Real Estate Is About To Drop - Again

What's up you guys, it's Graham here! So, I'm sure it's no surprise that lately, it's been impossible to check the news without seeing some of the most astonishing real estate related headlines. Like, "Home sales jumped to a 14-year high," "Prices soared 14% last month," "Home prices hit record highs," "The biggest gain in two years," "Mortgage demand up 25%." And yeah, I'm not even kidding, that's all in the last week!

Obviously, in the last few months, the real estate market has experienced something that could only be described as the eighth wonder of the world. Will prices continue to skyrocket while unemployment remains at a record high? I know we could point to record low interest rates, mortgage forbearance, and a decrease in inventory in terms of pushing up demand. But still, the question that gets brought up non-stop, time and time again, is whether or not this is sustainable and how much longer can this continue before eventually housing prices begin to stabilize or come down? Not to mention, at the same time, we have some other people warning about the housing market potentially dropping and that maybe we're about to come to an end of housing prices doing nothing but going up.

Well, we've got some answers. So, we're going to be going over whether or not it's a good idea to buy a home with interest rates at their lowest rates—well, pretty much ever—or is this just propping up prices long enough for them to eventually fall back down once foreclosures are processed and interest rates go back up? And I say all of this as somebody who's been working in real estate full-time for 12 years now. I own seven, going on eight properties, and real estate is my largest investment still to this day. But my second largest investment, however, is smashing the like button—and really good news on that—but the like button is now more affordable than ever, and it costs you nothing to make it turn blue for the YouTube algorithm. So thank you so much for doing that!

And also, a quick thank you to Morning Brew for sponsoring this video, but more on that later.

Alright, so I'm not going to bore you with all the details of what's happened over these last few months, so I will summarize everything in under a minute. In March, for the most part, the entire economy shut down, and the Fed lowered their benchmark interest rates all the way down to almost zero percent in a way to bolster up the economy. Low interest rates just mean that money is now cheaper to borrow. It helps promote a little bit more inflation, and that should keep people away from hoarding too much cash during a time where everything is going down in value and people are out of work.

But real estate took a slightly different turn. Low interest rates caused a surge of home buying demand because now the cost of a mortgage was a little bit cheaper, which meant people could get more home for their dollar. And so, everyone had the exact same idea: let's go and buy a house. But there was a problem; sellers were not listing their homes. Not only were sellers concerned about having strangers walk through their homes during a time where cases were spiking, but also, even if they did sell, where would they move to or who would give them a loan in the event they lost their job? That caused inventory to dwindle down to record low levels as people held off from listing their homes, and that's where all of this begins.

I'm sure this one does not need any explaining, but the price that someone's willing to pay for something is largely dictated by supply and demand. Like, if there's a lot of something available but very few people are willing to pay for it, like Disney's new release "Mulan," then prices come down. But if there's very little of something and a lot of people wanting to buy it, then prices go up, like with toilet paper. Well, toilet paper just basically happened to houses. Fewer listings available, combined with more people wanting to lock in a low interest rate on their mortgage, meant that people now began outbidding each other in an effort to buy what little inventory was currently on the market.

And now, here we are with housing prices reaching yet again their all-time record high. Some people worry this is another 2008-like housing crisis upon us, and others just feel discouraged that they're outpriced of the real estate market yet again. So what's going on?

First, let's talk about interest rates, because this is going to have the biggest impact on you and what you pay for a home. Like, here's a quick test for you; I want you to play along with this and tell me which one is the cheaper home to buy. The first option is a home for $300,000 that you could buy with a 30-year mortgage at 6% interest. Now, the second option is the exact same home next door that you could buy for $450,000 with a 30-year mortgage at 2% interest. Think about it for a second. There's a $150,000 price difference between the two, and the only variable here is the interest rate.

Well, if you guessed the $450,000 home would be cheaper, well, you would be right. The cost of buying that $450,000 home at a 2% interest rate works out to be $2,038.29 per month with the one percent property tax rate. And of course, the cost of buying the $300,000 home at a 6% interest rate works out to be $2,048.65 per month with that same one percent property tax rate. So, in this example, buying the more expensive home is actually ten dollars a month cheaper, even though it costs you an extra $150,000 in the purchase price.

