Is it time to panic yet? Where are we going? There’s a lot of talk and many headlines, both locally and nationally, around housing correction. When people hear “housing correction,” they immediately think of 2008. This one will be quite different for different reasons, and in different quantities, and that sort of thing. Nonetheless, a correction is very much possible and entirely on the horizon. But, there’s also more to it than that. Inflation, Supply Chain, Affordability, Interest Rates, and Construction—let’s talk about all these and dig right into it.
The first thing to talk about anytime you’re talking about the future of the market is inflation. Any article you read or any headline out there when talking about the market’s future has to do with inflation. Simply, it’s like how much buying power does your dollar have and is it more or less in the future? So when you look at inflation, you look at a lot of industries across the board. Inflation is probably about double what it usually is right now. Usually, it is set at about 2%. However, right now, it’s at 4%. Despite that, most articles you’re looking at and most experts are going to suggest that it will be short-lived.
That is because there are a lot of industries that suddenly went from very minimal demand to a ton of demand. Another possibility is that they were closed, but then reopened. Whatever it is, prices in those industries went up, and now they’re jumping back up to normal levels. However, that surge in demand will take a while to absorb everything and get back to a normal operational level.
And so that is going to affect prices, and thus, the affordability of those services and goods. But as we adjust to this new post-pandemic world, things begin to open up. Whether they close back down or not, that will start to bake into the economy, and hopefully, we’ll begin to level out.
Now the big question mark is whether we will see a change in the behavior of consumers or buyers.
Will buyers of real estate or other goods and services consider inflation here to stay? Will this affect and change their behavior from a savings and spending standpoint? Or won’t it? That is a huge question that we’re going to have to keep an eye on. So, if people stopped spending, then there would be fewer wheels turning in the economy. It might slow down, and thus the whole thing starts to shift downwards. That is one thing to keep in mind.
The next thing to consider when talking about the market’s future is the supply chain. I think most people who dig into this question of, “Are we slowing down or speeding up?” know about the supply chain. We’ve talked about the price of lumber as well as the cost of labor on this channel before. We’ve also talked about many other things relative to the building of houses, remodeling, and all of that. But what we haven’t talked much about yet are the materials. We also need to talk about materials, not just for homes and all that, but the supply chain of materials in general across the economy.
Consider cars, for example. There had been a shortage of microchips. Moreover, the whole supply chain got disrupted for several COVID-related and non-COVID-related reasons. Because of all of that, used cars are now 30% more expensive than they were.
Also, I’ve talked to some people looking at used cars. What they are saying is that they’re selling over their original MSRP with 50,000 miles on them. That’s a supply and demand issue. In principle, when the supply chain opens back up and things start flowing normally, that should change things and they should go back to a more normal flow. And, as a result, keep inflation, spending, and prices at a normal level moving forward.
Another thing that is definitely on the minds of many people, especially locally, including myself, is affordability. When you look at, sort of, on a national level, the affordability ratio is somewhere between 20% and 40%. That is, 20% to 40% of your income is spent on housing. That is pretty much the standard and what most people expect. Then, when you look at California, and definitely in the Bay Area, the average is well in the 50–55% range. Historically, that’s when you start to max out. It becomes sort of a breaking point when a buyer can no longer spend less than 50% of their income on their housing.
At a certain point, people will stop spending money. And we’re there. We’re at that level. Thus, it’s reasonable to assume that people will not continue to push that metric up from now on. They will not have up to 60–70% of their household income going to housing. And so you have to assume some things going forward.
For example, unless interest rates drop further, it’s unlikely they will continue to increase prices the way they have been. We’re at a point at which it just doesn’t make sense. Nationally and in the Bay Area, housing prices have exceeded wage increases over the last year and a half, at a much, much faster rate. So that affordability becomes a tighter squeeze for people. Eventually, everyone has a breaking point, ultimately. And I think we’re getting there on a price percentage basis.
Keep in mind that interest rates will continue to go up. Thus, the leverage on the money you have saved for a downpayment shrinks a little bit. Hence, your ultimate purchase price shrinks as well. So when you roll in the affordability, the interest on mortgages, and how much leverage you can sustain, it’s a recipe for prices to remain flat or potentially take a step backward. This may or may not have a significant impact on the housing market. However, all signs point to it not going up and up.
However, all these numbers don’t necessarily mean the market is going to crash. We could remain flat. We could have low 1%-3% growth year-over-year for the next few years instead of the 7%-10% nationally. Sometimes it is 20%-30% given a certain market we’ve experienced, especially when you consider building.
There’s a lot of construction starting to happen, especially in some of these major metros. Even here locally, I see a fair number of cranes in the air. I was just on vacation in Seattle when I saw a ton of cranes in the air. So, as the supply chain re-establishes itself, as the cost of lumber, materials, copper pipes, and all of those sorts of things come back to a normal level, construction, in principle, should continue. People should be able to continue to build and create more units. Granted, we are hellishly behind on household formation versus unit creation. This is also the reason why we have such a housing deficit.
If you get more supply, and buying power shrinks a little bit, that will start to equalize and bring prices down from a high, high level to a more normal level.
That’s kind of what I’m seeing. And I think, over the next couple of years, the frenzy isn’t going to exist in the same way. Overbidding and the crazy escalation clauses are probably going to start going away. Things that people are putting in or these ridiculously high preemptive offers in mass will probably stop. Now, that doesn’t mean there won’t be houses that sell for well over the asking price. There would still be those houses that would sell for a crazy, ridiculous price per square foot. But what it does mean is that the market will probably cool in general.
What does all this mean for you if you're considering hopping into the market?
The market will probably take a softer approach over the next couple of years. Of course, several factors could still easily change that. But based on what I’m seeing, reading, and experiencing here locally, that is my prediction. That’s what I think will happen.
Therefore, if you’re considering hopping into the market, that doesn’t mean you’re necessarily going to lose a bunch of money on your house. It doesn’t mean you’re going to get a screaming deal all of a sudden. However, it does mean that you may not have to continue climbing over every comp every time. You may not have to do that anymore every time something comes on and beat it to succeed. You might just be flat at the neighborhood’s dollar per square foot average and be successful there. That’s my hope. That’s what I’m starting to think will happen. But, we’ll see.
I hope my Market Update on the "High Inflation, Disrupted Supply Chain, Low Affordability, and Low Interest Rates--Where exactly are we going?" has helped you.
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Here’s to all your success!