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Current Economic Update: How It Affects The Housing Market

As we enter into 2023, many of us are keeping a close eye on the economy.  Is this the year the Fed finally admits we are in a recession and what does that mean for you, the real estate investor? There is fear with uncertainty and many questions about what is going on and what we can expect with interest rates, inflation, housing, and the overall economy.  At Pine Financial, we work hard to keep up on this and make decisions that will benefit us and our clients.  As we kick off the year, I thought it would be a good idea to provide a quick update on what we are seeing and how we continue to respond.

Mortgage Rate Hikes

The mortgage rate hikes have damaged demand.  There has been a reduction of transactions and values across the country. According to NAR, transactions were down 34% at the end of 2022 on a national level with the largest decline in the west.  Home values are interesting because the median, on a national level, is still up year over year but that is misleading because there was a run up in values in the beginning of the year.  There has been a slight drop from the peak of less than 1%. Both Minnesota and Colorado have followed the national trend hitting value peaks in the summer followed by a correction in the second half of the year.  Part of this can be attributed to seasonality but this was also expected with interest rates doubling in that time.  Both Colorado and Minnesota finished the year with a higher median value then they started the year with, and both seem to be doing well.

Inflation And The Market

All eyes are on inflation and inflation is stubborn.  The strong, and improved, labor market is helping hold inflation at an elevated level, but the Fed’s policy is starting to take hold as you would expect.  It can take months to see the impact of the Fed’s monetary policy, including rising rates.  The rate hikes began in March 2022, and we have seen a steady decline in inflation since July 2022 with the largest drop in December.  As of the posting of this article, inflation is sitting at 6.4% down from its peak of 9.1% in June 2022.  The Fed has also softened its stance on the 2% target, so we really do not know how committed they are to that.  If we see unemployment spike, which is possible, we could easily see them start to lower rates even if the 2% target has not been reached.

The Effect Of Unemployment On The Market

With that said, unemployment remains strong, currently 3.4% (a 53 year low!) so it is expected that we will see more rate hikes in 2023.  These could easily be limited to .25% at a time.  I say that because the Fed is suggesting a slow down when it indicated that it is time to see what impact the current policy is having.  Outside of unemployment all signs are pointing to a slowing economy which is exactly what we need to see.

I know rates are confusing but there is little correlation with mortgage rates and the short-term rate that the Fed adjusts. Just because we expect to see an increase in the short-term rates, that does not mean we will see mortgage rates increase.  In fact, most of the experts assume that mortgage rates will stay relatively flat to slightly declining through the year and future hikes are already accounted for in mortgage rates.  We have already seen a pretty dramatic decrease in mortgage rates recently from over 7% to at times dropping under 6% for a 30-year fixed rate loan.  As of the time I am writing this, the average 30-year rate is 6.55% according to Bankrate.com and 6.12% according to Fannie Mae.

Supply Vs. Demand: Not Enough Sellers

I have a lot of confidence in housing.  When I look at this stuff I always focus in on the fundamentals.  In economics that is supply and demand.  We are seeing and have seen a cooling in demand.  There is no question about that, but we are not falling off a cliff because we continue to have a supply problem.  There simply is not enough homes for sale.  Here are some of the reasons for this.

  • Seller strike – I have been hearing this term a lot lately. This refers to homeowners refusing to sell their properties.  Partly created by an aging population but it mostly comes down to interest rates.  90% of loans have a rate of 5% or less and 55% are 3.5% or less.  With rates in the 6% range, sellers are not willing to pay off 3% money.  We are seeing more and more homeowners either not move or are becoming landlords so they can hold on to that cheap money.
  • Profitable rentals – Current landlords are making money and not selling.  Rent has gone up significantly and tenants are not moving.  Rental retention is experiencing an all-time high at 65% according to RealPage Market Analytics.  With rents up and turnovers down, rentals are profitable and not hitting the market.
  • Builders slow – New home starts are way down in 2023.  According to the US Census Bureau, new single family home starts are down 29.9% in December year over year after a steady decline since April of 2022.  If you look at 2022 in its entirety, the total starts for the year are down 3% which is the first annual drop since 2009 according to Trading Economics.  We are not getting the much-needed inventory from builders.