If you're confused, here's how that works. When you calculate your mortgage payment, it's made up of both principal and interest, and the interest rate you pay can make a pretty substantial difference in how much your monthly payment is. For example, if you borrow $100,000 at a 3% interest rate, your monthly payment would be $422. But if that exact same loan now has a 5% interest rate, you're now going to be paying $537 a month. That means that as interest rates go down, your mortgage becomes cheaper, which also means you can afford to buy a more expensive home.

Like in our last example, it's no surprise that over the last 30 years or so, real estate prices have continued to climb as interest rates have continued to decline. And now we're at the cheapest rates we've ever seen while real estate prices have been the most expensive they've ever been.

The concern, however, is how sustainable this is and what's going to happen when interest rates end up going back up. And is there a worry of more inventory flooding the market as mortgage forbearances eventually turn into foreclosures? But before I answer that, I want to say a huge thank you to our sponsor today, Morning Brew. Now, you might think this is a coffee company, judging by the name and my obsession with 20-cent iced coffee, but you would be wrong. They're a totally free daily newsletter that gets sent to you every Monday through Saturday and brings you up to speed with the most important business news in just five minutes.

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And with that said, let's get back into the video. Okay, so back to the video. Let me explain what's going on, and I'll keep it really easy and just start with interest rates. In March, the Fed decided to lower their benchmark interest rates all the way down to the low number of almost zero percent. Of course, you might be wondering, whoa, zero percent interest, does that mean I could soon get a zero percent mortgage? And the answer to that is no. It's highly unlikely that we would ever be able to borrow money to buy a house at zero percent or that we would ever get to a point where negative interest rates mean that we pay back less money than we borrow. Chances are, this is never going to happen.

Now, what ends up happening is that when a bank lends money, what they're really doing is receiving a commission for pre-packaging a loan that they could sell to an investor who wants a relatively risk-free return. The biggest buyers of these loans are the government-sponsored agencies Freddie Mac and Fannie Mae, who will guarantee those loans to investors when the bank brings them a loan that fits their criteria. So banks end up using this as their guideline to give loans from, so they can immediately turn around and sell them off, thereby making a quick profit.

But as with any loan, there's always a small amount of risk involved. Not all homeowners will make their mortgage; some of them will pay late, and others will just flat out default as soon as they get the house. So obviously, banks and investors need to be compensated for this risk, and if they don't make that money from their interest rate, then they certainly will make that money by increasing their upfront fees.

Anyway, with that out of the way, the Fed has recently stated that they intend to keep interest rates low as long as they need to in order to stimulate the economy and will continue to keep interest rates low to meet their target 2% inflation. For real estate, that just means that housing will continue to be cheap to finance, and because the financing is cheaper, that extra money just gets siphoned into what the buyer is willing to now pay for a property.

But that, of course, lends the question: what happens when interest rates go up? It's difficult to say for sure since there's so many different factors at play, like the local economy for each market, its desirability, and how much inventory there is. But we'll talk about averages here, and here's what I found. Despite what you might think, one study concluded that historically, rising interest rates actually made no difference overall to the price of housing. In fact, since the 1980s, housing continued to rise even when mortgage rates were going up. Another study confirmed this as well; analysis from CoreLogic, Freddie Mac, and the Bureau of Labor Statistics found that housing prices did indeed go up even though interest rates also went up.

The reasoning behind this is actually pretty simple. One, interest rates are generally only increased during a good economy with strong wage growth, where people are spending money. And two, interest rates are also raised to combat inflation, which, as any real estate investor will tell you, inflation is generally good for real estate because that causes prices to rise up in tandem. So an easy way to put it is this: low interest rates just mean that real estate is now cheaper to finance, and interest rates only go up during a good economy where people are spending money and increased inflation, which, like I just said, is also good for real estate.

However, let’s be real; it's not like everything happening just benefits real estate. Like, an asteroid hits Earth, and all of a sudden, real estate prices increase two thousand percent as supply dwindles to record lows. The thing is, real estate is based on so many small factors like location, inventory, the local job market, and the health of the overall economy. And obviously, some locations are going to end up doing a lot better than others. For example, in the last 12 months, San Francisco only saw a six percent increase in prices compared to San Diego, which saw a 5.2 percent increase in prices. That goes to show you that local market factors and the local job market influence prices much greater than simply low interest rates.

