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Why Investors Should Be Cautious About the Current “No-Landing” Narrative
Despite the volatility in mortgage rates, the real estate market is experiencing growth in some of the country’s most expensive cities. Recent data from Zillow indicates a significant increase in property listings and homes going under contract during September. Cities such as Seattle, Los Angeles, and San Jose, which are at the high end of the market, exhibited the most substantial gains.
“Overall, new listings and sales have approached pre-pandemic levels in September,” remarked Kara Ng, a housing economist at Zillow, in an interview with Yahoo! Finance. “However, we still have a considerable way to go before normalizing supply.”
Buyers Unlocked from Rate Constraints
The high-end market had remained stagnant following the increase in interest rates post-pandemic, with many homeowners unwilling to relinquish their sub-4% mortgage rates in favor of rates surpassing 7%. The recent activity in the luxury market may reflect a renewed optimism regarding potential future interest rate reductions, encouraging buyers to enter the market before prices escalate further. Additionally, this may indicate a backlog of demand to relocate, which had been stalled due to uncertainty surrounding interest rates and market conditions.
Although there was a slight softening in the overall market—with approximately 940,000 homes available for sale nationwide in September—the current inventory level is still 23% below that of the same period in 2019. Nonetheless, data from Realtor.com reveals that listings in high-end markets, such as Seattle, Silicon Valley, Denver, and Washington, D.C., have risen by 25% or more compared to the previous year.
Furthermore, wealthier homeowners with substantial liquidity are less likely to be impacted by fluctuations in mortgage rates than other buyers who rely heavily on borrowing.
California Housing Trends Reflect National Patterns for High-End Properties
The increasing polarization of the real estate market between affluent buyers and the middle class has been substantiated by various statistics throughout the year. A report from Redfin indicated a nationwide decrease of 4% in overall real estate sales during the first quarter. In contrast, sales of luxury properties rose by over 2%, marking the highest year-over-year gains in three years.
The subsequent report from the second quarter showed that investor purchases of homes surged by nearly 30% in high-value West Coast markets, including San Jose and Las Vegas, as well as in Sacramento, Los Angeles, and San Francisco. San Jose experienced the most significant overall increase in home purchases, rising 15.2% year-over-year in the second quarter, with San Francisco following closely.
Most investor activity concentrated on single-family homes. Craig Pellegrini, a real estate agent in San Jose, noted at the time of the report’s release in August that “San Jose has attracted numerous overseas investors who are purchasing properties without viewing them in person, along with home flippers who renovate distressed properties and resell them for a profit. I am also witnessing parents acquiring second homes to rent out temporarily and eventually pass on to their children, many of whom have recently graduated from college and find it challenging to buy their own homes.”
Zillow’s price index report for September supports this market trend, indicating that interest rates are less of a concern for affluent buyers who are acting now to capitalize on potential price increases amid anticipated rate cuts.
Prospects for the California Housing Market in 2025
The expected rise in activity at the upper end of the market aligns with forecasts for the California real estate market in 2025, as projected by the California Association of Realtors. CAR president Melanie Barker stated in a press release: “An increase in housing inventory, coupled with lower borrowing costs, is anticipated to attract more buyers and sellers into the market in 2025. Demand will escalate as we enter the year with the lowest interest rates seen in over two years, particularly benefiting first-time buyers. Simultaneously, prospective home sellers, previously constrained by the ‘lock-in effect,’ will find greater flexibility to pursue properties that better align with their needs as mortgage rates continue to decline.”
CAR senior vice president and chief economist Jordan Levine added, “As interest rates decrease, inventory is expected to loosen, and demand will also rise due to lower mortgage rates and limited housing supply, leading to higher home prices next year. While price growth may slow, the ongoing housing shortage will maintain competitiveness in the market, barring significant economic disruptions.”
Strategies for Investors to Leverage Increased Liquidity in High-End Markets
While these developments seem promising, investors should consider how to maximize these opportunities. Here are several strategies:
- Focus on Emerging Markets Adjacent to Expensive Areas
Investing near high-value real estate markets is a reliable strategy, as there will always be individuals priced out of these expensive cities. Whether flipping homes or renting, demand is likely to remain strong in these emerging markets. - Engage in Home Flipping
Flipping homes in affluent cities presents both high risks and rewards. However, for well-capitalized investors, this approach can be lucrative, given the persistent demand for housing. By purchasing properties wisely, there is significant potential for profit, whether renovating older homes, constructing new ones, or making cosmetic upgrades. - Collaborate with Affluent Residents on Investment Deals
Many individuals in costly urban areas possess substantial financial resources but lack the time to manage real estate investments. This is where an adept investor can add value. Forming partnerships with affluent individuals requires a reliable investor with a proven track record and a robust contingency plan to mitigate risks. - Engage in Wholesale Transactions for High Returns
In high-value markets, wholesalers must establish credibility and strictly adhere to local real estate regulations. If closing deals prior to resale is necessary, adequate cash reserves will be needed to cover expenses. However, the potential returns can be significant due to the high price points. - Invest in Long-Term Rentals for Equity Growth and Cash Flow
Purchasing properties in affluent areas can be advantageous as markets often self-correct over time, with property values continuing to rise. Conservative investors can build wealth by holding onto properties that generate rental income while also appreciating in value. Eventually, with rising rents and mortgage amortization, these high-value assets can also begin to generate positive cash flow.
