y'all should have some good solid years (Bonus: that homeowner in paragraph 1 isn't a cheapskate like the flippers are).
- For my fellow mortgage and real estate professionals concerned about the liquidity, worry not. Everyone you don't sell a house to, or do a mortgage for, today, will be back next year. Everyone always said "don't live commission check to commission check," now we find out who was paying attention (which, in turn, means less competition on the other side of the tunnel -- whoop whoop!). The rate shock will be over, the impact of the inflation will not be. They'd probably get a better deal today than a year or two from now, but whatever, that's on them for trying to time the market.
@Chris Mason, you make a good point that interest rates will diminish seller demand since they won't want to enter in the other side of the equation. However, new buyers, either relocating across the country or the large block of younger first-time homebuyers, will still drive prices up to a point many seller won't be able to resist. I agree that rent will probably rise more quickly, but without new construction there won't be enough rental options in growing markets like Nashville and Chattanooga.
Quote from @Andrew Austin:
@Chris Mason, you make a good point that interest rates will diminish seller demand since they won't want to enter in the other side of the equation. However, new buyers, either relocating across the country or the large block of younger first-time homebuyers, will still drive prices up to a point many seller won't be able to resist. I agree that rent will probably rise more quickly, but without new construction there won't be enough rental options in growing markets like Nashville and Chattanooga.
The academic literature I've read said says that, of all the players in the real estate ecosphere, builders are the most rate sensitive. Quickest to break ground when rates are low, first to flee when rates are up. Some are bulls on overall home values, some are overall bears, but all agree that builders are skittish AF when it comes to getting spooked by rates (they build on borrowed adjustable rate debt, and they don't get the 7 or 10 year fixed intro period consumers get, it's typically adjustable right away, so rising rates makes it impossible to build out a spreadsheet projecting your costs, telling your investors what to expect and when, etc).
The inventory of new construction homes hitting the market 12 months from now will ("should") be dismal.
Quote from @Chris Mason:
Nah.
- Real estate will be less liquid. The number of transactions will decrease. When rates are sexy, it's no big deal to sell your house with a crummy kitchen in order to buy a house with a nicer kitchen, but one fewer bedroom, as a lateral move (sell a $500k home you don't like any more, to buy a $500k home you do like, equity from one is down payment on another, monthly payment ballpark unchanged). Now, in mid/late 2022, that would mean swapping out your 2.75% rate for a 5.XX% rate, the payment will be $1200/mo higher. Suddenly you don't hate your kitchen so much after all. Supply and demand are unimpacted by this, since it's 1 fewer seller AND 1 fewer buyer, but there are 2 fewer transactions (times however many million). So, as stated, liquidity will be down. Less houses will swap hands. People will do more staying put.
- Rent will be going up faster than real estate for the next couple years. All the would-be FTHB deterred by the higher rates still gotta live somewhere. That would-be FTHB isn't leaving the rent treadmill, but young people are still aging out of college and their parents house, they need to hop on that treadmill too, so the treadmill is about to be more crowded. Rent bidding wars wouldn't shock me, basically rent in 2023 doing what real estate did in 2021 (go bonkers).
- Because of the lack of liquidity in bullet point 1, demand for home renovations will be up. To any general contractor out there worried about the lack of flippers hiring you moving forward, worry not, that person in paragraph 1 needs to redo their kitchen, and as long as the cost (amortized either in a personal loan or credit card) is less than the $1200/mo bump she was otherwise looking at, she will conclude that the new kitchen renovation is a good deal. Rates follow inflation up, and will follow it back down, but in the meantime y'all should have some good solid years (Bonus: that homeowner in paragraph 1 isn't a cheapskate like the flippers are).
- For my fellow mortgage and real estate professionals concerned about the liquidity, worry not. Everyone you don't sell a house to, or do a mortgage for, today, will be back next year. The rate shock will be over, the impact of the inflation will not be. They'd probably get a better deal today than a year or two from now, but whatever, that's on them for trying to time the market.
