‘Crash’ hits home buyers not investors. Am I right?

Question

There is a lot of hype in the BP forums about the devastating effects the impending ‘crash’. It seems that this crash will have a negative impact on home buyers, but not investors. Do we really need to be freaking out?

Russell Brazil · Answer

People like to throw around the word "crash" and the percentage values they think prices will drop.  The fact is most people who do have very little understanding of history or economics.

Ben Zimmerman · Answer

A "crash" is only relevant if you need to sell or refinance.  If you have no intention of either, then the price of your unit is fairly irrelevant.

If you bought a 300k home a year ago at 3.5% interest is $1347 per month in principle and interest. If rates rose to 6%, then for the same $1347 monthly payment the home would need to be priced at 225k which is a 25% reduction in home value which we can consider as our theoretical worst case scenario. However it's unlikely that prices will drop this low since nobody expects interest rates to remain this high for long. We will likely see rates begin to drop again within a year or two. As such the market is factoring in these anticipated interest rate reductions into what it deems to be the current fair market value of assets.

Schiller won a Nobel prize for his work on real estate prices, saying that prices tend to mirror inflation rates. If the inflation rate was roughly 10% last year, then that 300k home should be worth 330k today (assuming interest rates go back to what they were).

This represents a prime time for buyers to accumulate more properties as currently prices are falling, yet prices are anticipated to skyrocket again once interest rates start to subside because that's how inflation works, assets simply cost more because the dollar is worth less. If you were to buy that home for lets say 250k with a 20% down payment, and if interest rates return to normal in 2-3 years, then the anticipated value of that home would probably be in the neighborhood of 330-350k. That represents a 70-100k increase in 2-3 years, which equates to tripling your down payment money in only a couple of years.

Relatively high rates of inflation are of huge benefit to anyone that is using loans to leverage their position. This is because inflation helps the investor from both sides of the equation. The asset is increasing in value at a leveraged 5 to 1 ratio thanks to inflation (assuming a 20% down payment was used. Meaning a 6% inflation rate translates into a 30% ROI), and the value of the debt is simultaneously being eroded by inflation. A dramatically simplified example says that a 300k home would take 30k hours of labor to repay that debt if the average income was $10/hr. However if inflation causes the average wage to rise to $20/hr, then it only takes 15k hours to repay that same 300k mortgage. This makes it twice as easy to repay the debt.

If you had just bought a house with 20% down payment, then you can view it as you owning 20% of the house and the bank owns the other 80%. But if inflation causes all prices to magically double overnight, then your equity rises dramatically and now you own 60% of the house and the bank only owns 40% even though you haven't repaid a single cent towards the loan balance.

Marcus Auerbach · Answer

There is a lot of consensus amongst industry researchers and banks that individual markets in the US will go in different directions. Some markets may soften by maybe -5% to -10%, others may appreciate 5% to 10% for next year. 2024 and 2025 forecasts are positive throughout again.

Some markets exploded in the last tow years like TX, FL etc. will see prices to deflate a little, for PA and the Midwest the story is different, housing is still relatively cheap and affordability good. Mobility is a lot higher and we see people relocate from the coastal markets and work remotely. We work with a lot of relocation clients and the numbers are growing. Cost of living is a big reason, but we also hear smoke, fresh water and storms as reasons.

Looking at our market Milwaukee, considering the increasing popularity (from a complete underdog), the lack of new construction and the very limited housing we have I would not be surprised if home prices would double in the next 10 years given the low starting point.

Mike Dymski · Answer

Many investors were impacted severely in the last crash; so, absolutely, depending on circumstances (although a crash is highly uncommon).  Some markets had mass vacancies, tons of unsold properties, no credit available, high unemployment, untimely balloon payments, and limited travel.  I try to buy in locations (and property types) with little risk of extended vacancy.

Dillon Cook · Answer

BRRRRing is very dependent on future rates/prices.  Senior economists across the board are split on their *predictions*.. Each have reasonable arguments on the Fed hiking rates further or backtracking them.  Who's to know.  Finding immediate equity in deals is more important now to give cushioning, and obviously overleveraging is a bad idea.

Ben Zimmerman · Answer

"Normal" is a relative term and must be taken into context.  We can not evaluate what is normal inside of a vacuum.  For every basis point that interest rates rise, the US government must pay an extra $3.1 Billion in interest on its debt, or in other terms a 1% increase translates into $310 billion in annual interest.  We can't base normalcy of interest rates based on data that is multiple decades old when the debt to GDP ratio was hovering around 40%, it is currently closer to 140%.

Suffice it to say I think that interest rates will drop dramatically from current levels.

Eliott Elias · Answer

It hits a ton of these fake investors that over paid for property and banked on appreciation. Investors are still home buyers, and these rates still suck as an investor

Nate Sanow · Answer

I agree with the original post here.

In my market, the only drop in price is on asking price, and that is usually only if a property is over priced, ahead of the market, acting like it’s still 2020-21… it is not… but it is also not 2008-10. Well priced property is getting asking price or better, both by my own experiences and statistically speaking per my MLS.

And to your point, my regular non-investor buyers ARE hurting. I actually really wish someone would compile stories to the chairman of the fed that this whole rate hike thing is backfiring in the oddest way; those with rate locks of low rates don’t sell and thus cause an even greater inventory issue. We are facing the odd juxtaposition of buyer-ish-market factors like high rates and higher DOM, blended with low supply which creates increase demand and therefore.. price.

What ends up happening is a retail, non investor buyer has to both pay more for a property and more in interest.

I’m wondering if any other Midwest-ish type markets share my sentiment

Theresa Harris · Answer

Ben is right, it only negatively affects those who are selling their home and even then those who have larger mortgages.  If someone has a small mortgage and sells their house in a buyer's market and buys another one, yes they will lose some money, but they are also buying low.  When the market goes up, so to does the price of their new house.

‘Crash’ hits home buyers not investors. Am I right?

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