Conclusion
Timing investments in emerging markets can be highly rewarding in real estate, but it also entails risks, as it may result in owning properties that take longer than anticipated to appreciate. If feasible, investing in established markets presents a safer approach with fewer downsides, provided that one avoids over-leveraging. Given the current market cycle, investing now as the market begins to rise, alongside anticipated interest rate reductions, could be advantageous.
However, with an upcoming election and a new presidential administration, many investors have deferred their purchasing plans, irrespective of the outcome. This could create an opportunity for optimistic and well-funded buyers to capitalize on the market.
In the previous post: “Is Now a Better Time to Invest in Real Estate Debt or Equity?“
Why Investors Should Be Cautious About the Current “No-Landing” Narrative
Has the U.S. Housing Market Finally Begun to Thaw After the Pandemic?
It seems like the housing market might be showing signs of life. According to a recent report from Redfin, pending home sales in early October have seen their largest year-over-year rise since 2021, with a 2% increase in the four weeks ending October 6.
This news is likely to be welcomed by real estate investors who have felt the market has offered limited opportunities over the past few years. However, it’s important to take a cautious approach—one promising statistic doesn’t necessarily indicate a broader trend.
Is the Housing Market Truly Recovering?
Let’s explore the different factors at play.
Interest Rate Reductions: A Critical Factor or a Red Herring?
The Redfin report links the surge in pending sales to the Federal Reserve’s much-anticipated rate cut announcement in mid-September. According to Redfin, this announcement prompted buyers to re-enter the market in late September, despite mortgage rates having already been falling for weeks before the cut.
This psychological boost is crucial. Although buyers were aware of the falling rates beforehand, many seemed to be waiting for a formal signal to act. This could be attributed to a lingering fixation on the ultra-low rates of 3% to 4% that buyers enjoyed before 2022.
Any rate cut announcement serves as a nudge for prospective buyers, making them feel that now might be the right time to purchase, even if mortgage rates had been decreasing already. In an unstable mortgage market, such announcements hold significant influence.
However, mortgage rates are just one piece of the puzzle when analyzing housing market performance. As noted by Investopedia, the real estate market is driven by four primary factors: interest rates, demographics, economic conditions, and government policies.
Demographics: Shaping the Market
During the pandemic, demographic shifts had a profound effect on U.S. real estate, with major population movements like the Sunbelt migration fueling booms in cities such as Phoenix and Austin, which later became unaffordable for many.
Age is another key demographic factor, and the millennial generation’s pent-up demand continues to be a driving force behind the rise in home purchases. Despite the challenges of the past few years, millennials who have longed to become homeowners are now entering the market in greater numbers, as more properties become available.
Rising Inventory: A Sign of Stabilization
A key factor contributing to the market’s stabilization is the growth of housing inventory over the last year. The pandemic had a significant impact on the availability of homes, with sellers hesitant to list properties due to COVID-19 restrictions and, later, higher mortgage rates.
Some homeowners, particularly those upgrading to larger homes, found it financially challenging to sell and take on higher mortgages. Others, however, simply chose to wait for a more favorable market.
Although the latest Realtor.com report shows that inventory remains down by 23.2% compared to pre-pandemic levels, we are seeing an upward trend. For instance, new listings have been rising since last year, with a 5.7% year-over-year increase for the four weeks ending October 6.
As of September 2024, some states have even surpassed their pre-pandemic inventory levels, including Tennessee, Texas, and Idaho, with others, like Washington, close behind.
Vulnerabilities in Certain Regions
However, not all regions are showing positive signs. For example, some areas, particularly those affected by extreme weather, have seen inventory spikes not because of market recovery, but due to homeowners trying to offload damaged properties they can’t afford to repair.
For instance, regions like Florida and North Carolina, hit by hurricanes, have experienced increases in home listings, but these may reflect a response to climate-related challenges rather than market health.
Opportunities for Investors
Investors should be discerning when choosing markets, focusing on regions where inventory is growing due to increased home construction rather than climate-related distress. States like Idaho, Utah, North Carolina, and Texas, which are building new homes, offer potential, though caution is needed in areas prone to natural disasters.
The Midwest and Northeast, meanwhile, still face significant challenges in recovering to normal market conditions. These regions have lower rates of new construction, meaning inventory remains scarce, which could present both opportunities and difficulties for investors.
The Bottom Line
The U.S. housing market is showing signs of recovery, but the situation remains complex and varies by region. Interest rates play an essential role in unlocking the market, but investors should also consider other critical factors, such as homebuilding trends, climate risks, and government policies. While the market is heading in the right direction, it’s crucial to examine regional differences carefully before making investment decisions.
In the previous post: “Is Now a Better Time to Invest in Real Estate Debt or Equity?“