Man, I could have wrote this exact same post. This is exactly what I think and have been saying will happen. The overall housing market will simply shrink as a percentage of GDP as both the number of buyers and sellers are reduced. The market will still be healthy, there will just be less overall action. Ancillary businesses that are not solid will suffer - movers, furniture sellers, refinance lenders, etc - but beyond that there's simply no logical reason outside of some apocalyptic event for housing prices to drop.
Quote from @JD Martin:
Quote from @Chris Mason:
Nah.
- Real estate will be less liquid. The number of transactions will decrease. When rates are sexy, it's no big deal to sell your house with a crummy kitchen in order to buy a house with a nicer kitchen, but one fewer bedroom, as a lateral move (sell a $500k home you don't like any more, to buy a $500k home you do like, equity from one is down payment on another, monthly payment ballpark unchanged). Now, in mid/late 2022, that would mean swapping out your 2.75% rate for a 5.XX% rate, the payment will be $1200/mo higher. Suddenly you don't hate your kitchen so much after all. Supply and demand are unimpacted by this, since it's 1 fewer seller AND 1 fewer buyer, but there are 2 fewer transactions (times however many million). So, as stated, liquidity will be down. Less houses will swap hands. People will do more staying put.
- Rent will be going up faster than real estate for the next couple years. All the would-be FTHB deterred by the higher rates still gotta live somewhere. That would-be FTHB isn't leaving the rent treadmill, but young people are still aging out of college and their parents house, they need to hop on that treadmill too, so the treadmill is about to be more crowded. Rent bidding wars wouldn't shock me, basically rent in 2023 doing what real estate did in 2021 (go bonkers).
- Because of the lack of liquidity in bullet point 1, demand for home renovations will be up. To any general contractor out there worried about the lack of flippers hiring you moving forward, worry not, that person in paragraph 1 needs to redo their kitchen, and as long as the cost (amortized either in a personal loan or credit card) is less than the $1200/mo bump she was otherwise looking at, she will conclude that the new kitchen renovation is a good deal. Rates follow inflation up, and will follow it back down, but in the meantime y'all should have some good solid years (Bonus: that homeowner in paragraph 1 isn't a cheapskate like the flippers are).
- For my fellow mortgage and real estate professionals concerned about the liquidity, worry not. Everyone you don't sell a house to, or do a mortgage for, today, will be back next year. The rate shock will be over, the impact of the inflation will not be. They'd probably get a better deal today than a year or two from now, but whatever, that's on them for trying to time the market.
Man, I could have wrote this exact same post. This is exactly what I think and have been saying will happen. The overall housing market will simply shrink as a percentage of GDP as both the number of buyers and sellers are reduced. The market will still be healthy, there will just be less overall action. Ancillary businesses that are not solid will suffer - movers, furniture sellers, refinance lenders, etc - but beyond that there's simply no logical reason outside of some apocalyptic event for housing prices to drop.
"But but but everything is 2008 v2.0!"
Getting causality backwards, that quoted person did. The 2008 recession did not cause the real estate crash, the real estate crash caused the recession.
Since America was taken off of the gold standard, the only recession that caused real estate values to decline was the end of Cold War recession. I wasn't around then, you graybeards tell me if my understanding is correct, but what I'm given to understand is that values plummeted in military base towns, and in towns where a big military contractor (Boeing, Lockeed Martin, etc) had a big factory that everyone worked at, in both cases due to the broad expectation that the one base or industry propping the town up was about to go away (I grew up in one such town, the Air Force base became a ghost town [on base housing all boarded up, etc], then a superfund site, then a new home community years and years later, heh). So you had "normal" homes go up a modest amount, these few military towns plummet a lot, and the overall number was like -2% or something.
Detroit has gone from Motor City to Mortgage City. Quicken/Rocket, United Wholesale, Homepoint, and so on, all being major wholesale mortgage players, all headquartered in/around metro Detroit (good place for cost effective hard-working workers, call it the Motor City work ethos of their parents still being around if you want, but good luck having good rates, low costs, and smooth operations, if your 8k or 20k workers are in San Francisco making San Francisco salaries, it's not like this is bread or chocolate where the wonderful Pacific ocean air is going to infuse into the mortgages and make them "taste" any better...). The mortgage industry has shed tens of thousands of jobs, including 5k just yesterday, and mass layoffs (either official, or unofficial by making working conditions more onerous so folks quit on their own) for each one of those companies I just named too. 2020/2021 mortgage companies that IPOd/SPACd at $16 or $20 a share are now selling for $4 or $7 (talk about a fire sale!). Mortgages aren't the Titans of Detroit that cars once were, and I have no personal material or financial interest in Detroit aside from (obviously) lots of telephone-only colleagues there, but it is one area I will be watching for a "repeat" of what can happen when too much business in a metro area is concentrated in a single industry.
