Original Article Date: April 12, 2022
The real estate market is currently in choppy waters due to rapid interest rate. In the past two months, we have witnessed rates rise 200 bps. As a result, monthly payments are close to 20% higher than 2 months ago. Speculative activity is getting curtailed, some types of homes are not getting over bid, and sellers are getting spooked with builders listing half built homes to take advantage of peak prices. Demand is still strong, but affordability is severely hit and it will take a couple of months for the ship to steady. As always, we plan on using a disciplined approach to evaluate the cash flow of any deal before moving forward.
Some examples of how market is evolving:
1. Builders are panicking and listing half built homes and presale homes
to take advantage of a potential peak in prices. If you are looking to buy these, remember that you may lock in the list price, but your interest rate will only be locked a few months down the line (or you pay obscenely high rate locks). Be wary of pre-sales as you may be paying an arm and leg in monthly payments with no certainty on home values.
2. The most undesirable homes, (eg., HOA) homes, are getting stuck on market.
HOA homes are generally not favored with seasoned investors due to restrictions on rentability etc. These homes are finally starting to see low traction even on East-side. In the middle image is a townhome by Pulte homes. A similar townhome by the same builder in same community got bid to $1.25M+ two months ago. Now the same home has been on market for 24 days at $1.1M. Lastly, even single family homes with low HOA $s are not spared as investors continue to avoid these (refer to third image below).
3. The high end of the market is seeing the most impact,
anything below average sales price for that market is getting a lot of touring still as that's the only thing Buyers can afford. Even desirable Bellevue homes are getting low bids, Sellers are obviously pissed and raising prices closer to what they want to sell for. I suspect listing price is going to start more accurately reflecting sales price going forward.
Q. I understand interest rate, but why is this happening on a microeconomic level?
On demand side, demand is split into four different sides, and each is acting differently:
1. Primary home buyer: These folks were rushing two months ago to buy to take advantage of low interest rates of 3%, now that rates are closer to 4.5-5%, their monthly payments are bloated by 15-20%, and hence budgets that were already stretched cannot afford to bid anymore. The same $1M home is close to $5200 of monthly payment, instead of $4000 that buyers a few months ago were getting.
2. Speculative investor looking to gain in appreciation but home doesn't cash flow: These folks were already in pretty bad shape since the underlying asset wasn't even covering their liabilities, now that the market is turning around, a lot of speculative activity is getting curtailed as they don't want to risk buying at peak.
3. Cash flow investor: These investors were disciplined when making offers. They were buying 6 CAP properties at a 3% interest rate, effectively arbitraging the difference. Now those 6 CAP properties are not profitable with a 5.5% interest rate, hence they are waiting it out for deals.
4. All cash buyer: The true all cash buyer (not the pseudo all cash flyhome buyer who still has to pay for mortgage) is only roughly 6% of the market, which comprises of mostly foreign investors (a lot from China). These are not as impacted but since their demand is pretty low, and borders are still closed from China, activity is curtailed till later half of year when China finally opens up.
On supply side,the market is effectively split into two:
1. Builders (New home sales): Builders holding costs are spiking up due to rate rise , and they are concerned about a potential peak in prices. A lot of builders are starting to opt to sell their home in whatever the current condition is (half-built, pre-sale, unstaged), and lock in prices, and have Buyer ultimately take the risk of interest rates
2. Home resales: Typically we see a seasonality in which home sales are peak during summer, when school year ends and families are the most comfortable moving. Winter time is usually a low season. This side of the market has been relatively really tight as families didn't have to move due to WFH etc. Now that offices are opening, we are starting to see some more deferred moves finally taking place. Sellers who are listing right now are starting to get divided into two big buckets:
- Rushed folks: These folks are starting to see market is not as frothy as before, and trying to rush to sell to take advantage of good prices right now.
- The deniers: who are adamant their home is worth $XX because their neighbor sold for that three months ago. Their original strategy was to list low and get a lot of interest for a bidding war. Now that some of that strategy is not working, they are shifting strategy to list it at the price they want to sell for.
Q. How do you get all this information?
We are local investors/agents working with buyers and speaking with sellers constantly and see these trends both anecdotally and through MLS numbers we pull.
Q. What about a further interest rate rise as Feds raise rates?
Markets are supposed to be efficient, and 30 year bond prices are supposed to priced for a 30 year range, instead of a short-term 1 year horizon. What that means, given all the current information, the interest rates are priced efficiently at the 4.5-5% mark for primary buyers. Can this change? Yes, if new information arises, rates might fluctuate more.
For any deals you undertake right now, make sure your economics work with even a 5%+ interest rate before you plunge in.
In case of any questions, or comments, please feel free to contact us at firstname.lastname@example.org and we will be happy to discuss your specific situation.