Grappling with the Residential Real-estate Conundrum

Opportunity or Crisis?

By Jeff Liguori

The U.S. economy has been strong, with the unemployment rate remaining below 4% (considered full employment by most economists) from the start of 2022 through July of this year. Although it just recently ticked above 4% with the August report by the Bureau of Labor Statistics (BLS), this 31-month stretch has been the longest period of full employment since 1970.

Consequently, incomes have been on the rise as employers compete for employees and inflation has persisted. What has this meant for housing? Coming out of COVID (which caused a sharp — and unexpected — spike in the demand for real estate), prices of homes soared. The combination of remote work, a migration out of cities, and a healthy dose of federal stimulus ignited a mini-frenzy of homebuying.

The median sale price of existing homes in the U.S. increased from about $281,000 in March 2020 to almost $427,000 at its peak in July of this year, a surge of 52%. Incidentally, the median home price in Massachusetts is currently the third-highest in the country at roughly $600,000.

Because of significant inflationary pressures, the Federal Reserve initiated a rate-hiking cycle in 2022 — possibly the most aggressive in history — and the rate on a 30-year mortgage increased to about 6.5% from about 3% prior to the Fed’s actions. For context, the monthly payment on a home purchased for $300,000 with 20% down is $1,500 per month today, up from $1,000 per month a few years ago, which translates to a 50% increase in after-tax dollar spending.

“Coming out of COVID (which caused a sharp — and unexpected — spike in the demand for real estate), prices of homes soared. The combination of remote work, a migration out of cities, and a healthy dose of federal stimulus ignited a mini-frenzy of homebuying.”

Why hasn’t this softened the market? Supply and demand. Cash transactions for real estate now account for almost one-third of all transactions, the highest percentage since 2014, according to the National Assoc. of Realtors. Thus, fewer folks require financing, which has supported prices of existing homes. More importantly, fewer homeowners are using their equity to ‘trade up’ to bigger, nicer homes because the cost to upgrade is exorbitant, thus keeping a lid on supply.

What’s Next?

The horizon isn’t very clear for real estate. Homes are the least affordable they’ve been in decades, and some economists believe they may be the least affordable ever (or at least since the data has been recorded). Prior to the Fed raising rates, both the median household income and the income needed to buy a home in the U.S., which accounts for monthly payments, insurance, property taxes, and maintenance costs, was about $75,000 per year. The income needed to buy has seen a drastic increase due to the higher interest-rate environment.

Some economists believe that new homebuyers are spending north of 40% of their income on housing costs. Renting is not a great alternative, especially in desirable areas, as rents — up until recently — have become largely unaffordable. Tight lending standards by banks, skyrocketing insurance costs, and the effect that inflation has had on building materials have created quite possibly the least affordable housing market ever. According to Zillow, an astounding 43% of homebuyers in 2023 used a gift from friends or family to help with a down payment.

Jeff Liguori

“The horizon isn’t very clear for real estate. Homes are the least affordable they’ve been in decades, and some economists believe they may be the least affordable ever.”

From a long-term perspective, demand is likely to persist. There is a shortage of housing in the U.S. as Millennials are in their prime home-purchasing years, and, until recently, construction of new homes has not kept pace with demand. Real-estate prices should stay firm.

The Fed is expected to cut rates in September, which may help the logjam. But if higher rates have curtailed supply, will lower rates increase the supply of homes for sale? Typically, the Fed eases rates due to fears of a recession or during one, which means unemployment is rising and incomes stagnate. If the past several years are an indication of what happens when residential real-estate demand outpaces supply, the next few years may prove to be the inverse of that dynamic.

Election Impact

Residential real estate is a complex and nuanced market, significantly influenced by geographic location and migration trends. Unlike the market for stocks, bonds, or other assets, it is a zero-sum game. People must live somewhere, whether by renting or owning.

As the election approaches, both candidates have introduced policies to address the real-estate puzzle as part of their platform, ranging from significant tax credits and federal subsidies (Harris) to streamlining the permitting process for construction (both Trump and Harris) to opening portions of federal land for new home builds (Trump). A summary can be found on the National Assoc. of Homebuilders website.

The unforeseen ramp in real-estate demand due to COVID-era policies has taught us one thing: predictions are a fool’s errand. Let’s hope the current quagmire unfolds into opportunity and not crisis, because both scenarios seem possible.

Jeff Liguori is the co-founder and chief Investment officer of Napatree Capital, an investment boutique with offices in Longmeadow as well as Providence and Westerly, R.I.; (401) 437-4730.