The biggest question I am asked most often is, “where do you see the real estate market going?” This question is coming from real estate investors at every stage of the game including people who how hundreds of units and people who have yet to buy their first house.
Over the last few months leading up to the 100 Millionaires Summit, I took the time to do the key research that would be able to give me a good idea of what that answer would be.
The conclusions I came to were presented live at the event and I have been asked by numerous attendees and investors who didn’t make it to the event if I would share my slides or write on the subject.
Since I already did most of the heavy lifting and now have a few hours before my girlfriend comes back from yoga. It’s time to get this information written down. Some of what I have found may shock you and some of it may seem like common sense, but read to the end and share your thoughts on anything I might have left out.
Are Low Interest Rates Going To Remain?
Low mortgage rates remain a bright spot in the pandemic economy, despite the fact that they have been inching up ever so slightly in recent weeks. This continues a pattern of incremental fluctuations amid uncertainty over the effect the Delta variant of the coronavirus will have on the economic recovery.
But if you’re in the market to buy a home or looking to refinance an existing mortgage, this could be the ideal time to find a lender and lock in a low rate before rates rise more. The average rate on a 30-year home loan recently crossed above 3% for the first time since early summer and currently sits at 2.99%.
There are many analysts that are calling for extreme increases in the interest rates over the next few years. Although it would certainly seem like the logical thing to do, we haven’t exactly seen the FED make obviously right decisions when it comes to interest rates.
I believe the next 10 years will be similar to the last 10 years in terms of interest rates and don’t see it being a major factor in the prices of real estate. There are much bigger forces at play that we are going to discuss in this article.
The Elephant In The Room
Lately, everyone likes to point to the US Economy as being the major factor over whether real estate is going to crash. They point back to 2008 and say, “look there is proof”, but unfortunately most real estate bubbles haven’t coincided with the US market. For the sake of information and since most of my friends are invested in the market we will take a quick look at it anyway.
Recently Goldman Sachs cut its U.S. economic growth target to 5.6% for 2021 and to 4% for 2022 citing an expected decline in fiscal support through the end of next year and a more delayed recovery in consumer spending than previously expected.
The firm previously expected 5.7% gross domestic product (GDP) growth in 2021 and 4.4% growth in 2022, according to research released on Sunday from authors including its chief economist Jan Hatzius.
They pointed to a “longer-lasting virus drag on virus-sensitive consumer services” as well as an expectation that semiconductor supply likely will not improve until the first half of 2022, delaying inventory restocking until next year.
And on top of the near-term virus drag, they also expect spending on some services and non-durable goods to stay persistently below pre-pandemic trends especially “if a shift to remote work results in some workers spending less overall.”
I know that many investors look to the stock market as a sign of what the real estate market is going to do, but what I have found is that there are very few correlations to these two markets except in the extreme examples of the great depression and the great recession.
So barring a black swan event affecting the real estate market I don’t believe our next real estate correction will be able to be predicted using the stock market as the only indicator although it will play a factor in aggravating the coming storm. Again, there are much larger forces at work here.
The Role Of Government In Real Estate Can’t Be Ignored
Legislation is also another factor that can have a sizable impact on property demand and prices. Tax credits, deductions, and subsidies are some of the ways the government can temporarily boost demand for real estate for as long as they are in place. Being aware of current government incentives can help you determine changes in supply and demand and identify potentially false trends.
For example, in 2009, the U.S. government introduced a first-time homebuyer’s tax credit to homeowners in an attempt to jump-start home sales in a sluggish economy (only those who purchased homes between 2008-2010 were eligible). According to the Government Accountability Office, 2.3 Million people took advantage of the tax incentive.
This was quite a sizable increase, although temporary, and without knowing the increase was a result of the tax incentive, you may have ended up concluding that the demand for housing was going up based on other factors.
The biggest concern in the real estate world could be the legislation around the 1031 exchange, which currently incentivizes investors to trade up into larger assets in order to defer taxable gains. I do believe this part of the tax code is still safe, and am keeping my eyes on the landlord/tenant legislation as the concepts of rent control or the total stop to evictions was recently lifted due to the pandemic coming to an end.