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The 2008 husing crash was in part caused by easy mortgage qualifications pushing up housing prices and then ARM rate spikes making payments unaffodable.
That shouldn't be an issue this time around, but...
What about the relatively easy mortgage qualifications for investors?
With zero experience and 20% down and inexperienced investor can get a no income verification loan as long as they have the credit score and the PROJECTED rents meet the DSR.
Many have used these loans to bid up the prices of SFR's in vacation areas, purely based upon projected STR income.
What happens to these STR investors if inflation causes a dip in vacation travel?
Can they get enough rents converting them to LTR to pay their inflated mortgage payments?
Quote from @Drew Sygit:
The 2008 husing crash was in part caused by easy mortgage qualifications pushing up housing prices and then ARM rate spikes making payments unaffodable.
That shouldn't be an issue this time around, but...
What about the relatively easy mortgage qualifications for investors?
With zero experience and 20% down and inexperienced investor can get a no income verification loan as long as they have the credit score and the PROJECTED rents meet the DSR.
Many have used these loans to bid up the prices of SFR's in vacation areas, purely based upon projected STR income.
What happens to these STR investors if inflation causes a dip in vacation travel?
Can they get enough rents converting them to LTR to pay their inflated mortgage payments?
Keep in mind, DSCR is a subset of non-QM. Non-QM is only 2-4% of market. Do DSCR is some % of that 2-4%. Only in the bigger pockets context does "DSCR = non-QM." People calling me from this website talk about DSCR, DSCR, DSCR, but for my other sources of business, non-QM almost always means (they are never this direct, I'll cut through the chitter chatter) "I'm self employed and lie to the IRS about my income, so I need a non-QM loan that'll look at my business bank statements instead of my tax returns to calculate my income for the purchase of a primary residence." And those bank statements tell a story that would trigger an IRS audit if the IRS saw it, not because they're broke, but because they're good earners, but comingling biz and personal finances, presumably to write everything off and look broke to the IRS.
From CoreLogic -- "The non-QM share of total mortgage counts declined during the pandemic and reached its lowest level in 2020, at 2% of the market. However, the non-QM share has almost doubled in 2022, representing about 4% of the first mortgage market."
https://www.corelogic.com/inte...
Conventional loans (Fannie/Freddie) are the gold standards with the lowest default rates.
Then you've got Gov't loans (FHA / VA / USDA) and non-QM (DSCR, "alternative documentation," modern subprime, etc). Each implicitly tests a theory. Gov't loans on average are higher DTI and lower FICO scores (for example 3.5% down and 660 FICO with a 53% DTI is a totally doable FHA loan). Non-QM pairs "uncalculated" DTI with higher FICO scores and larger down payments (we don't know DTI [lots of these folks are self employed and get 'creative' when reporting income to to the IRS, so the tax forms are unreliable {that's why they need non-QM to begin with!}, credit scores are great, and they have big fat down payments (which could hint at their "real" income that you won't see on tax returns).
All the data that I've read says that non-QM is outperforming FHA. In 2019 for example (just to use the Core Logic article since you may also have it open), we're talking about FHA loans having delinquency of 13%, while non-QM has about 2.5% for same.
No crystal balls, but I don't see non-QM/DSCR being the harbinger of doom. 1) It's a small number of loans, and 2) it outperforms the FHA loans that haven't had major changes since well before 2008 (the 2005-2008 loans were far riskier even than today's FHA, no one blames FHA for 2008, and FHA at any point in the last 20 years is higher risk than today's DSCR/non-QM).
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What’s not being discussed is the largest asset class on a banks books - commercial real estate.
