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SHOW NOTES FOR EPISODE 630: HOW TO PREPARE FOR A HOUSING MARKET CORRECTION
It’s not a matter of if but when the housing market will correct or even crash! But what does that mean for real estate investors and what can you do to prepare and leverage when it does happen? In this episode, Bill shares both the risks involved and opportunities available for savvy investors who are well prepared.
Introduction
Recently a group of 5 economists were surveyed by MarketWatch to get their take on how they predict the summer housing market sales might go.
Seasonally, we’re at the point in the year where we tend to see peak home prices, says Danielle Hale, Realtor.com chief economist. “There are a variety of reasons for this, including the fact that a lot of the homes for sale and sold at this time of year are larger, family homes,” says Hale. What’s more, she says while listing prices have shown acceleration or a faster rate of growth, in recent weeks, sales prices have seen steadiness or slight easing in momentum. “This suggests that home prices could be at a bit of a turning point, in which slower growth is on the horizon,” says Hale.
More listings are getting price cuts
Data from real estate listing site Redfin, released in May, found that nearly one in five home sellers had dropped their price, the highest rate (of price reductions) since October 2019. And Zillow economist Nicole Bachaud says faint signs are starting to emerge that the market is rebalancing. “The share of listings with a price cut is creeping up, possibly a sign that sellers cannot be quite as ambitious in their pricing strategy as they could have in recent months. Inventory continues to rise as well, though it’s still significantly lower than pre-pandemic norms,” says Bachaud.
Greg McBride, chief financial analyst at Bankrate, says: “The market will cool somewhat as more would-be homebuyers have been priced out by rising home prices and soaring mortgage rates, but even a tempered level of demand will still exceed the ultra-low level of supply. The pace of home price appreciation will moderate but homes will still be selling for much more than they did six or 12 months ago, even if sellers don’t get the moonshot price they’re currently asking.”
And Bachaud also thinks price growth will start to slow — but not yet. “Homes are selling as fast as they ever have, after only seven days for the typical home and nearly half of homes are selling for above their list price,” says Bachaud.
Prepare for inventory changes
Bachaud goes on to say a more balanced market is likely around the corner as rising costs may keep enough would-be buyers on the sidelines, allowing inventory to begin catching up with demand.
Steve Reich, chief operating officer at Finance of America Mortgage, says seasonality definitely comes into play as spring and early summer are typically prime-buying windows for families looking to get a larger home or relocate while kids are out of school. “As a result, more inventory may come on the market,” says Reich.
That said, buyers wanting a new construction home may find a challenge, Reich says: “The potential for prolonged inflation and increased prices across the board will likely trickle down into higher costs for new construction and make it more expensive to bring new builds to market, further complicating the housing supply,” says Reich.
Buyer demand has softened
MarketWatch recently reported, pending home sales fell for the sixth straight month in April, thanks to high home prices and increasing mortgage rates. And Redfin reported that searches on Google for “homes for sale” for the week ending May 21 were down 13% from a year prior. “Right now, as the market tries to settle in at higher rate levels, buyer demand has gradually softened as consumers assess what their affordability looks like. Both buyers and sellers have moved to the sidelines to see where the dust settles, which is fairly common in periods of high volatility and uncertainty. This is definitely a wait and see moment,” says Robert Heck, vice president of mortgage at online mortgage marketplace Morty.
So, is this a precursor to a market correction? And if so, are you prepared to take adavance of the opportunity and/or mitigate your risk?
Risks and opportunities are both present in housing market corrections. Here are some steps you might want to consider.
There’s been a growing concern about a housing market correction after two years of record home price appreciation, during which the median national home price increased by 34%. It appears that correction is finally here. Home sales and mortgage applications for April and May are down considerably, while newly listed homes have risen rapidly as property owners try to capture home price gains before the market turns.
But there’s good news! The start of a housing market correction is the perfect time for investors to prepare for what could be coming.
First things first: A correction is not a crash
A housing correction is not the same thing as a housing market crash. During a correction, home prices return to more normalized levels of buying and selling. They don’t fall suddenly and dramatically as they would in a crash. In other words, things balance out. In today’s market, that translates into slower home price growth and possibly longer time on the market.
Properties that were listed for top dollar, banking on continued market competition and limited supply, will likely see fewer offers. Some sellers may even have to lower the asking price to meet more realistic pricing, although not every market will see the same rate of slowing or price decreases as others. It all depends on the cause of the demand and lack of supply that drove prices up in the first place.
Save your money
Real estate market corrections are a great time for investors to stock up on real estate while prices are down. Lower purchase prices mean greater opportunities for higher returns. However, with interest rates rising, the cost of borrowing gets more expensive, and lower purchase prices may not directly translate into better returns. Having the cash to buy properties without borrowing money could mean you seize opportunities that others cannot.
Reduce your leverage
Housing market corrections are not necessarily synonymous with recessions. For instance, during the COVID-related economic downturn of mid-2020, housing prices soared. This time around, however, there are a lot of signs that housing prices could drop while the economy shrinks.
During recessions, economic spending slows. Rental rates and real estate values often fall as demand lessens. This can cause properties that were once well-performing to garner less-than-ideal returns or even negative cash flows during the slow period.
It’s a good idea to have some money saved to cover any losses incurred during this time, but it’s equally important to make sure you’re not overleveraged. Being overleveraged in your investments means you don’t have enough income or cash flow to cover the property in the event that it stops paying, even temporarily. If you recently took out a line of credit and your margins for profitability have thinned, it could be a good idea to sell the property now while prices are high to reduce your debt exposure.
Hold for the long term, sell what isn’t profitable
Buying low and selling high is one of the cornerstone principles of profitable investing, but selling real estate when its high isn’t always the best move. Cash flow is one of the major benefits of real estate investing. Even if the value of your property has declined, it doesn’t mean your return has declined. If you have a strong cash-flowing property that is netting a good return, holding on to the investment for the long term can offer protection during tough times and combat high inflationary periods like those we’re experiencing today.
Tax deductions from depreciation and certain property expenses are another benefit that should be seriously considered before jumping the gun and selling while prices are high. When you sell a property, not only do you give up any cash flow the property was generating, but you also have to pay capital gains on any profit earned from the sale in addition to recapturing all of your prior deprecation. Those who have seen values rise upwards of 40% over the last year could be left with a hefty tax bill at the end of the day.
I recommend evaluating your portfolio and to only consider selling properties that aren’t performing well or could be at risk for default if the market were to worsen. If the property doesn’t produce cash flow as-is, it could be beneficial to sell now and save the money to reinvest in more affordable properties with higher returns as the market corrects itself down the line. Prices may sink for a bit in a housing market correction, but if you take a long-term approach to your investment and focus on the value it brings with income and tax benefits over the value of the property itself, riding through a market correction will be a breeze.
References:
https://www.fool.com/investing/2022/06/02/housing-market-correction-how-real-estate-investor/
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