After-Tax Cash Flow From Selling The Old Asset Is The Next Housing Market Crash Coming?

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Is The Next Housing Market Crash Coming?

San Diego, CA – “Buy low, sell high” is a well-known saying attributed to legendary billionaire investor and philanthropist Warren Buffett. Given today’s super-hot residential real estate market, it’s hard to imagine how much longer this madness will continue.

Buyers are bidding to buy homes, many all-cash offers, no financing, no contingencies, asking prices of tens or hundreds of thousands of dollars more than sales prices, double-digit annual home price increases and extremely low inventory. for sale.

According to the Case-Shiller Home Index, average annual home appreciation in 20 major metros was 14.6% year-over-year compared to this past May. Phoenix had the highest annual price increase of 22.3%, followed by San Diego at 21.6% and Seattle at 20.2%.

I distinctly remember that in 2005-2006, at the peak of that last super-hot residential real estate market, many people were saying that the market would continue to boom and prices would rise for another ten years.

Still, home prices began to decline by 2007, and a wave of short sales and foreclosures dominated the formerly super-hot market by 2009-2010. In some cases property values ​​fell by more than 50% in the hardest hit places like Phoenix and Las Vegas.

But this time it will be different… no. If there’s one thing that’s certain about real estate (and life in general), it’s that it’s cyclical. Each boom followed by a bust, and each bust followed by a final recovery and then another boom, etc.

In the case of real estate, the cycle is longer than the general economy and lasts an average of 15 years. In this particular case, it’s important to note that we’re discussing the residential (homes) real estate cycle, which can be quite different from the commercial (investment property) real estate cycle.

So, where are we today? Interest rates with mortgages are at very low levels. For example, our sister mortgage company recently closed a 15-year fixed rate loan as low as 1.99%. This is quite remarkable considering the skyrocketing rate of inflation. This past June, inflation rose by 5.4% year-over-year.

This was the biggest inflation increase since 2008. At this pace, the US is on track for double-digit inflation by 2023. Compare that to just 2.4% in 2018 and 1.8% in 2019 and an annual inflation rate of 1.3. % in 2020.

The money supply, government debt, and public spending by the federal government are enormous. It seems that not too long ago, when politicians were arguing about the federal budget, they were talking about millions, or at most billions of dollars. Now that doesn’t seem like a big deal if not a trillion.

US unemployment has been steadily improving since peaking at 16% in May 2020. As of early June, the unemployment rate was around 5.9%. However, these statistics can be misleading as they do not include “underemployed” people, e.g. Those who have moved from full-time to part-time employment, or who now earn less than before the pandemic.

In addition, it does not count workers considered to be “permanently unemployed” (unemployed for more than six months) and those who have “stopped looking for work”. The “real,” or so-called U6 unemployment rate, is about 9.7%.

So, how does all this translate to the residential real estate market? The current real estate cycle is 15-16 years old, which is alarming, but basically, as long as money is so cheap, buyer demand is so high, and the supply of homes available for sale is so low, “the music is still playing.”

Moreover, we should not underestimate the “Covid-effect” on housing. One of the reasons why homes have become so valuable is the lockdown and the resulting paradigm shifts of working from home, teaching from home, playing at home and eating at home.

If cycles are the law of the universe, then it is safe to assume that these cycles must also change. When? No one knows for sure, because we only know that this cycle has changed after it has already changed.

However, in my estimation, the catalyst for change will be an increase in short-term interest rates by the Federal Reserve, which sooner or later will result from higher inflation.

Our real estate brokerage receives a lot of inquiries from buyers and investors looking to purchase property. In our opinion, real estate buyers should proceed with extreme caution in such an overheated real estate market.

Double-digit annual price growth is not entirely sustainable because real wage growth is in the low single-digits. It is important to understand that real estate is not a very liquid asset and there are substantial costs associated with selling it.

For most residential property owners, real estate should be a long-term game and buyers should take that into consideration when purchasing a property. When the inevitable market correction occurs, home equity can be greatly reduced or wiped out in the case of large mortgage-backed homes.

In such instances, property owners may find themselves “inverted” on their mortgages, meaning they will owe more than their property is worth. Short-sales and foreclosures will become familiar terms again.

On the other hand, lucky residential property owners who currently own highly appreciated real estate assets may be in a perfect position to cash out of their equity when the market is hot and prices are high (remember what W. Buffett said).

Residential homebuilders, especially those that build in the lower price range with projects already underway, or that will stand up and deliver completed homes in the next 12 to 18 months, are in a good position because demand from current buyers is much stronger. supply.

Whether that deadline has passed, however, is anyone’s guess. Exorbitant costs of materials, high cost of land and labor, and exorbitant government fees make it difficult for builders to deliver affordable housing and make a profit.

There may soon be another important consideration for sale: Uncle Sam. The current administration is openly talking about raising taxes, and despite their election promises, it won’t just affect the “rich”.

For example, under their latest tax proposals, the homeowner’s exemption from capital gains tax on the sale of primary residences could be greatly reduced or eliminated altogether. Oh, the capital gains tax rate is also going up.

Another significant tax change on the horizon for those who own any investment property, even if it’s a small rental home or condominium, is the proposal to reduce or eliminate the so-called “1031 tax exchange” under which capital gains taxes can be deferred. Investment properties with small and large rentals.

Every situation is unique, but my general advice to clients who want to buy real estate now is to have a compelling reason for them to do so. I recommend being patient and not buying in a frenzy, which will pass sooner or later.

Again, you w. Let’s remember what Buffett says about buying low and selling high, and he certainly has the track record (and bank account) to prove what he’s talking about.

For consumers who own real estate and want to hold it for the long term, I recommend that they review their mortgage and interest rates (if they have a loan on their property).

If profitable, they should look to refinance them, with or without a cash-out, to take advantage of these extremely low interest rates, which at this point are well below the rate of inflation, making them practically “free money”.

For consumers who are considering selling or have short-term ownership plans, this can be a great opportunity to review their property values ​​and determine whether to sell now, when the market is so hot and prices so high, it’s a good idea. .

Ultimately, no one knows what the future holds, but some things are certain: real estate is cyclical and change is inevitable. The current residential real estate market cycle is mature, prices are very high and so it is reasonable to expect a market reversal.

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