And that does mean that eventually, if more inventory comes on the market, then real estate prices should begin to stabilize or, dare I say it, actually go down. And with inventory at record lows, with record low interest rates, that has kept prices buoyant. Eventually, I have a feeling that over time, more sellers are going to be comfortable listing their homes in this market. Inventory will increase, and over the next few months or years, things should begin to normalize.

But then there's also the concern of foreclosures. As it is right now, homeowners have the option of opting into mortgage forbearance that allows them to temporarily pause their payments and then add them back on to the end of the loan. The good news here is that it looks like month after month, the amount of loans in forbearance has been steadily decreasing, and the latest finding was that last month, loans in forbearance went down from 7.2% to now 6.8%.

Now, in terms of how severe this is and what this means for the entire housing market, the actual numbers are not as alarming as it is today. Homeowners have, on average, across all the homes out there, about sixty percent worth of equity in their property. Meaning for every one hundred dollars of value that they have, they only owe forty dollars. And forty-two percent of all homes are owned free and clear. That means we would be highly unlikely to see a wave of foreclosures unless housing prices dropped about 30%, leaving a portion of those mortgages underwater and then subject to foreclosure.

So here's how that works: when a home is foreclosed, that just means that the homeowners stop making payments to the bank. So the bank has to foreclose on that home to recoup the loan. But if you owe a bank a hundred thousand dollars on your home worth 150 thousand dollars, there's no way you're letting the bank take over the home because it's worth more than what you owe on it. So instead, what you do is sell the home, you use that money to pay back the bank, and then you walk away with the 50 thousand dollars in equity.

So in this case, even though there are mortgages in forbearance, it's unlikely that all of those people are going to stop paying their loan once the forbearance period is up. It's also unlikely that everyone is going to start selling at the same time and that everyone together is going to start crashing the market.

Now, in terms of the numbers here, 3.6 million people were more than 30 days late on their loan, which represents about four percent of the entire housing market. Now, as of last year, ten percent of homes with a mortgage owed more than what the home was actually worth, meaning about 0.4 percent of homes in forbearance right now are at risk of foreclosure where the homeowner owes more on the home than what the home is actually worth. The remaining homes out there have enough equity in them where if the homeowner needs to, they could sell it, pay back the bank, and then walk away without having a foreclosure on their record.

The biggest risk here, though, is that if everyone decides to list and sell their home at the exact same time, just flooding the market with inventory. But I think realistically, that's probably not going to happen. The biggest concern that I see right now is with retail space, where currently almost 20% of loans are in default as businesses close down.

Overall, though, here's my advice: low interest rates are keeping prices high, record low inventory can't stay low forever, and eventually, I think interest rates will go up. But who knows how much or when that will happen? Yes, we have mortgages in forbearance and incredibly high unemployment, but overall, it's a lot more important to look at the local market conditions than national trends.

For example, I could see real estate prices in New York and San Francisco going down, but prices in Texas and Phoenix going up as more people want to move there. Real estate is really going to be a local market depending on where you live. And even though national trends can have a small influence on price, it is not the end-all be-all. Instead, all you need to really know is that you only buy a home that you could afford, that you intend to live in long term without selling.

Generally, I don't recommend buying real estate unless you have the intention of holding it at least 10 or 20 years because anything can happen in the short term. But as long as you buy something that you could comfortably afford alongside with a healthy emergency fund in case something happens, then you should be okay. I'm still buying real estate and I currently have another home under contract, but you need to look very closely for the right deals and make sure you can afford it or that it cash flows enough for you to break even in the worst-case scenario. If you could do that, even if there's a downturn, you'll be totally okay to weather through the storm until things recover.

That's exactly what I'm doing, along with smashing the like button for the YouTube algorithm. So, with that said, you guys, thank you so much for watching! Make sure to destroy the subscribe button and the notification bell. Also, feel free to add me on Instagram; I post it pretty much daily. So if you want to be a part of it there, feel free to add me there.

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Thank you so much for watching, and until next time!