There are few things more enjoyable than a warm blue sky day after a week of rain. I tend to find myself in a good mood, excited about everything that comes with warmer weather and longer days. Spring and Fall are often referred to as transition seasons, with Spring being the awakening period. The housing market tends to follow a similar seasonal pattern.
These are the topics I would like to discuss today.
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Interest Rates
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Supply Levels
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Update on Commercial Real Estate & Bank Term Funding Program
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Where do we go from here?
Interest Rates
On January 1, 2024, the 30-year fixed mortgage rate was at 6.62%. However, the last three months have shown hotter than expected inflation prints and as a result mortgage rates adjusted upwards. The average 30-year fixed-rate mortgage was reported at 7.29% on April 10th (Mortgage New Daily)​. Mortgage experts predict that mortgage rates in coming weeks will likely settle back down in the high 6’s.
Here is a quote from Powell during his March Fed meeting that summarizes their outlook on the first quarter, “The story is really essentially the same, and that is of inflation coming down gradually on a sometimes bumpy path. We’ve got 9 months of 2.5% inflation now and we’ve had two months of bumpy inflation. The question is are they more than bumps? We can’t know that and that’s why we are approaching this question carefully.”
Following the March inflation report, there's been a noticeable dialing back of enthusiasm in the markets, which had previously surged in response to a perceived shift in the Federal Reserve's stance at the previous year's end. At that juncture, the markets had forecasted a 60% likelihood of an initial rate reduction occurring in March, along with a near certainty of at least one cut by June. Yet, March has passed without any rate reduction, and the previously anticipated June cut now seems far from certain. Despite these developments, the Federal Reserve has consistently maintained its forecast of three rate cuts in 2024 (US Today).
I always risk being a pessimist but here it goes. Some interesting counterpoints to the soft landing, strong economy narrative, specifically around the labor market.
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Assuming Pre Pandemic labor participation, unemployment is already over 5%. This is compared to the headline rate of 3.8%.
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In February job creation skewed toward part-time positions. Full-time jobs decreased by 187,000 while part-time employment rose by 51,000, according to the household survey (CNBC). March gains also tilted heavily to part-time workers. Full-time workers fell by 6,000, while part-timers increased by 691,000. Multiple job holders rose by 217,000 (CNBC)
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As of February 2024, full-time employment accounted for 82.6% of all employment in the US, which is the lowest level since October 2020 (Advisor Perspectives).
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Consumer Credit Card delinquency soars past $1 Trillion, most with 20%+ APR (Business Insider).
Supply levels
Inventory has completely taken over the narrative in recent months as markets all over the country struggle to keep up with demand. The Bay Area is no exception, but as seasonal norms return to the marketplace we have been fortunate to experience a healthy uptick in supply levels over the last few months.
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New Listing/Mo |
2023 |
2024 |
Delta ∆ |
|
January |
498 |
581 |
16.67% |
|
February |
645 |
800 |
24.03% |
|
March |
827 |
1,052 |
27.21% |
*MLS data provided | Single Family Homes | Santa Clara County
For perspective in 2021 & 2022 we had over 1,350 new listings in the month of March (30% increase from current year). However we are now within 10-15% of pre-pandemic averages, a positive sign for buyers. The stock market recently closed at an all time high and many buyers have come to terms with the new norm with respect to mortgage rates, as a result our local buyer demographic has been very active. The market has rebounded significantly and sales prices continue to trend upwards towards 2022 highs.
|
Median Sales Price ($) |
2023 |
2024 |
Delta ∆ |
|
January |
$1,500,000 |
$1,700,000 |
13.3% |
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February |
$1,475,000 |
$1,800,000 |
22.03% |
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March |
$1,670,000 |
$1,900,000 |
13.77% |
*MLS data provided | Single Family Homes | Santa Clara County
With February of 2023 closings representing a bit of an exception to the trend last year, prices are currently appreciating at 13% YoY. All of this while mortgage rates remain steady in the mid to high 6% range.
