Housing prices, and how builders can protect themselves going forward.
The housing market has been growing for 10 years. Values have skyrocketed in the later part of those 10 years. 30-year interest rates are artificially low. We all know these facts. So, what happens next, and what can you do to protect yourself?
Housing prices may start to fall in 2022. Why?
- The Federal Reserve (the Fed) is going to increase its rate. This will result in a rise in short-term borrowing rates and CD rates. Long-term rate increases will follow, as long-term rates typically don’t stay under short-term rates for long. Rising long-term interest rates equate to lower house prices.
- The Fed will likely end quantitative easing. To put it simply, the Fed buys long-term government bonds and long-term mortgage-backed securities (that is, homeowner mortgages). These purchases increase the demand for those items, which increases the price paid. Increasing bond prices lower the yields (interest rates). This is why mortgage rates are artificially low. When the Fed stops buying (stops increasing the demand), prices will drop which will raise long-term interest rates. If the Fed then actually sells some of what they purchased, that will increase supply, again lowering the price and increasing rates.
- Home prices have gone up at unsustainable rates.
The market shouldn’t crash. Why not?
- I think that the Fed will not sell a significant quantity of government bonds and mortgage-backed securities. There are many complex reasons. If you are curious, give me a call and we’ll discuss it.
- Housing starts are not at crazy high levels like they were in 2006. As a Builder who survived the Great Recession, it can seem that way to you, but the reality is that starts are still lower than 2006. The population has increased over the last 15 years, increasing average demand. We are not overbuilding like we were back then. There is less competition than before, and you are a better builder than you were 15 years ago.
- Thank inflation. There is inflation in everything these days. Does anyone think the price of a quarter pounder at McDonald’s, or a dozen eggs, or the minimum wage is going back down to where it was in 2008? Housing prices won’t either. While eggs, gas, and housing may fall, I don’t think 2008 pricing is in the cards.
- Banks are not doing crazy lending like they were in 2006. While I have seen easier lending than 10 years ago, it is still on the conservative side (if you have tried to get a home loan recently, you know what I mean). So there is not going to be a big correction there.
At some point, maybe this year, maybe in 5 years, or maybe in between, I think housing prices will fall. That will be painful to builders, homeowners, and lenders. Having said that, I’m not thinking 2008 pain, but we are prepared for that, as you should be as well.
What can you do to protect yourself?
- Build quickly. If you build 10 houses per year, and it takes you 8 months for each, you have 7 under construction at any given time. If it takes you 6 months, you have 5 under construction. The risk you are taking is either on 5 or 7.
- Hold land positions for very short periods of time, and not at large dollar amounts. Most losses are in the value of the land, not the home being built.
- Don’t borrow money on lots you aren’t building on. The risk is too long and large for potential gain. Let someone else take that risk.
- Take large deposits on presales and sales during construction. When values decline, people walk from meaningless deposits, but not from 10% deposits. When possible, you hold the deposit. Nothing says non-refundable more than you holding the money.
- Don’t sit on built inventory long. This increases your risk of values dropping as you hold it.
- Don’t build presales faster than specs. While getting that presale off the books fast sounds like it reduces risk, a 10% deposit presale has less risk than a spec. Build all at the same rates.
For now, let’s go fast, keep our risks reasonable, and make money while the sun shines.