All discussion is on residential but commercial has not been discussed - both office and multi family
What is going to happen when these loans all reset at rates 2x their current rate and syndicators on a multifamily deal penciled in a refinance at 4% and that rate is now 6 and cap rates also inched up?
Interest rate hikes knocked 20M out of the buyer pool because of affordability. That is not sustainable as there will not be buyers for the homes that come on the market based on comments above.
Something has to give. I am not predicting a crash but if homes went up 45% and dropped back down by 30% would anyone be complaining (except those that just bought) that they had 15% appreciation over last 2-3 years?
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Quote from @Drew Sygit:
The 2008 husing crash was in part caused by easy mortgage qualifications pushing up housing prices and then ARM rate spikes making payments unaffodable.
That shouldn't be an issue this time around, but...
What about the relatively easy mortgage qualifications for investors?
With zero experience and 20% down and inexperienced investor can get a no income verification loan as long as they have the credit score and the PROJECTED rents meet the DSR.
Many have used these loans to bid up the prices of SFR's in vacation areas, purely based upon projected STR income.
What happens to these STR investors if inflation causes a dip in vacation travel?
Can they get enough rents converting them to LTR to pay their inflated mortgage payments?
The number of people using DSCR for STR's won't move the needle at all when it comes to foreclosures. There just aren't that many of them relative to the rest of the industry.
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All good feedback:)
yes, massive crash incoming. sell all your properties to me.
I am going to disagree with a lot of people here and give my honest option.
I think we ARE headed for a crash despite stricter lending. When people lose their job and can't get another one due to mass hiring freezes they have to sell or face foreclosure, they don't have a choice. It's the same thing that happened in late 2007.
You have a lot of people who are selling thinking they are going to get top of the market but haven't come to the realization that rates have shot up dramatically. Also, buyers are going after cheaper properties or just waiting out the market.
If someone can explain how you pay a mortgage you can barely afford with no cash reserves and no steady income then I may change my stance. Because that's about to be the majority of America in the next few months.
David Greene talked about interest rates high in order to battle inflation. Inflation which is directly correlated to rising home prices. Prices of homes go up when there isn't enough supply vs. demand. In Nashville we've seen a slight decrease in demand but it pails in comparison to the lack of inventory.
I will say that builders who are building higher end $800k+ homes in parts of the "up and coming" areas of Nashville are getting nervous because their product is sitting on the market for past 2 weeks. Entry level homes are still flying off the shelves which is where I'm investing.
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Quote from @Chris Seveney:
What’s not being discussed is the largest asset class on a banks books - commercial real estate.
All discussion is on residential but commercial has not been discussed - both office and multi family
What is going to happen when these loans all reset at rates 2x their current rate and syndicators on a multifamily deal penciled in a refinance at 4% and that rate is now 6 and cap rates also inched up?
Interest rate hikes knocked 20M out of the buyer pool because of affordability. That is not sustainable as there will not be buyers for the homes that come on the market based on comments above.
Something has to give. I am not predicting a crash but if homes went up 45% and dropped back down by 30% would anyone be complaining (except those that just bought) that they had 15% appreciation over last 2-3 years?
Lot of new syndication recently is accepting more investors to avoid the debt cost, hence they increase the waterfall to be attractive as well.
Good to hear these responses as I am trying to understand this too.
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Something positive/weird already happened. When CPI of 9.1% is released this week/weaker than expected. The MBS market is actually strengthening a bit (if MBS stronger, lower mortgage). It seems a 5% mortgage is the max for now. Hopefully.
I think we'll see a correction and prices going down, esp. in high demand/growing markets for a few reasons:
1. The big migration will slow down. Many of the people who moved away from high cost markets for remote work already did so. We will get closer to slower migration trends which will reduce demand in trending markets.
2. If we're headed toward a recession more people will lose their job. Also, stocks going down means investors and high earners have less money to invest. This will reduce demand as well.
3. Higher interest rates. If someone can afford, say, a $1200/mo mortgage, with higher interest rates it'll mean a lower price for the house.
With all the above, lower demand will lead to lower house prices (which I believe we already start seeing). I don't want to call this a "crash" though. More like a post-COVID, back to normal correction.