Signs, signs, everywhere signs (of the real estate market)

“Signs, signs, everywhere signs, 
blockin' out the scenery, 
breakin' my mind
Do this, don't do that, 
can't you read the signs?”

So goes the old 1970s song originally by Five Man Electric Band but redone by Sacramento's own Tesla in 1990. Those lyrics certainly still apply not only to highway billboards and guide posts along old country roads, but also signs of things to come in just about every aspect of the economy. In fact, there are signs we can look for that will tell us if the market is on the rise or ready for a slight decline; a seller’s or a buyer’s market.

Of course, home sales don’t act in a vacuum and things never line up perfectly, so some cities or regions may show several conflicting signs at the same time. But, in general, by tracking certain telltale data, we can see trends in the real estate market and know when it’s a smart time buy, sell, or invest.

Signs of a hot (sellers) market:

1. Buyer demand is high, especially in the starter and mid-price ranges.

2. At the same time, housing inventory is low, feeding demand.

3. Based on that combination, sales keep closing at steadily rising prices.

4. Houses don’t stay for sale long, with Days on Market low and dropping.

5. The volume of home sales is higher than average and increasing.

6. You’ll see multiple and competing offers on many listings.

7. Sellers offer few amenities, credits, or incentives to buyers.

8. You see few price reductions, as home usually sell at or above asking price.

9. Realtors see a lot of traffic on their listings, including on-line and in-person visits.

10. In fact, the release of new listings are often an event unto themselves!

Signs of a cooling (buyers) market:

1. Unlike a seller’s market, you’ll actually see increases in the housing inventory available.

2. The Days on Market climbs steadily as homes don’t sell nearly as quickly.

3. Even when priced right, sellers see fewer offers on their listings, and far less bidding wars or competing offers.

4. Listings get less online and in-person views, and there is far less traffic at open houses.

5. Increasingly-desperate sellers start reducing prices at a greater rate.

6. They also start offering more incentives and credits to attract and appease potential buyers.

7. Bucking the trend of ever-escalating prices, new listings are priced at the level of recent closed sales or even lower.

8. Homes also sell for a smaller percentage of their original list price.

9. Due to decreasing demand, the volume of sales starts to lag.

10. Real estate ads get bigger, louder, and more extravagant!

Like we mentioned, these are just signs that point to a destination, but there are many stops along the way. Somewhere in between a white-hot seller’s market with fast-climbing prices and a stagnant buyer’s market with price declines sits many degrees of more balanced markets.

Here are some signs of a balanced or neutral market:

1. Inventory levels are normal compared to previous years.

2. There is no excess or surplus of housing inventory, with three to six months active inventory considered a normal range.

3. New listings are priced at or near prices of recently closed listings.

4. Sales volume is consistent and typical with the same season in previous years.

5. Median sales prices have stabilized, which can mean a normal negative or positive range with no huge spikes or valleys in prices.

6. Homes that are priced correctly sell within a typical 30 to 60 days, but Days on Market aren’t abnormally high or low.

7. Real estate ads (and blogs!) are a little smaller and less loud again!

Of course, Sacramento is in an extremely hot seller’s market right now, with a huge inventory crunch, rampant demand following redevelopment in the region, low interest rates, steep competition for buyers, and rising equity for sellers and homeowners.

But in the coming months and years as the market goes through normal and healthy seasonal and market corrections, you’ll be able to identify some of the signs along the way!

According to historical market cycles, when will the next real estate crash occur? (Hint: not for a long time!)

Imagine if you had sold all of your real estate in 2007, right before the historic crash? Understanding the predictable phases of every real estate cycle can empower the average person to make incredibly prescient decisions about their real estate far ahead of the curve, cashing in when others are losing money.

In part one of this blog, we outlined the first two phases of every real estate cycle, Recovery, or Phase I, and Expansion, or Phase II.

We’ll now explain Phases III and IV, and answer the trillion dollar question: When will the next real estate crash happen?

Read on to find out!

Hyper supply

Phase III of the real estate cycle

In Phase III of the real estate cycle, we see a pronounced rise in rents, as the demand for affordable housing to rent outnumbers supply, driving up costs.

Rising rents makes the building of new units more attractive and financially feasible again, so more builders break ground on new projects.

As long as this upward pressure on rent is exerted, the demand for new construction is hot, with builders scrambling to meet that demand for financial gain.