One thing is certain. Every real estate investor quickly became aware of just how much power the government really has over what we do in our daily operations.
The Impact of Disruptive Technology, Think AirBNB
The real estate sector has historically been stable as an investment class and many believe it is immune to the rapid adoption of new technology. This thought process will create the allure of risk mitigation, but I caution you to inspect how technology will affect your real estate investment opportunities.
Naturally, all real estate asset classes will be affected differently, and asset classes like multifamily are more insulated due to the defensive characteristics and the fact that shelter is a basic need.
There is a fundamental shift in the office sector as companies realize that productivity could be increased by eliminating commute times and that remote opportunities provide value for the employee and the employer. Employees are now able to take advantage of low-cost environments and companies could handpick employees and adjust pay rates based on the cost of living in these locations.
Office space becomes a premium that many companies will no longer need as the working class embraces the new normal of Zoom calls, Slack channels and other mediums of communication and oversight. These technologies were not built to sustain this mass adoption, and as they iterate to account for demand the speed of adoption will multiply.
Institutional Investors Are Moving Into Residential Real Estate.
I’d be remiss if I didn’t at least highlight that although the size and scope of the institutional investor presence in the global real estate market are most likely relatively small today, that doesn’t mean that it will continue that way or that they don’t currently have a large presence in certain markets.
Industrial real estate in particular looks to have some steep competition, particularly as a similar evolution seemed to happen in industrial plants formerly owned by corporations and largely sold off during the mid-1980s to early 1990s.
A source like a commercial realtor has much better visibility into the true environment so I interviewed Beau Berry who is the largest Commercial Realtor in Northern Florida. You can check out the interview here. From this interview and from my research it seems that the “big guys” are feeling much better about investing in commercial multifamily for the long term, and so this trend should be watched closely.
If published sources seem to be reporting on these kinds of changing winds, it’s also the logic behind the drivers of real estate ownership and investment which seem to confirm this sort of a movement.
How Does The Current Labor Shortage Impact Real Estate?
Although there are a few sectors that have been extremely disrupted by the pandemic labor shortage, the problem is really systemic and it touches everything, especially the real estate market. We already know that there are serious shortages in construction labor, transportation, and warehouse workers, but their impact on real estate is enormous.
For example, housing completions are down 4.5% from July 2021 to August 2021, and privately-owned housing units authorized, but not started, are up a whopping 47.6% year over year (3.7% from July 2021 to August 2021).
There are a number of factors at play here, mostly related to labor, the most pressing being that there are not enough materials to start projects, caused by both manufacturing shortages and supply-chain issues, which go back to a lack of human capital to create, unload, transport, sort, store, reroute, and sell everything from lumber to paint and shingles.
What housing is available is being snatched up practically as fast as it can be listed, with the existing single-family home supply averaging about 2.6 months in August 2021. According to Realtor.com, 6.1 months’ worth of new homes are listed for sale, but more than 90% of those are either under construction or haven’t even broken ground yet. All this crazed buying is pushing real estate prices through the roof, with no relief in sight as the construction industry continues to experience unpredictable slowdowns.
Digging Into The Research Of Migratory Patterns
Over the course of history, people have migrated from different continents, different countries, and different cities for a variety of different reasons.
Top 10 reasons for migration throughout history
1. To escape past or future persecution based on race, religion, nationality, and/or membership in a particular social group or political opinion
2. To escape conflict or violence
3. To find refuge after being displaced due to environmental factors
4. To seek superior healthcare
5. To escape poverty
6. To offer more opportunities to children
7. To reunite with family
8. To obtain education
9. To escape/avoid climate disasters
10. To marry
Numbers 5 (to escape poverty), 6 (to offer more opportunities to children), and 8 (to obtain education) are particularly applicable in today’s migratory environment.
In late 2020, United Van Lines conducted a survey examining the reasons behind Americans’ migration patterns.
The survey results indicated 40% of Americans who moved did so for a new job or job transfer (down from prior years), and more than one in four (27%) moved to be closer to family (which is significantly up over prior years).
Above and below are the top outbound and top inbound states respectively.
Data from March to October 2020 also revealed the COVID-19 pandemic influenced Americans’ decisions to move.
