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June 17, 2022 Market Update

Friday, June 17, 2022   /   by Bryan Baylon

June 17, 2022 Market Update

Those who have joined the real estate market in the last 10 years may not have fully realized that the housing market is always cyclical. Every time there is a long term positive cycle, people say "this time it is different" but the cyclical nature of housing is caused by human nature, which can always be relied upon to assert itself eventually. Much harder is trying to forecast exactly when human nature will do its party trick. When times are good, greed gets the upper hand and when times turn hard, fear takes over and wrecks everything. Greed in the housing market was the primary cause of the Great Recession of 2008. Greed caused people in 2004 through 2006 to do all sorts of crazy loans with dodgy lenders and crooked borrowers equally to blame. When prices stopped moving higher (they always do stop at some point) all those loans fell apart, supposedly safe Mortgage-Backed Securities collapsed in value and fear took over the market. This was actually a slow moving train wreck that ran from 2004 through 2011.

The situation in 2022 is very different, yet similar in some important ways. Many people have made a lot of very large paper profits in housing over the past 10 years, without having to resort to loan fraud. Those profits have been especially large in the last 2 years. What is driving the market today is fear of those profits disappearing. If they sell now, those paper profits become hard cash, always useful when the rest of the economy is going a bit wonky. Or they can be converted into different assets using a 1031 exchange. Hard cash profits incur capital gains tax, so the 1031 exchange looks an attractive way to avoid that tax. However, if you exchange into something that is exposed to the same market risks, your profits stay at risk too. Cash can be exchanged for almost anything (not love, though). But cash itself, is still a poor vehicle to store wealth when inflation is running at close to 10%. If we were all logical, it would make some sense for everyone to stay invested in the housing market and sit tight. But we are not all logical. Fear will cause some people to sell and those people can easily spook more people and with the social media environment we now inhabit, a stampede is happening almost as soon as you realize what is going on. The promotion of disaster stories gets a lot of clicks and clicks reward the poster no matter how untrue their content might be. You could say it is logical to be fearful, because fear is highly contagious.

Fear of the market going down can become a self-fulfilling prophecy. If there is a stampede, injuries occur. An orderly exit is almost impossible to engineer. Human nature makes everyone want to do the same thing at almost the same time.

What started as an orderly cool down in March quickly turned into a flight to safety in April and May and now we seem to have a stampede for the exits developing in June. The rise in interest rates was a signal for this to happen. It was not the only cause, because if supply has stayed low, it could have coped with a significant fall in demand. But it is not just lower demand we are facing, but far higher supply because of the rush of home owners wanting to exit the market. New listings are coming from all directions.

Economic forecasters like to claim that when interest rates rise, home prices go down. That assertion can easily be disproved by detailed research into interest rate and home price history. At this stage I like to quote Ezra Solomon "The only function of economic forecasting is to make astrology look respectable." This quote is often wrongly attributed to John Kenneth Galbraith - he did say it in 1988, but he was quoting Ezra Solomon in 1984). Another human trait is to attribute any quote to the most famous person who said it, not the original creator, but I digress. Being correct does not help when a stampede is headed your way.

If people want to believe it, dramatically rising interest rates will cause people to believe that home prices are going to fall, and because they believe it, and act on that belief, home prices can sometimes fall as a result of interest rate rises. Usually they don't, but sometimes they do. The times they do is when they cause a stampede. It is not yet clear whether this stampede is going to become big enough to cause home prices to fall in a significant way. It is clear that they could, but it is not clear that they will. It depends on the size of the herd stampeding.

Of course, if you live in your home as an owner of a primary residence, you are probably not going to join the stampede. But a LOT of people have been tempted to buy second or third homes by the thought of them appreciating. Selling one or two of them might make perfect sense. A LOT of people have become private landlords and have a collection of rentals. Selling the ones they like the least might make perfect sense. A lot of people have started operating short-term rentals and their houses have turned into a business, effectively becoming small hotels. This has driven up values and reduced the stock of ordinary homes. It is possible that fear could spread to these owners and some of there short-term rentals could come back into ordinary home supply just at the wrong time. These are all wealthy people not ordinary people, so the herd is not huge.

The biggest impact could come not from these small real estate owners (investors), but from the bigger players. Large scale institutional buyers of homes to rent, such as Invitation Homes, Progress Residential, RoofStock, American Homes 4 Rent, etc. have gobbled up a lot of ordinary affordable homes across Greater Phoenix, especially in the last 15 months. If these players decided to stop buying, it would create another big hole in demand, just as demand is already sinking. The amplification of the downtrend could be destructive in ways we have never witnessed before.

I just heard today that one of these big players has cancelled every purchase they have in escrow, forfeiting their earnest money in order to not complete their purchases. This is ominous.

Market incites provided by the Cromford report.
Keller Williams Northeast Realty - The Baylon Group
Bryan Baylon
2005 W. Happy Valley Rd #150
Phoenix, AZ 85085

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