briefcase | invest smarter | Issue #112

Headlines and commentary these days seem a bit like...

Here are a few headlines we've chosen to ignore violently...

Is The Housing Market About To Crash? — Bankrate

The Most Splendid Housing Bubbles in America — WOLF STREET

Wells Fargo is stepping back from mortgages after the Fed's rate hikes helped crater the US housing market — Markets Insider

Housing Market Crash: How Soon Will One Happen — GO Banking

Housing Market Crash Fears After Prices Fall for Fifth Month in a Row — Newsweek

Bubble, crash, crater...Don't you love the media? We can think of fun words too...Like recalibrate, deceleration, equilibrium.

Instead of sensationalism, we want to help us all practice a bit of real estate stoicism.

The reality is things aren't as bad as people may think, and although mortgage rates and price drops can be painful, they're actually a natural part of a functional capital market.

Dysfunctional: How Did We Get Here?

TLDR: Limited supply and low interest rates created a monster seller’s market, a horror story that supported the high price frenzy of the last few years. But, as soon as interest rates rose, we saw a few things happen...

All caught up? Now let's look at how real estate markets are recalibrating and becoming more functional.

Functional: Interest Rates

Inflation is taming, and interest rate increases are decelerating, with the latest rise being only 25 basis points. Markets are predicting interest rates have peaked and will actually drop slightly over the coming years.

Mortgage demand is down, but barely. When compared to historical averages, we are at similar levels to 2014.

Meanwhile, most homeowners have a rate locked in of 4% or lower, meaning higher interest rates won't impact them as much. What this will do however is limit transactions as folks decide to stay put to avoid getting a new mortgage with a higher rate.

This will decrease supply, which will actually put upward pressure on house prices. According to an analysis by the Urban Institute:

During these periods of sharp interest rate increases, we did not have the acute housing supply shortage we have today, which could slow the deceleration in home price appreciation. In short, despite a sharp drop in affordability because of higher mortgage rates, home prices are unlikely to decline.

Functional: Prices

Yes, housing prices will decrease, but it's a bit of a red herring to do short-term comparisons. Between April 2020 and June 2022, housing prices in the U.S. jumped over 41%. This was driven by the pandemic and the remnants of central bank zero interest rate policies (aka 💸 free money).

So when prices drop 20%, it may seem like the sky is falling, but keep in mind you still have a 40% buffer from where prices were just a few years ago.

Source: AWOCS

This chart is highly informative and gives a better perspective on prices, rather than getting caught up in the headlines.

The truth is the current homeowner is still very fiscally healthy. We have over $29 trillion in home equity, only $11 trillion in mortgage debt, and 42% of homes are owned free and clear.

Given this level of strong equity, The Wall Street Journal says:

A 28% decline in U.S. home prices between 2006 and 2009 sent the value of some 11 million homes below their mortgage balances, triggering widespread defaults, a near-collapse of the financial system and a deep recession. Home prices would have to fall between 40% and 45% from their peak to put the same proportion of mortgaged homes underwater today.

So will prices drop from current levels? Most certainly. Will they drop 40%+? Likely not given the limited supply and deceleration of interest rate increases by the Fed which is creating a healthier balance of supply and demand.

Functional: Supply & Demand

As the cost of a mortgage rises, demand will weaken. Given the significant imbalance over the past few years of soaring demand and weak supply, this is a welcome development.

Speaking of development, builders are also not keeping up with the (currently weakened) demand for housing. See the historical average of housing starts in the U.S. per year:

Estimates are that we need 3 million homes to meet current demand, and we are only building 1 million per year. And, that will slow further given the current state of homebuilding.

So What? The sky isn't falling. But we entering an era of equilibrium in real estate. This is a good thing, but being at the top of a rollercoaster means there will be some downward momentum and controlled freefall along the ride.

We prescribe a healthy dose of cautious optimism and real estate stoicism.

💵 Mortgage: Applications jumped up 7.4% last week as rates dropped, then rose again — HW

💵 More-gage: Refinance activity was also up 18% last week — MBA

👋🏻 NEUMANN! Neumann reveals his vision for Flow renters to “feel ownership” — TRD

🏢 Post Office: Alphabet to spend over $500M cutting office space in Q1 2023 — CO (and Briefcase)

📈 Prices Up: The Case-Shiller Home Price Index rose 7.7% YoY in November, down from 9.2% in October — Zillow

🙋🏽‍♀️ More Please: Federal Reserve Governor Lisa Cook said more rate hikes are needed to ensure inflation is tamed — NMN

...ChatGPT takes the bar exam even though its dream was to be an AI Art Bot, thanks Dad.