For respondents who cited COVID-19 as an influence on their move in 2020, the top reasons associated with COVID-19 were concerns for personal and family health and wellbeing (60%); desires to be closer to family (59%); changes in employment status or work arrangement including the ability to work remotely (57%); and wanting a lifestyle change or improvement of quality of life (53%).
Demographics That Play A Role In Real Estate
Demographics are the data that describes the composition of a population, such as age, race, gender, income, migration patterns, and population growth.
These statistics are an often overlooked but significant factor that affects how real estate is priced and what types of properties are in demand. Major shifts in the demographics of a nation can have a large impact on real estate trends for several decades.
For example, the baby boomers who were born between 1945 and 1964 are an example of a demographic trend with the potential to significantly influence the real estate market. The transition of these baby boomers to retirement is one of the more interesting generational trends in the last century, and the retirement of these baby boomers, which began back in 2010, is bound to be noticed in the market for decades to come.
In order to be able to predict a large-scale change in real estate, we simply have to take a look at these 3 very large groups of homeowners. The baby boomers and the millennials are the 2 largest generations in history and what they do over the next few years is going to play a major role in the real estate market.
Based on the picture above, we can see that Gen X is still in its buying range and many are shifting into larger homes to accommodate growing families or aging parents.
Home Ownership By Age Group
This chart shows us the amount of ownership by age group. If we pay attention we can see that as a person ages, they are more likely to consider homeownership as a good investment.
The low inventory we are currently seeing in the market is due to 2 major factors. The first is that baby boomers are currently just paying off their mortgages and are now living on fixed incomes. This coupled with increasingly higher rents is forcing them to hold onto their homes in order to live out their lives.
The second factor is that Gen X is still deep in their buying years and is now beginning to invest in multiple properties as they see their parents struggling financially. Without pensions of former generations, they are turning to real estate investing as viable means to retire.
What most people don’t realize is that the millennials are only just beginning their move into the market. This generation sees real estate as more than just a place for them to live, but also as a source of income as they now have access to rent out rooms thanks to disruptive systems like Airbnb.
All of this points to an even higher surge in prices over the next few years. By now you must be asking yourself, “Is there ever going to be a correction? Prices of assets don’t just simply go up forever!” Well before we get to that, let’s look at one more factor that I had left out of my original presentation, but will include here.
Printing Money & Inflation Of Assets
When the pandemic hit in early 2020 and the entire economy hunkered down, demand collapsed. We were not driving to work, going to restaurants, or taking vacations and business trips. Suddenly, there was gasoline at the gas stations with no takers, perishables that restaurants were not buying, and theme parks and malls shut down and then reopened to few visitors.
Supply chains started getting disrupted and prices spiked for goods in high demand (think Clorox wipes, toilet paper, and hand sanitizer). With job losses in the millions and no data on how long the pandemic would last, consumers cut spending on non-essential.
40% of US dollars in existence were printed in just a short 12 month period and it wasn’t just spent on consumer goods as most people think. This money has found it’s way into the hands of business owners and corporations. Who are now flush with cash and looking for assets to store this new wealth in.
This coupled with an already strong demand for real estate is causing further inflation on home prices which can easily be seen in the current market.
The FMHPI is an indicator for typical house price inflation in the United States. It indicates that home prices increased by 11.3 percent in the United States in 2020 as a result of robust housing demand and record low mortgage rates. Growth is expected to slow to 7 percent in 2022, according to their latest forecast.
I believe this is a conservative number and may eventually be increased.
The pace of home sales has cooled since the first quarter of 2021 when it was at 7.2 million. Freddie Mac predicts home sales to hit 6.8 million for the full years 2021 and 2022.
Additionally, they forecast house price growth of 16.9% in 2021. However, they expect house price growth to slow to 7.0% in 2022 (still much stronger than the 5% average we are used to). Strong house price growth is expected to lift home purchase mortgage originations from $1.9 trillion in 2021 to $2.1 trillion in 2022.
Will There Ever Be A Correction?
The below chart shows the life expectancy of the average American by gender and as an average. You can see that in the US women tend to outlive men by an average of 5-6 years. (I’ve heard that married men tend to live longer and I agree).
