“The secret of health for both mind and body is not to mourn for the past, worry about the future, or anticipate troubles, but to live in the present moment wisely and earnestly.”
We selected this expression as we believe it represents the mindset that we wish to embody as we close out 2022 and look ahead towards the New Year. The last few months have been filled with adjustments and uncertainty, asking many of us to reflect on our lives and how we go about our day. In recent years we have been blessed with an abundance of prosperity and as the markets have reflected a turn we often find ourselves regrounding in what it is that we truly value.
In March of this year the Federal Reserve, after admitting that inflation was not transitory, began increasing interest rates. While inevitable and widely anticipated as rates were at historic lows, many did not anticipate the fastest rate hike cycle in nearly 40 years.
In November, Fed Chair Powell was quoted signaling smaller increases, “It makes sense to moderate the pace of our rate increases as we approach the level of restraint that will be sufficient to bring inflation down.” So with a recent 50 bps increase in December we finish 2022 around 4.50% at the upper bounds of the Federal Funds. During the December meeting Powell hinted at what is to come in 2023, “I wouldn’t see us considering rate cuts until the Committee is confident it sees inflation moving down towards 2%.” So higher for longer appears to be the message moving forward. The consensus is three projected rate hikes of 25 bps each over the first few months of 2023. This peak of 5% - 5.25% (30-yr fix rate at ~7%) is likely to remain in effect for most of 2023 and before we see any signs of a downward trend.
Although this reduction in the pace of increases is a positive sign for the real estate market, borrowing costs have not been this high since 2008. As a result we have seen lenders revert to creative financing solutions like 2-1 Buydowns or in some cases 3-2-1 Buydowns. These upfront costs are often paid for by sellers to incentivize buyers to pay more and thereby reducing the Bid-Ask Spread found in today’s market. In exchange, assuming a 2-1 Buydown, the borrower will receive a 2% reduction in rate the first year and a 1% reduction in the second year. After which borrowers will look to refinance 24-36 months from closing, as rates are expected to be lower than they are now.
Despite this rapid rise in borrowing costs we have not seen home prices reflect the same trend line in the Bay Area. This is largely due to inventory constraints both in new development as well as resale. For perspective, year over year (YoY) transaction volume is down 47% but the average sale price is only down 7.3% YoY (Santa Clara County SFR). Developers are dealing with rising construction costs and tight margins, while existing homeowners are succumbing to “The Lock-in Effect.” Nationally 73% of outstanding mortgages are locked in at rates below 4% and 40% of homes are without a mortgage all together. Homeowners are not incentivized to sell as it means the replacement home is likely more money at a higher rate.
So, is it a housing bubble or a market correction? Are we seeing the effects of quantitative tightening and the end of an artificially stimulated economy or a crash? Is it 2008 all over again? In my professional opinion, we have seen evidence of a compression as the Feds have adjusted their fiscal policy but I do not believe we will see a crash next year. The nation has the strongest credit profile of all time amongst borrowers, this is the result of post 2008 changes to lending requirements. The average credit score is between 776-788 for existing borrowers. With a decade of equity growth the average Loan to Value ratio (LTV) for existing home loans is 42% and keep in mind 40% of homes don't even have a mortgage. This equates to $11.5 trillion dollars of tappable equity, tappable equity being the amount of money a homeowner can extract from their residence without dipping below 20%. This equity position is the highest on record and when combined with the number of millennials reaching peak household formation years, I don’t see where a forced mass sell off would stem from systematically.
Building off Millennials, the US population has more 30-35 year olds than ever before. This is considered the peak household formation period and typically when people start to purchase their first homes. We saw the effects of this over the last two years as interest rates were a catalyst to a large first time home buyer demographic, motivating many to make that commitment. Millennials are also looking to inherit the largest transfer of wealth ever seen - The Great Wealth Transfer - 72 Trillion dollars will be transferred from US Boomers to Millennials over the next 25 years. This equates to nearly one seventh of the world's assets. This transfer will likely be the engine behind the market demand for the next two decades. If you would like to discuss estate planning or Proposition 19 with one of our strategic partners, please let us know. Estate planning will play a large role in wealth preservation as the Boomer generation faces the rising costs of long-term health care and inheritance tax.
As we look ahead to Q1 and Q2 we do expect local inventory levels to rise marginally as we return to a more traditional, seasonal market. This will likely produce one of two outcomes. The first leaning on the textbook understanding of supply and demand. When mortgage rates rise, we may see demand continue to taper. Simultaneously as we approach spring, historically, we will see the greatest amount of inventory (new listings) for the year. With demand down and supply up we could see the average sales price drop. The second plausible outcome is more a function of emotion and macroeconomics. With limited new supply and the holiday season we have seen a number of our buyer clients prioritize family and friends over their home search. Starting in January we may see a refocused buyer pool, complimented by more options. In conjunction with international uncertainty as foreign economies battle their own fiscal policy and rapid inflation. During these times we often see the dollar and US real estate become a safe haven for international investors, especially in places like the Silicon Valley. As a result, increasing the number of transactions and possibly average sales price with more multiple offer situations.
If you are looking to purchase a home this New Year it may be a good time to refocus your search and an opportunity to get ahead of competition. Reconnect with your lender about creative solutions, let us know if you need an introduction. Rates are unlikely to fall in the near future as history tells us we are approaching normalcy whereas the past few years will be referred to as an era of exceptionally low rates. As for supply we are not forecasting a mass sell off so be patient. The new year will certainly bring new opportunities.
If you are a seller who is looking out into Q1-Q2 of the New Year, reach out to us regarding local inventory levels. Rates will be at the forefront of all your favorite news outlets but inventory may prove to be the most impactful variable moving forward. As buyers show more constraint, pre-market preparation also becomes a vocal point. Let’s make sure every dollar invested provides the return you are looking for in this market. We anticipate activity to trend upward the first half of the year as inventory increases, but as we approach Q4 2023 we suspect any appreciation gained in the year will be nominal at best.
We are incredibly excited for the New Year and have an immense amount of appreciation for all of your recent support with our transition to Christie’s International Real Estate - Sereno.