There is no doubt we are in a different real estate market than we were just a few months ago. On June 13th, 2022, the stock market dropped almost 4% and mortgage interest rates increased ½ percent in one day, which was the largest increase for one day since they started tracking rates. If you listed a home in May and priced the property at “market” you could expect multiple offers and buyers willing to pay way over asking price. In early March, a 30-year fixed rate mortgage was still in the high 3% range, but by late June they had risen to 6%.
Buyers rushed in as rates were rising to lock in a mortgage rate and buyers seemingly did not care about the price. In just a few months, in August, they cared considerably more about price because the higher interest rates combined with price increases over 10% over a one year period started making homes unaffordable. Many of our rental owners “cashed-out” on these high prices, but those who did not may need to wait until rates decrease again to do the same.
Currently, the market is not in balance: there are too many sellers and not enough buyers motivated to buy at these prices. There are three tranches of sellers right now: those who will only sell if they get the right price, otherwise they are content to retain their home, their low mortgage payment and low taxes; those who prefer to keep their property as a rental, for the same reasons as the first sellers, and who can enjoy positive monthly cash flows while they wait for the market to improve; and those sellers who need to sell. The first two groups will cancel their listings or allow them to expire and then stay put or lease it out. The last group will lower their expectations and their asking price as buyers wait for a correction in prices.
How will this real estate recession differ from 2007 to 2010? Prices will not drop as severely since there will not be an avalanche of foreclosures and short sales. The number of sales will drop off dramatically, currently sales are down 40% from a year ago, and if interest rates stay where they are or go higher, prices could drop 10 to 15%. For those who choose to be an “accidental” landlord, or who currently own rentals, this recession may be financially enjoyable. As buyers wait for prices to adjust, they will need to rent, and can afford more expensive rentals. For those impacted negatively by an economic recession, they will have no choice but to rent.
Most rental owners refinanced when rates where at all-time lows, and with Prop 13 and low property taxes, these owners should have nice margins on their rentals, that is, their total payment (principal, interest, taxes, insurance and management fee) should be well below the market rent. That was not true in the previous recession, many of our owners had little or no financial room and could not afford professional property management. Keeping a property with good profit margins, taking advantage of the tax laws (depreciation, write-offs, 1031 tax exchanges, etc.) may be a very wise move rather than selling at a discount.
The only potential pitfalls for our rental owners is additional renter protection laws. Historically, when interest rates increase, the number of owner occupied households decrease. But in the past 10 years, even though rates decreased substantially, renter households have increased, so with interest rates doubling in just the past few months and with the expectation that rates will stay elevated for the next few years, owner-occupied housing will fall to all-time lows. We could even see the majority of households be renters within the next 10 years (they currently comprise 45%) and these renter households, whose votes count as much as owner occupied households, will demand additional protections from their elected officials.