How Will It End?
By Strategic Passive Investments
In March 2022, for the first time in more than a year, more Americans were considering selling a home than buying one. In fact, just over one in every 10 homeowners reported to MorningConsult as part of the market research firm’s March 2022 Consumer Spending Report that they now believe purchasing a home in their own neighborhood is a “somewhat or a very bad” investment decision. Things are changing, but the market has resisted what appeared to be insurmountable headwinds for so many years now that many real estate investors feel as if the climb upward will never stop.
Savvy real estate investors know, however, that the housing market and the economy are cyclical. What comes up will, eventually, come down. That foundational truth presents investors with some very basic questions that must be answered early in order to best optimize on the inevitable:
How will we know the market is slowing and/or changing course?
What will the best investment strategy be at that time?
How can we most effectively prepare for this event?
There are, of course, as many theories about what will indicate a market shift and how to read the bellwether signals as there are economists, which is to say about 17,520 individuals officially employed with the term in their job titles, per the U.S. Bureau of Labor Statistics and countless others serving as analysts and informal market researchers. However, real estate investors should be watching for just a few clear signals that may indicate a shift in consumer sentiment is coming.
One of the biggest is the indicator mentioned above: People are not feeling so good about their current real estate “investments” even if those so-called investments are their primary residences. While the MorningConsult report deals more with how homeowners feel about prices in their neighborhoods in the present, it is a short leap to reach how homeowners feel about the potential price on their home in the future. As homeowner confidence cools, prices are likely to level off and cool at least slightly with it.
The Inflation Equation
In late March, economists watching the bond market sent up a warning flag in response to an inverted yield curve, which occurs when longer-dated bonds start offering lower annual yields than shorter ones. Essentially, this indicates that investors are more worried about the state of the economy or the stock market in the near future than they are about the long term, which tends to mean they are seeking “sure-fire” investments like short-term bonds to protect their assets.
Nearly every time there has been a recession in the last 60 years, it has been heralded by an inverted yield curve preceding that economic weakness by between six and 18 months. However, it is not perfectly accurate; in 1965, an inverted yield curve did not precede a recession. In fact, the recession did not happen until five years later – after another inversion!
It is not entirely surprising that the country experienced an inverted yield curve in March. After all, the Russian invasion of the Ukraine was ongoing; inflation seemed to be heating up, and there was talk of a “new” cold war. No wonder investors were rushing to find someplace solid to put their assets.
The real question will be how the markets will react to a combination of inflation and rising interest rates. In the past, the Federal Reserve has elected to lower interest rates – thereby keeping mortgage rates low, among other things – in order to help tamp down inflation when the economy was under stress. This time, however, this strategy is not an option. Interest rates were already at record lows and must be raised in order to avoid further, catastrophic imbalance.
As interest rates rise, it will become harder and harder for would-be buyers to finance a home. At the same time, as inflation becomes more severe, it will become increasingly difficult for future homebuyers to save enough money to make a down payment on a home purchase. This will likely be the tipping point at which home prices stop rising, although it is unlikely they will begin to fall significantly, at least at first. Instead, we will see the traditional “cooling” wherein appreciation eases off and levels while some overvalued markets begin to lose a little value.
This tipping point, which is less of a tipping point and more of an easing-off-the-gas point, will be key for real estate investors. It will indicate that a change is coming and, in a country accustomed to a seemingly irresistible real estate boom that cannot be stopped by political turmoil or even a global pandemic, this indication could seem far more devastating than it truly is.
This will particularly be the case if the situation is compounded by a drop in demand, such as occurred in the wake of the Great Recession when many Millennials opted to delay homeownership voluntarily because they remembered owning a home in light of a family foreclosure rather than as part of the “American Dream.” Although this was a delay in the timeline rather than a permanent change in the American approach to homeownership, it could result in a sharp drop in demand at a point at which the market is already on tenterhooks.
How Investors Can Prepare
Real estate investors have been saying since about 2016 that we were “due” for a correction. Many have even begun to look for one, champing at the bit to not miss the boat next time the market crashes. However, this market crash – or correction, or easing – will look different from the last one that most investors remember – if they remember it at all. This crash will not be precipitated by bad loans (most likely) or adjustable rate mortgages. Even the current market heat is driven by a different fuel source.
The best way to be prepared is to have a good network in place that can help you acquire assets and to have a game plan for accessing the capital necessary to do so. Then, watch and wait. Times are changing, and those who are prepared will reap the best returns.