The average life expectancy is around 78 years old. You might be asking how this comes into play, but if you look back a the research on demographics. You will see that our baby boom generation is still between the ages of 57-75 which still leaves them 3 years before they begin to depart this world.
There is an old saying, “you can’t take it with you” which holds true with real estate. They won’t be taking it with them and much of it will be left to their heirs who will either rent it out or finally put it back on the market for sale. We can expect to start seeing this older inventory coming to the market in 2025-2029 in waves.
One other factor that I haven’t had time to cover is the dramatic increase in builder confidence. Developers are back in full swing and have been focusing heavily on building luxury homes and apartments.
Over the next few years, you can expect to see many new investors getting into the development business. There will be major profits for a few years and many millionaires will be made, but all of this increased inventory will eventually hit a point of diminishing returns as too much supply hits the market all at once.
The 18 Year Property Cycle
Allow me to introduce the 18-year real estate cycle. If this is the first time you are hearing of it, the economist Fred Harrison was one of the first people to identify the existence of the property cycle. He traced it back for hundreds of years to conclude that the length of a full cycle averages out to 18 years, with each cycle divided into distinct stages. (see below)
So, let’s take a look at each stage of the cycle, what drives the shift from one stage to the next, and what different types of investors are thinking and doing at each point…
We’ll start as prices have bottomed out at the end of the recession, and the recovery phase is just beginning to get underway. Prices have fallen far enough to tempt the bravest investors back into the market, attracted by the high yields that are on offer as a result of prices falling while rents stay pretty much the same.
(Rents don’t fall because everyone still needs somewhere to live. Even if renters were brave enough to take advantage of the lower prices and buy, this is the toughest point in the cycle at which to get a mortgage because banks are struggling too.)
These brave investors are what we can think of as the “smart money”: contrarian investors who’ve spotted the opportunity to get in at rock bottom, and are willing to take the risk of buying up assets while confidence is low and the investment case is still unproven.
Of course, nobody knows precisely at what point the bottom of the market has been reached. Smart investors are just willing to take an educated guess, based on the knowledge that their upside potential is greater than their downside risk. Meanwhile, amateur investors are totally absent from the market – even though lower prices and lack of competition mean that it’s precisely the best time to buy.
They might even crystallize their losses by selling at the bottom of the cycle “before prices fall any further”, or be forced to sell because their portfolio was poorly structured to weather a recession. So, if there’s pessimism all around you and the media is full of doom and gloom even though the major catastrophic events of the recession seem to be over, the recovery phase might just be getting underway.
As the recovery phase develops, more buyers will have the confidence to enter the market – having the effect of pushing prices gradually upwards. Look out for big companies and pension funds starting to buy up distressed portfolios: they have the market intelligence to get in early but can’t take the risk of getting in too early, so it’s a good signal of the recovery solidifying.
The prime assets will always be the most attractive, so this early growth tends to begin in the centers of the most economically powerful cities and “ripple out” from there.
Perhaps following a slight mid-cycle dip as the earliest movers take their profits, the recovery phase will give way to the explosive phase. It’s now clear that prices are on the up, and the banks will be over the shock and willing to start lending again. That supplies enough confidence and capital for major building projects to start again, so expect to see more cranes on the skyline.
House prices will begin to increase markedly faster than wages, and it’s at this point that the media gets interested – you’ll probably start to see headlines along the lines of “House prices increasing by £200 a day” and “My house earned more than I did last month”.Fuelled by this, people start to speculate: they either “move up the ladder” to somewhere bigger before it gets even further out of their reach, or they increase the mortgage against their home to fund holidays and cars.
Banks make it easy for them to do so because everything’s in full swing and they just want to lend as much as they can. At some point, logic and fundamentals go out the window and group psychology kicks in. The higher prices go, the more everyone assumes that prices will keep going up – so they buy at any level, pushing prices even further.
The smart investors who got in early will be quietly selling off their holdings to lock in their profits, but the mania is such that nobody will notice. As we move towards the peak of the explosive phase, it’s a seller’s market, and sellers know it – so estate agents conduct “open house”-style block viewings to stoke demand even further.