I was recently on an expert panel that Scott in our office was moderating.  I made the comment that a slower economy is good for investors because it creates opportunities.  Scott challenged me by asking where the inventory is going to come from to create those opportunities.  That was a very challenging question to answer.  The only answer I can come up with is I believe we could see some inventory from forced sales because of job losses.  We are starting to see layoffs in certain industries which could easily force a family to sell their home, but I would not project a flood of fire sales for the reasons we have discussed in the past including high quality loans and record levels of equity.  It is also interesting that the job market overall remains strong.

Demand Is Down, But Not For Long

The demand side of the fundamentals is far more challenging to understand right now because I believe there is pint up demand.  It is true that current demand is down with days on market (DOM) going up.  It has increased 124% in Colorado and 47% in the Twin Cities.  Those are big numbers but when your starting point is days or week and not months, small changes turn into large percentage increases.  On a national scale, DOM year over year is steady but the high demand in the summer compared to the lower demand today is off by 116%.  Looking at DOM alone, we are still considered a sellers’ market.  This is especially true in Colorado and Minnesota with housing sitting on the market less than two months. (47 days in Colorado and 50 in the cities).   Although current demand is lower than we have seen in years, I believe there to be a substantial number of buyers on the sidelines.  Here are some reasons I believe this.

  • Blackstone – Large institutional buyers have halted buying in many markets across the county.  None bigger than Blackstone who is the largest buyer and owner of single-family homes in the nation.  Back in August they announced that they halted home purchases in 38 cities across the country.  Although they have been hit with recent redemption requests, they are still worth over $975 billion and have plans to re-enter these markets when they align with their investment objectives.  That just means they are on the sidelines until they feel those markets will be profitable again.  My guess is this is true with most of the large institutional buyers.
  • Applications are up – According to the St Louis Federal Reserve, mortgage rates peaked in October at 7.08% for a 30-year fixed rate loan.  That has dropped to the low 6% range by the end of December which is apparently good because there was a spike in loan applications.  Applications were up in December by 27.9% which is far higher than anyone expected before falling in January.  This increased again the first week of February.  Refinance applications were up 17.7% indicating that borrowers are getting comfortable in the 6% interest rate range.  If rates drop more or sellers start to offer rate buy down incentives, I expect to see an increase in demand.
  • Millennials – A recent survey performed by Zonda of millennials came back with some interesting results.  I think this can be significant because millennials for the most part have preferred the flexibility of renting to owning.  The survey tells a much different story.  Of the participants, when asked why they are not buying, 55% said they are waiting for pricing to come down.  I like this because it tells us there is demand on the sideline waiting and hoping for a correction.  This could have also contributed to the increase in applications when interest rates fell in December and early February.   In any case, this will help create a floor if we see prices start to slide.  In another question, Zonda asked when do you expect to buy?  The results are detailed in the chart below.

    Zonda says that it has not seen results like this in over 7 years.  This is telling us that regardless of the economic conditions, 33% of millennials plan to buy within the next three years.
  • Investors – I am lucky enough to talk to investors every day.  I don’t have a survey or any statistics but mom and pop investors like you and me are also waiting for a deal.  A large majority of the investors on the sideline are telling me they are waiting for rates to come back down or a dip in values.  I am not confident they will see either in 2023 but I do take some comfort in that fact that institutional investors, millennials, and mom and pop investors are all keeping some dry powder at the ready.  This should help prevent a housing bubble.

MOI: A Snapshot Of Supply And Demand In One Statistic

Obviously, there is a chance I am wrong, and we don’t see expanding demand.  If that is the case, we would still need to see a 55% increase in inventory just to get to a neutral market.  We would need more than that to shift to a buyers’ market.  We have a real inventory problem which you can clearly see with months of inventory (MOI).  I like looking at MOI because I believe that gives us a great snapshot of supply and demand in one statistic.  As a reminder, MOI measures the amount of time it would take to sell all the properties on the market assuming no new inventory was added.  It accounts for current absorption rates as well and the amount of available inventory.  When you look at the MOI charts it becomes obvious that the average is between 4-5 months. On a national scale currently, MOI is 2.9 months.  The Twin Cities has 1.4 MOI and Colorado is at 1.5 MOI indicating continued strength in housing.

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