This expansion of new units and rental housing is characteristic of both the expansion and hyper-supply phases of the real estate cycle, as building projects take a long time to initiate and finish.

The first sign of trouble in the real estate cycle

At a certain critical point, the amount of new inventory for both rental and owner-occupied real estate units will start to saturate the market.

Prices on rentals and homes have also been driven up by demand, but now supply has finally caught up with demand thanks to two cycles of consistent building and expansions, reaching a point called hyper supply.

That brings the first leak in the boat or indicator of a downturn in the real estate market: increases in unsold housing inventory and higher vacancy rates for rentals.

As all of these builders finish the new home and new rental unit projects they started back in the expansion phase, the number of available units bypasses the need, so we see the occupancy rate climb above the long-term average.

However, rental process and home prices are still rising, although their rate of growth begins to slow, as the saturated market no longer can justify these prices.

At this point, the market is at a crossroads. What happens next will determine the severity and timing of the inevitable recession, or Phase IV of every real estate cycle

If builders and developers pay attention to the declining growth in rental rates and demand and choose to stop building, the market correction begins. The same can be said for home sellers pricing their houses for sale, although the home buying market finds its true value and corrects itself much faster as there needs to be a willing buyer (and appraisal) for every single transaction.

However, if builders ignore the warning signs and keep churning out more apartments, condos, townhomes, and new home subdivisions, they further flood the market at the worst possible time.

Unfortunately, few builders or developers hit the OFF switch themselves, as they’re motivated by squeezing out every drop of financial incentive possible and not wanting to be the first one to leave the party.

Recession

Phase IV of the real estate cycle

With that critical sign of trouble, we’ve now moved into Phase IV of the real estate cycle, or recession.

As the market shifts from hyper supply to recessionary conditions, we face the second warning sign of trouble as occupancy rates fall below the long-term average.

Builders and developers are forced to stop new construction, but the multitude of projects they began during the hyper supply phase are still reaching completion.

This additional unneeded inventory leads to lower occupancy rates but also lower rents (and home prices), as buyers and renters have more and more to choose from, which start devaluing real estate.

The third warning sign is upon us, an increase in interest rates, which acts like a match thrown on a pile of dry timber to ignite a full-on housing recession.

Sooner or later, the Federal Reserve is driven to increase interest rates to fight inflation brought by the rapid expansion of prices we saw through the expansion and hyper-supply phase.

As interest rates climb, developers and builders slam on the brakes and stop building any new projects, as an increase in borrowing costs doesn’t make new development feasible or attractive.

However, the market is suffering through dropping occupancy rates, lower rents (and housing prices) because of oversupply, and higher interest rates for home buyers.

In combination, this quickly creates a negative ripple effect across the real estate market and affiliated industries, from builders and developers to home sellers desperate to cash in on the (missed) high point of their equity, landlords, income for realtors, loan officers, bankers, appraisers, title company reps, inspectors, attorneys, construction companies, laborers, etc. all the way down the line.

When vacancy rates start plaguing landowners, sellers, and builders, values plunge, with foreclosures soon following. The real estate cycle has come full circle.

How long do these real estate cycles last, and how often do they come around?

While it may seem like prices drop and the market changes overnight, the real estate cycle is as predictable as clockwork. By carefully studying the real estate market and every pattern of ups and downs throughout our history, respected economist Homer Hoyt discovered that the real estate cycle gone through this course of the four phases once every 18 years, all the way back to 1800.

The only two exceptions to this rhythm were in for World War II (he earlier noted that wars and world events could disrupt the cycle) and when the Fed inexplicably double the interest rates in 1979.

So according to Hoyt’s research, when will we see the next real estate crash?

The housing crash of 2008 and subsequent Great Recession definitely triggered our movement into Phase IV of the real estate cycle.

The market moved from the recovery phase to the expansion phase around 2014 or so. In fact, some major metro markets like Boston, New York, Denver, and San Francisco, etc. are already seeing a hyper-inflated rental market, accompanied by builders scrambling to meet demand and cash in as quickly as possible

So according to those projections and the typical pattern of this cycle, real estate values will peak in 2024, after which the recession phase begins anew.

The Four Phases of the Real Estate Cycle (and when we'll see the next crash)

The Four Phases of the Real Estate Cycle:

“The next major bust, 18 years after the 1990 downturn, will be around 2008, if there is no major interruption such as a global war.” — Fred E. Foldvary (1997)

If you want to read the ups and downs of the housing market, there may be no better place to turn than the venerable halls of Harvard University to check in with some of the most noted economics and real estate minds in the world.