So what happens when we see 2-3 rate cuts and mortgage rates fall below 6%?
Update on Commercial Real Estate
As discussed in greater detail in previous Pulpan Brothers Group newsletters, a large portion of commercial real estate debt is held at the regional bank or small bank level. This figure is reported to be close to 40% or $1.9 trillion of the $5 trillion total outstanding commercial debt. I bring this up often for a number of reasons. The first being media headlines that group the commercial real estate market with residential. However similar their fundamentals, the challenges they each face today are drastically different. The post-covid world has placed a spotlight on homeownership while the commercial sector is facing challenges with rezoning and office space where vacancy rates have reached upwards of 40% in areas like San Francisco (Globalist).
With over $1 trillion in commercial debt set to mature this year banks are facing decisions around restructuring at significant discounts. There is a phrase in the lending industry called “Pretend and Extend,” by refusing to write down distressed underwater mortgages and giving business borrowers extra time to repay their loans, banks “extend” their inevitable losses by “pretending” everything is fine and ignoring short-term valuations (Nasdaq). This will surely buy the industry time to see if business owners can revitalize these buildings to pre pandemic rent & vacancy levels. However, only time will tell…
Update on The Bank Term Funding Program
This is also a follow up to a topic we discussed in greater detail in an earlier campaign. This Bank Term Funding Program (BTFP) was established in March of 2023 by the Federal Reserve to support American businesses and households by providing additional funding to eligible depository institutions, ensuring banks could meet depositor needs. As you’ll remember this was shortly after the collapse of Silvergate, Silicon Valley Bank and First Republic Bank, three of the four largest bank failures in U.S. History.
By its conclusion on March 11, 2024, BTFP loaned out approximately $160 billion, with these loans set to mature in a year. The identities of the borrowing banks remain confidential, and surprisingly, there's been minimal media coverage on this (Reuters).
A notable aspect of the BTFP was the exploitation of an arbitrage opportunity by financial institutions in January of this year. They capitalized on the difference between the BTFP's lower loan rates and the higher interest rates the Fed paid on reserve balances. Essentially, banks borrowed cheaply through the BTFP and parked these funds as reserves with the Fed, profiting from the rate disparity with minimal risk. This resulted in a sudden $45 billion increase in the balance sheet shortly before the Fed decided to close the program.
The good news is that banks seem to be paying it back! (FRED Economic Data)
So where do we go from here?
This is a challenging question and one I don’t pretend to know the answer to but I find our current moment in time to be as interesting as any. We have a resilient housing market driven by the simple fundamentals of supply and demand. If interest rates trend downward, as expected, I believe we will see an increase in buyer demand and with that will come more appreciation. However, with prices already nearing 2022 peaks, I don't see how our current trendline continues without some help on the mortgage rate side. I came across this example the other day and figured I would share (these are on national averages).
From 2002 to 2022, upgrading to a 25% more expensive home would have required the average homeowner to increase their monthly principal and interest payment by 40%.
Today, that same Trade-up buyer’s payment would increase an average of 103%. This highlights the real world pressure keeping current mortgage holders “locked” into their homes.
Simply giving up their current rate to move across the street to an equivalently priced home in today's market would result in a nearly 40% increase in principle and interest, roughly as much as the historical Trade-up cost.
I do believe we will continue to see higher density housing developments (condominiums/townhomes) trend at lower YoY rates when compared to single family homes. This has to do with new higher density inventory coming to market, whereas building new single family homes at scale is just not feasible. For perspective, condominiums and townhomes have only appreciated ~5% YoY (MLS data) compared to the 13%, as depicted above, for single family homes.
Last year prices peaked in August due to an exceptionally harsh winter. This year Punxsutawney Phil didn't see his shadow, meaning early spring and I think he’s got it right. We’ll see prices peak earlier this year before leveling off towards year end.
Happy Spring!
