(Disclaimer: The content of this article is not intended as financial or investment advice but rather information for educational purposes only.)
This article is based on the episode of the Building Equity podcast “Economist Explains the TRUTH about 2023 Housing Market Crash! | US Economy + Real Estate Break Down” with guest Simon Caron of the Uneducated Economist YouTube Channel, available on YouTube right now. Click here to watch the episode. Check out Simon Caron’s channel here.
For 2023, there are many questions surrounding the housing market. Pundits and economic experts range in their suggestions; factors such as inflation and low housing inventory are used liberally to espouse either an anticipated crash or correction. While the industry is shrouded in uncertainty and worried investors continue to sit on the sidelines, it’s also important to consider that a record high number of investors who bought properties from 2009 to 2015 with self-directed IRAs have sold those properties in the last several months.
This means that while many have missed out on opportunities, there’s also a substantial number of investors who have capitalized, harvesting profits that have flowed back into their tax-free self-directed retirement plans. As we navigate through a high-inflationary environment, it’s more imperative than ever for investors to deploy their capital in meaningful ways.
Looking at the Price of Lumber to Predict What’s Next for the Housing Market
To get a better understanding of micro- and macroeconomics and its impact on the housing market as well as foresight on the upcoming year, perhaps one of the best examples of a commodity experiencing similar unpredictable fluctuations in recent years is lumber. Starting with a rise prior to the 2020 pandemic, the price of lumber peaked at $1,700 per thousand board feet in May of 2021, surging over 50% in a year. While there were indications in late 2019 of an impending rise in price with mill closures, mill curtailments, and overall inventory depletions, all signs pointed to a supply chain breakdown as the major impetus and not so much the Fed printing more money, even though they went from $850 billion on their balance sheet to $4.3 trillion.
Entering the pandemic, we saw the price of lumber start to shoot up. After people started spending their stimulus checks on lumber to build new decks, fences, and remodel their homes, there was a sharp depletion in inventory, very much like the low inventory rates seen in the housing market. As a response to the sharp decline in lumber inventory, mills began firing up, pumping out loads of lumber, only to see the price dip back down to $400 per thousand and then back up to $800 as the industry attempted to keep up with supply and demand. With lumber production being a multi-faceted operation, it’s difficult to see where the demand should be according to the inventory levels.
Areas across the U.S. are seeing inconsistency with lumber inventory as some pockets are adequately supplied while others are not. Until inventory can be fulfilled evenly across the country, it’s expected that these fluctuations in prices will continue before an equilibrium is found.
Now juxtaposing the housing market with the lumber industry, you’ll see a similar trajectory as the demand for homes increased; we witnessed a huge jump in home prices, which also started climbing as the 2020 pandemic ensued, reaching epic rates into 2022. But as mortgage rates continue to rise and builder sentiment falls, just as the price of lumber starts to come down, the cost of homes will follow, creating a more opportunistic landscape for investors in the real estate industry.
Signs of a Housing Correction, Not a Crash
With builder sentiment falling and existing home sales down around 15% compared to last year, there’s major concern regarding the future of the housing market. Many builders do not wish to get stuck on a project that will result in selling for less as construction costs rise, which can then contribute to low inventory rates. Most speculate that this overall disposition indicates a looming crash, but the most critical component of a pending crash is an increase in foreclosures. For foreclosures to take place, the economy would have to see a rise in unemployment, which would be a major catalyst for people being unable to make mortgage payments. But even in the current economy with talk of a pending recession, we are not seeing a rise in unemployment, which is currently at 3.5%, nor are we experiencing a jump in foreclosures. Foreclosures in general are still relatively low.
A more realistic outcome for the future of the housing market would be a downturn in home prices. Homes that saw an increase in price of over $100,000 this past year could see their purchase tag reduced by $60-$70,000, which theoretically wouldn’t be a crash but more of a return to normal. Even with a third of homes being purchased by all cash buyers, as mortgage rates teeter around 7%, it’s reasonable to believe buyers will be deterred, resulting in the eventual reduction in home prices. Especially since mortgage rates are no longer increasing at the exponential rate as they were before, it’s more likely to estimate that a reduction in house prices is inevitable, pointing to an eventual housing market correction.
The Federal Reserve’s Role in the Housing Market
One of the key strategies implemented during the financial crisis of 2007 to 2009 and the start of the 2020 pandemic was called quantitative easing. The Fed purchased longer-term securities on the open market, including U.S. Treasuries and mortgage-back bonds. The perfect metaphor for a mortgage-backed security is if a bunch of mortgages are thrown into a box and that box is sold off to an investor; everybody’s paying their mortgages and the investor receives the capital investment back plus interest. Because this practice nets significant profits, the Fed created a huge demand in the market for these types of securities, given that it’s guaranteed a buyer and there aren’t concerns about who to sell to. This results in the mortgage rates climbing, security prices falling, and the yields rising, which increases overall mortgage payments due to the interest rate jump.
These mortgage-backed securities (MBS) are not the toxic asset that they once were; there was a time when people received these mortgages when they really shouldn’t have: either they didn’t have a job, any viable income, or they owned more than one property. Today, these borrowers are much more qualified, making these types of investments much safer.
The Federal Reserve’s Impact on Inflation
As the Fed influences interest rates, they also seek to control inflation by raising rates to slow the economy and bring inflation down. Beginning in 2018, the Fed began looking to set an average inflation rate. The biggest misconception surrounds the 2% target; many confuse the 2% average inflation rate with a 2% target rate. It’s anticipated that we will see interest rates low when they shouldn’t be, and we will also see them high when they probably shouldn’t be as well. But it’s a 2% target inflation rate over time, meaning that monetary policy can be adjusted to a lower or higher rate, but over time, the Fed is still aiming for that 2% average inflation rate.
Interest rates were artificially low for a significant amount of time, causing asset prices to rise dramatically, like the housing prices. This practice is carried out so when prices do drop or when interest rates rise, the Fed can bring those asset prices back down to where they should have been prior to the artificially restricted interest rates to control inflation.
Based on this information, it’s plausible to believe we’re going to see interest rates stay elevated for a longer than anticipated amount of time. Even after the inflation comes down, the interest rates will stay high to achieve the average inflation rate of 2%.
Smart Investing in a High Inflationary Environment
As interest rates continue to tick upwards and inflation weighs on the economy, the pressure is on investors to make heathy, safe investments. Many people are still cautious, waiting for a good opportunity to deploy their capital, whether it’s in stocks or real estate. The most challenging aspect for investors is knowing when to engage, finding the right entry point into any market. It may seem like the safest option is to save your dollars, especially since the U.S Dollar Index is the highest it has been in 20 years, but holding onto money over time results in erosion, reducing purchasing power. It’s not unreasonable to predict a deflation scenario as the demand for dollars could explode. On the contrary, it’s also not irrational to predict that over time the dollar could completely lose its value; either way, investing right now is the smartest thing to do.
One of the benefits of a real estate investment over others, like a stock at $100, is having control of your investment strategy. With real estate, chances are if you have a good tenant, you’ll be getting paid over the next few months. And even if you purchased recently, over time, you’ll be able to increase rent which changes the financials of your return on investment, allowing you to stretch your money even further. Whether it’s high yield mortgage-backed securities or simply a rental property, it’s more imperative than ever for investors to get into the game and deploy their money for long-term gains.
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