Déjà Vu All Over Again

The real estate market feels like it’s happening all over again, doesn’t it? Back in 2005 and 2006, the market was red-hot, and even though many knew it would slow or fall, very few predicted the full carnage of the Great Financial Crisis. I was one of them – I bought a home in the summer of 2006, rationalizing the high price based on its relative value compared to the home I was selling and other listings on the market. It was 50 years newer, twice the size, had a much larger lot on a cul-de-sac, an extra-large 2-car garage, and was in a better neighborhood and school district. Surely, I could sell it for no gain in a worst-case scenario, right? Wrong. I soon lost my job, and that house went into a short sale for $100,000 less than I paid.

I feel that same type of rationalization happening again with many buyers and sellers. “There’s no supply, so that will keep prices from falling significantly.” “Date the rate, but marry the house – just pay today’s price and rate, and refinance later.” “WFH makes an inferior location acceptable.” All of these have some basis in fact, but the monthly payments just don’t make sense for many, if not most, buyers. And I’m concerned that prices may soon fall.

The Telltale Signs

The housing market was collapsing before the GFC because buyers couldn’t afford the home prices. That’s happening now. Then, the foreclosures started, as those with little or no skin in the game found themselves underwater. This should be a much smaller factor in the coming years, but not a non-factor.

Let’s take a look at some data to see what’s really going on. The graphic below shows how fast resale volume has fallen over the past year in Chicago (blue bars). It follows a similar trajectory as 2007 before the GFC technically started. Over the past 2 years, monthly payments (principal and interest only, assuming a 20% down payment) have shot up due to both high prices and high interest rates. Both data series are shown as 12-month rolling numbers to smooth out some of the seasonality in Chicago.

A few things stand out to me:

• Monthly PI payments have roughly doubled just since 2020. This data shows rolling 12-month payments peaking at about $1,600 in September, but the current non-rolling monthly payment is actually over $1,800 at today’s 8% rates. Of course, other costs like groceries and insurance have also risen in similar fashion due to inflation. Salaries have climbed, but not enough to keep up.

• In June 2021, total resale volume surpassed 2005 peak levels of approximately 135,000. Government stimulus and low interest rates certainly juiced the market. In Chicago, it took nearly 13 years for prices to surpass the previous peak of $267,000 from August 2007 when they hit $270,000 in April 2020. But it took only 3 years for prices to hit $350,000 in June 2023, jumping $80,000 or 30%. And price appreciation in Chicago over this 17-year period is tame compared to most other markets, particularly those in the Sun Belt.

• By spring of 2008, resale volume in Chicago was already down about 35% from the peak, which is almost exactly where Chicago is right now – down 35% on a 12-month rolling basis since August 2021. Again, the previous downturn in real estate was before the GFC officially started in March 2008 with the collapse sale of Bear Stearns. Fall of 2008 brought the collapse of Lehman Brothers, the bailout of AIG, and a stock market crash followed by massive job cuts of hundreds of thousands per month. A recession starting in the next few months would surely drive volume lower than today, particularly if rates stay higher for longer.

What’s Next?

Prices in Chicago bottomed at $135,000 in April 2012 and began climbing along with sales volume, spurred by low interest rates. There was a brief dip in volume in 2014 due primarily to interest rates passing the high 4% mark, but the market generally stabilized over the next few years until the fall of 2018, when a stock market correction and government shutdown caused a slight downturn in sales volume and likely dampened the 2019 spring market somewhat.

Fast forward through the pandemic, and basically everyone that wanted or needed to buy a home over the past few years was able to do so at lower prices and lower rates, thanks to government stimulus, newfound equity, and loan forbearance. Demand was pulled forward and inflated by investors. But where is homebuying demand going to come from in the short term? Renting is largely cheaper per month with less up-front costs (down payment) and less stringent financial hurdles (credit, etc.).

Why buy now, potentially at an inflated price and high interest rate that you may not be able to refinance for several years? The people buying now are generally those that have to due to life changes – job change/relocation, new baby/family member, marriage, divorce, and most importantly, retirement. Largely the only people selling right now are also in a “have to” situation.

Low supply has been the saving grace so far to keep prices stable, but rates at 8% are likely to test pricing’s staying power. Now we have wars in Europe and the Middle East, staggering national debt (approx. $229,000 per household), another potential government shutdown, another election year coming, ongoing labor disputes/strikes, and interest rates that are predicted to be higher for longer. In my view, this confluence of factors does not bode well for the economy in the short to mid-term.

A Bumpy Ride Ahead

The monthly payment (orange line) will continue to climb or flatten over the next few months to a year, assuming prices and interest rates hold. Many homes purchased over the past few years were second homes, vacation homes, or investments. Should unemployment grow due to a recession, some may decide to sell one of their extra homes, providing much-needed supply, which in turn could push prices lower. A deep recession could further accelerate these sales and price declines.

I’ve been wrong far too often to make confident predictions, but my best guess is that it will be a very bumpy ride this fall and winter. I suspect sales, prices, and rates will all fall over the next 6 months to 1 year due to a likely recession. I know I’m going to be very cautious over the next several months. What do you think? Anybody feeling bullish at the moment, and if so, why?

If you’re in the market for a new home, be sure to check out the affordable housing solutions available at HACC Housing. Their team of experts can guide you through the process and help you find the perfect home that fits your budget and needs.