The Housing Market: A Crash or Crisis?
This Time It's Different...
The housing market has been a hot topic lately. Buyers, sellers, and anyone paying attention seem to have an opinion on where it’s heading. Sellers think it’s a hot market, buyers view it as hellish, and bystanders think it’s cool to watch. And it’s for good reason. Today’s housing market has broken just about every housing statistic over the last two years. Home prices have reached record highs as the supply of homes on the market fall to a record low. The number of homes sold above the asking price has hit a record high. And 30-year mortgage rates are now above 5% for the first time in over a decade, after being at historic lows two years ago. The only things not breaking records are the stock market and salaries.
It’s normal for a home in this market to sell for thousands of dollars above the asking price. Recently, in Arlington, Virginia, a home listed for sale at $899k received 21 offers and sold for $300k above the asking price. There’s nothing unique about a home that receives 21 offers, it received 21 offers because there is something unique about the housing market it’s being sold in.
Inventory is at an all-time low in most housing markets across America. Because of the low inventory, sellers are receiving multiple offers from buyers who are competing against each other for the same home. Buyers have turned the home buying journey into a competition. And their goal is to win the competition by any means necessary, even if it means taking risks they may regret later. Because of the competition to win a home, buyers are encouraged to present offers above the asking price while also waiving contingencies that are put in place to protect buyers, including home inspections and appraisals. The joy of your offer being selected over 21 other offers lasts longer than the pain of overpaying for a home you toured for 15 minutes.
As the price of homes sold continues to hit new records, many people believe we have seen this movie before and they know how it will end. However, there are key differences between today’s housing market and the one that led to a crash in 2006. The key differences indicate that we are not heading for another housing crash, we are heading towards a housing crisis.
In 2006 we had an inventory surplus. There were more people selling homes than buying them. The surplus was a result of borrowers who were able to obtain loans for homes they could not afford. This was made possible because of loose lending requirements, to put it nicely. What led to the housing crash in 2006 were buyers who were able to obtain a mortgage with very little documentation to prove their income and ability to repay debt. Buyers believed rising home prices would last forever and save them from being on the wrong side of a bubble.
To take advantage of the appreciation in home prices, buyers would purchase a home using an interest-only mortgage. This type of mortgage allowed the borrower to only pay the interest portion of the loan for the first five years. Then, they would begin paying interest and principal at the end of the five years. The idea was the borrower would sell their home before the five-year period expires and walk away with appreciation, which is the difference between what the borrower owes on the home and how much the home sells for.
Here’s a best-case scenario if you were a buyer in the year 2000 trying to take advantage of the housing bubble. You would purchase a home in 2000 for $500,000, then sell the home in 2005 for $800,000, the difference of $300,000 is the appreciation you would pocket. The temptation of a nice return on investment worked for some borrowers, which made it attractive to others.
Unfortunately, like any bubble that’s formed, those who show up late are left holding the bag. And their bag was filled with hot air, not money. Cracks in the housing market's foundation began to form as the housing market became flooded with homes for sale and a drought of buyers to buy them. Instead of buyers competing for homes and driving up home prices, sellers were competing for buyers who were driving down home prices. Homes were being sold for less than what was owed to the bank, which led to foreclosures and the strict lending practices that are in place today. Almost overnight, your appreciating asset became a depreciating liability.
Today’s housing market is experiencing the opposite of what we experienced during the housing crash of 2006. Across America there is an inventory shortage of homes, meaning there are more buyers than there are homes for sale. Ask any buyer today, and they will share horror stories about inventory shortages and bidding wars in their market. The competition for the limited number of homes on the market creates a bidding war, leading to historically high prices for homes sold. In the Northern Virginia market, homes are receiving multiple offers and, on average, are going under contract within a week. To reverse this trend, supply will need to increase to meet demand, which does not seem likely within the next few months.
One reason for the low supply of homes is that homeowners today can afford the homes they live in. We can thank strict lending requirements enacted after the 2006 housing crash for that. Today, homeowners do not carry a large balance, if any, on their mortgage. Therefore, when they sell their home it’s by choice and not fear of foreclosure. Rising interest rates will also influence a seller’s decision to sell. A homeowner paying an interest rate that’s below today’s rate will be reluctant to sell their home if it means buying a higher-priced home with a higher mortgage rate. Homeowners who are reluctant to sell their homes will put downward pressure on the supply of homes available to buyers. In today’s housing market, buyers are eager to buy homes while sellers are reluctant to sell. This will cause demand that benefits sellers at the expense of buyers.
Three main factors will lead to a shortage of affordable homes:
Low inventory of existing homes on the market
Labor shortages and an increase in the price of materials to build new homes
Rising interest rates
As home prices and mortgage rates rise, many homebuyers will find it difficult to afford homeownership. One solution to make housing affordable is by increasing the inventory of homes on the market. This can be done by existing homes coming on the market at a greater speed, and home builders building new homes. Until the inventory shortage is solved, home prices will continue to rise and the “American Dream” will be further out of reach for many first-time home buyers. As if that is not enough, would be home buyers will turn to the rental market, which is also experiencing a rise in prices due to a limited supply.
Competition for homes on the market will continue to be at an all-time high as people migrate across the country in search of affordable housing. When a buyer moves from a high cost of living area to a lower cost of living area, they view the most expensive homes in their new market as a bargain compared to where they are migrating from. This is causing the price of homes in once-affordable areas of the country to reach record highs. One factor contributing to the migration of home buyers is the work from home experiment. Those who are fortunate to work from home have the flexibility to work from anywhere they have a reliable internet connection. Home becomes where the Wifi is.
There’s another factor that’s driving the home supply down and causing a crisis of affordable homes. Investors are flooding the market with billions of dollars and buying homes, sometimes entire neighborhoods, and turning them into rental properties. What would have been a first-time home buyer’s dream home, is now someone else’s return on investment.
Low inventory of homes, higher prices, and rising interest rates spell trouble for buyers entering the housing market. The longer buyers wait for home prices to crash, the more difficult they will find it to purchase a home that meets their needs. First-time home buyers will find it most difficult to compete in this market. And as buyers get priced out of the market they live in, they will face a decision of renting or moving to a lower cost of living area.
Across the country, buyers with dreams of purchasing a home have been replaced with the reality of higher mortgage rates and skyrocketing home prices. As home prices outpace incomes, the lack of affordable homes will lead to a housing crisis, not a crash.