Just like the cycle of any market, what we do know is inevitable – some call it a downturn or a correction; others a bubble or even a crash – is that what comes up must come down, and then up again.

In fact, these same Harvard economists accurately predicted the financial crash in 2008, or at least the timing of it if not the severity. They didn’t know some complex algorithm or hidden financial secret that the rest of us don’t, they just understood one thing: that any real estate market cycle goes through four phases.

In fact, as early as 1876 an economist named Henry George noted that all real estate cycles move through four phases.

Understanding these market shifts, what causes them and what happens next can empower the average person to make incredibly wise decisions about their real estate holdings far ahead of the curve of public sentiment or knowledge.

Imagine if you had sold all of your property in 2007 before the historic crash? What would it look like if you had kept liquid in anticipation of the Great Recession and had the means to snatch up properties so discounted the banks almost couldn’t give them away? If you knew these signs of a housing market ready to expand and appreciate wildly, you could certainly take advantage of that and when you could ascertain the warning signs that the roller coaster was at its peak and about to go on a wild ride, you could sell, sell, sell way ahead of your unsuspecting and vulnerable neighbors.

Believe it or not, all of that information is readily available. So when will the next real estate crash happen? Read on to find out!

Recovery:

Phase I of the real estate cycle

Having gone through the dark days of the last economic downturn, we all understand the characteristics of a recession, at least anecdotally. Recessions are characterized by:

High rates of unemployment

Decreased levels of consumer consumption

Downturn in corporate investment and expansion into buildings, factories, machinery, etc.

The price of land is depressed. In fact, property and real estate are at their lowest value any time during the four-phase cycle.

But during this phase, the population doesn’t stop increasing, and that means a higher demand for goods and services.

The government typically intervenes during this phase, aiming to spark the economic recovery in the form of lowered interest rates.

While demand inevitably marches on and the cost of borrowing money and investing is lower than ever, smart companies start looking to expand their businesses. There might be some small businesses that have to close their doors, but the larger corporations see this valley as a golden opportunity to expand and snatch up invaluable market share.

This expansion includes hiring new employees, building new factories, plants, stores, etc., and investing in new technology, machinery and infrastructure.

At the latter end of this phase, the extreme rates of vacant offices, retail spaces, plants, and homes starts to decrease. There is just too much inventory, prices and interest rates too low, and demand too high for economic expansion not to start in earnest.

Expansion:

Phase II of the real estate cycle

The real estate market leaves Phase I and enters Phase II of the cycle once companies and consumers have started to purchase or rent most of the available properties, easily tracked by low vacancy rates and shrinking inventory. In fact, occupancy rates surpass long-term averages during this period.

With vacant or available properties becoming far scarcer, opportunistic landlords start to raise rents. Most real estate expenses are fixed so their revenues and profits also increase with these inflated rents. With rents unprecedentedly high, buying vacant land or existing properties for development is more attractive than ever.   

New construction and development begins to boom, but the problem is that these projects could take a long time to get underway and reach completion – sometimes several years. In fact, the average new development takes two to five years to finish. So we still have strong demand but supply to fill that demand can’t be built or developed fast enough, resulting in increased upward pressure on rents, land and housing prices.

So by the time this new supply becomes readily available, the climate of high demand, high rates, low occupancy rates, low interest rates and low supply has been active for five to seven years, a period of robust economic expansion. 

But very soon, people start overpaying for existing homes, land and properties. “Investors” and consumers alike start basing the price their willing to pay on the scarcity of supply and the anticipated growth of rent and housing prices – not actual market conditions.

This is a critical point in the real estate cycle where perception of future growth outpaces the facts, and setting up the perfect storm of conditions for the next phase in real estate – the boom, the bubble, or, as economists call it, hyper-supply.

***

Tune in for part two of this blog coming soon where we examine the two remaining phases of every real estate cycle – and share these Harvard economists’ predictions for exactly when we’ll see the next real estate downturn.

Ten financial experts weigh in on how a FED rate hike will affect the real estate market.

How will the FED rate hike affect the real estate and mortgage markets? Will housing slow down because of a slight bump in the FED, or will it continue its steady appreciation based on strong demand and emboldened consumer confidence? We collected the personal thoughts and opinions form ten noted financial and housing experts:

1. Nela Richardson, chief economist for national real estate brokerage Redfin:

"Buyers now don't seem to be all that spurred or driven by a rate increase. That lack of urgency will translate into next year's housing market. There's interest, but there's not a lot of inventory to buy."