Even properties that wouldn’t have excited anyone a few years earlier end up going to sealed bids. Properties routinely sell well above their asking price, and developers start marketing ever more “off-plan” properties to capitalize on the demand. Banks aren’t immune to the mania, so they loosen their lending criteria to grab a bigger piece of the action.
Even if some individuals within the banks are aware that the boom is unsustainable, they’re still under pressure to compete with everyone else: shareholders won’t be happy with them sitting back and not lending while everyone else is so optimistic. This lax credit keeps the party going for longer than anyone would previously have expected.
At some point, a commentator or economist will predict that everything’s about to come crashing down because everything is so fundamentally overvalued – but a year later prices will still be rising, and that commentator will be branded a “doom-monger”.
A final couple of years of the explosive phase, as prices and mania reach their peak, are what Fred Harrison branded the “winner’s curse” phase. Why is it a curse to be a “winner” by placing the highest bid for a property during this time? Because the next recession isn’t far away, and it won’t be long before the asset you’ve bought will be worth markedly less.
You obviously can’t know when the “final years” of the upswing are until they’ve already happened and it’s too late, but there’s no shortage of warning signs that we may be near the top if you know where to look. One such sign is the announcement of overblown building projects like “world’s tallest building”, “Europe’s largest shopping center”, and other sorts of over-ambitious ideas.
These projects are conceived at a time of supreme confidence and funded in a permissive lending environment. It’s often the case that the bust has already happened by the time they’re completed, and they sit mostly empty – a monument to the delusion that has just passed.
Another surefire sign is the rationalizing of the ridiculously high prices that the mania has brought about. Justifications will be found for why “things are different this time” and we’re in for an era of permanently higher prices… yet at some point, reality will set in, and the recession phase is imminent.
Because the market was being driven by sentiment rather than fundamentals in the frothiest years, it’s easy for confidence to suddenly evaporate and take the market with it. Prices plummet, and people who are over-leveraged go bankrupt – triggering waves of forced selling, which pushes prices down even further.
It’s impossible to pinpoint the exact moment when this is going to happen, but you won’t need to be told when it does: nothing sells newspapers like bad news, so the media will stoke the panic with endless horror stories. The recession phase seems like it will last forever, but it never does: at some point, the smart money will be tempted back in, and the whole thing can start all over again.
You can see from the chart above 3 examples of past cycles. The below chart shows what is the most likely dates associated with the current cycle we are in.
How Can You Profit From The 18-Year Property Cycle And Come Out On Top?
Fred Harrison claims evidence going back hundreds of years for the cycle’s duration averaging 18 years, but I prefer not to dwell on the exact timing. 18 years is an average, so could easily be off by a few years in either direction.
Getting hung up on the exact duration of the cycle is a distraction. Just the fact that there is a predictable cycle (of any duration) is the point, and you can see the stages progressing even if you don’t know how many years have passed.
There are, though, four very basic “rules” you should follow as an investor – and now you know about the cycle, it should be easier for you to do so:
- Don’t panic and sell a property just because prices are falling. Thanks to the cycle, you know that prices won’t go to zero and it won’t be that long (in the great scheme of things) until they’re back beyond where they were.
- Don’t put yourself in a position where you’re forced to sell at the wrong point in the cycle. This means not over-leveraging at the peak, and making sure your portfolio can withstand temporary falls in value.
- Don’t get carried away (like everyone else is) during the winner’s curse phase. This is the worst possible time to buy a property, because prices will soon fall and won’t recover to the level you bought at until relatively late in the next cycle. It’s an even worse time to remortgage and use the cash for fancy cars and holidays. You might think you’d never be so daft, but plenty of people were last time around.
- Don’t get mislead by the media. As we’ve already seen, the messages they pump out around the key turning points of the cycle are almost exactly the opposite of what professional investors are doing. Putting on the blinkers and shutting it all out is easier said than done, but it’s vital for making the right decision.
Just stick to those basics and you’ll already be doing a heck of a lot better than most amateur investors. Stick to the fundamentals of real estate investing and be sure to reach out to me in the Community section of Alchemist Nation with any real estate and wealth building questions you have or want to learn more about!
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