2. Ralph McLaughlin, housing economist at Trulia:

“When rates do increase, it could be as little as a quarter percent. I don’t expect that to have a big impact on the market, but it could temper home price growth, which is good news for prospective homebuyers. Interest rates won't have much of an effect on the 'rent versus buy' math. Buying would still be cheaper than renting in most metros around the country."

3. Selma Hepp, chief economist for Trulia:

“If the Feds decide to increase the rate at their meeting tomorrow, any increases in rates will be nominal and gradual. Impact on homebuyers will be minimal. For example, an increase of 25 basis points on a mortgage loan of $250,000, raises the mortgage payment by $35. I don’t think that will turn people off from buying a home, but they may end up looking to buy a slightly less expensive home.”

“I think the strong economic fundamentals, including robust job growth, better-paying jobs, rising wages and strong consumer demand will, in fact, increase demand for homes. Long term, interest rates may slow home price appreciation but I don’t think it will have a notable impact on home sales.”

4. Mark Fleming, chief economist at First American Financial:

“Of course, we cannot be sure exactly how mortgage rates and the housing market will respond to a Fed rate increase.  But, we can say with some certainty that the Fed will eventually raise rates. When it does, the housing market isn’t doomed to fail, but rather adjust to the reality of interest rates that are reflective of a strengthening economy and certainly more traditional financial conditions. A stronger economy, more or better jobs, rising wages, increased confidence—these factors all increase demand for housing. In other words, rising rates are indicative of increased home sales and upward pressure on prices.”

5. Jonathan Smoke, chief economist for Realtor.com:

“The Fed decision is symbol over substance as far as immediate direct impact to mortgage rates go. Their move will impact the consumer and the broader perception and expectations for rates given how much attention is paid to the Fed and this particular decision.”

“In aggregate I think the near-term impact is negligible if not positive. The 30-year rate already varied by 50 basis points from its low in January to its high in June, and since then we’ve floated back down 20 basis points. No one is expecting rates to move substantially in the months ahead given global economic weakness.  We’re likely to see about 50 basis points of increase over the next 12 months.  The historical perspective shows that even at 50 basis points higher than today, mortgage rates are incredibly low.  Couple that with improving household finances and incomes—especially in the segments who are driving home sales this year—slightly higher rates won’t put a damper on the increased demand we’ve seen this year. We’re months if not years away from the type of high rates that would pose substantial risk to home sales, especially since what’s driving the gradual movement to higher rates is a much healthier economy producing consistent solid gains in employment and household formations.”

6. Svenja Gudell, chief economist for Zillow :

“I don’t think it’s going to have a big impact. It will have a small impact in markets like San Francisco where housing is expensive. It will hit markets where there is very little wiggle room, more than a market like Cleveland or a metro area where home values aren’t so high. It’s not going to be a showstopper. The Fed is not interested in rocking the system; it will be a fairly smooth ramp up.”

7. Lynn Fisher, vice president of research and economics with the Mortgage Bankers Association:

“We think that the fact that they’re ready is a reflection of an improving domestic economy. The jobless rate is at a 7-year low and wage growth is starting to heat up. Both will buoy demand.”

8. Steve East, chief economist and market strategist for Height Securities:

“It’s more clear that the Fed is going to raise rates than that the long end is going to go up because presumably some rate hike cycle is priced in. Even if the Fed’s actions do hit the mortgage market, I don’t think a 25 basis point increase in mortgage rates is going to make a difference in demand.”

9. David Kelly, chief global strategist at JPMorgan Asset Management:

"Aspiring homeowners have to meet three criteria to qualify for a mortgage: sufficient savings for a down payment, an acceptable credit score, and proof that they can make their monthly payments. That final component is the most susceptible to rise along with interest rates, but is also by far the easiest of those hurdles to surmount.”

10. Joe LaVorgna, chief U.S. economist at Deutsche Bank:

"Debt service is not the problem for people who want to take out a mortgage. Lower rates and a flatter curve aren't going to help the housing market too much if you can't get a mortgage because standards are still too tight. How good can the economy be if rates are still at zero?""

"When the Federal Reserve raises rates from low levels it is generally taken as a sign of economic confidence—that the economy no longer needs the Fed’s help—and that rising confidence is generally positive...”