Back in 2020 during COVID buying residential real estate seemed like a no brainer. Everyone thought housing markets like in NYC were dead as the city shut down and people started working remotely. With housing/market sentiment and rates at all-time lows, it seemed like the perfect opportunity to buy real estate.

Fast forward a few years, NYC real estate and the rest of the US housing market is up close to 30% since 2020. Everyone was shocked at how quickly the market rebounded and how expensive homes across the country have become.  

Now with prices near the highs, the question becomes is now (September 2023) a good time to buy a home or an apartment/condo?

Disclaimer: Buyside Hustle is in no way, shape or form a financial advisor and does not provide investment advice. Any piece of advice you learn in this article is the opinion of the author and can change at any time. In other words, make your own decisions.

What drives the housing market?

To understand whether it’s a good time to buy real estate, we need to understand what drives the US housing market. Just like basically anything else, price is simply all about supply and demand. When there is a lot of supply and little demand, prices should fall. When there is a lot of demand and low supply prices rise.

Here are the key drivers of the housing market:

1. Economic Conditions / Employment

One of the most significant factors influencing the housing market is the state of the economy. When the economy is strong, with low unemployment rates and robust GDP growth, people tend to have more disposable income, which can lead to increased demand for homes. On the other end, during economic downturns, high unemployment and economic uncertainty can reduce demand, causing a slowdown in the housing market.

Basically, when unemployment is low for long periods of time and people start to accumulate a ton of excess savings, demand for homes is typically higher (i.e. 2021/2022). But as you can imagine, when unemployment is high demand falls.

Excluding the temporary blip of COVID, unemployment rates have been trending lower ever since the 2008 Financial Crisis, a huge tailwind for housing demand.

2. Supply of Homes

The basic principle of supply and demand applies to the housing market. When there is a shortage of homes relative to the number of buyers, prices tend to rise. Conversely, when there is an oversupply of homes, prices may stagnate or decline.

There are a number of factors that influence the supply of homes:

• New construction from homebuilders
• Current housing inventory – homeowners listing their home on the market for XYZ reason (i.e. lost their job, relocating, etc.)
• Geographic location – real estate is very localized, supply/land in some geographies may be more abundant than others

After the Financial Crisis in 2008, the supply of homes trended down dramatically as people lost their jobs and couldn’t afford their mortgage. On top of that, there was very little demand since people were very cautious given the state of the economy.

Now with mortgage rates at very high levels, people are reluctant to list their homes on the market since they would lose their 3% mortgage and have to buy a house at a much higher mortgage rate.

3. Mortgage Rates

Interest rates set by the federal reserve play a pivotal role in the housing market. Mortgage rates have a direct impact on how affordable buying a house is. When interest rates are low, borrowing money for a home becomes more attractive as mortgage payments on low, leading to increased demand and higher prices. On the other hand, higher interest rates can deter potential buyers, slowing down the market.

Think about what happened after COVID. The Federal Reserve cut interest rates to zero and mortgage rates fell to all time lows. The yield on the 10-year US Treasury bond fell all the way to 0.5% (way less than the rate you could get in some of the safest cash investments today! You could get a mortgage for ~2-3% – basically free money.

When the economy bounced back, those low mortgage rates caused a massive wave of demand, driving housing prices to all-time highs.

4. Demographic Trends

Demographic factors, such as population growth and age are also big drivers of housing demand. Simply put, if there are more people entering the age to buy homes (~25-35 years old), then demand for housing goes up.

Currently there is a huge wave of millennials in the US entering the prime age range to buy a home driving up demand.

5. Migration Trends

Real estate is a very local business. You could have demand low in one part of the US and really high in another. From 2010 to 2020, demand for housing in the US centered the big cities like NYC and San Francisco. These two cities experienced population inflows and a big rise in wealth as it was the perfect era for to work at technology and finance companies.

Once COVID hit, the rise of remote work led to increased demand for larger homes in suburban and rural areas, especially across the southeast. Prices in the southeast have risen more than any other region. Cheaper cost of living, lower taxes, better weather were the primary drivers in the movement to the south. Places like Miami have become the go to destination for people who want to leave NYC.

As you can see from Redfin below, the top 5 states people moved to post COVID were FL, TX, NC, SC and TN while the top 5 states people moved from were CA, NY, MA and IL.

6. Consumer Confidence

Consumer sentiment and confidence in the economy can influence buying decisions. High levels of consumer confidence often lead to increased home purchases, while low confidence can result in decreased demand. Most of this sentiment is driven by how well the economy is doing and how low unemployment is. There are external factors, like geopolitical events or natural disasters, that can also impact consumer sentiment.

7. Government Policies

The cost to carry a home each year can greatly influence housing demand as well. A lot of people think the main annual costs to own a home is just the mortgage payment. In reality, depending on where you live taxes, home insurance and/or an HOA (if you own a condo) can add a significant amount to your monthly payment.

If these expenses rise significantly in a short time frame in a certain region, demand for housing will likely decline leading to a drop in prices (all else equal). In the past couple of years, inflation has driven the cost of carry a home substantially – higher taxes, higher insurance higher costs in general to maintain a home which have not yet been reflected in housing prices.

8. Monetary Policies

Lastly, governments can create housing demand through changes in monetary policy. For example, since the 2008 Financial Crisis through 2022 the Federal Reserve has encouraged home purchases as the central bank purchased hundreds of billions of dollars of mortgage-backed securities (MBS).

Mortgage-backed securities are basically securities that own a pool of individual mortgages. With these purchases, spreads on MBS (i.e. the difference between the 10 or 30 year US treasury bond and MBS) remained at all-time lows for a long period of time, which kept mortgage rates really low.

Housing Demand Surged in 2021/2022

In 2021 and 2022, everyone asked whether they should be buying a home as prices were rising at one of the fastest paces ever. The few years following COVID were the perfect balance to drive housing demand and prices to all-time highs.

All of the supply/demand drivers we discussed above all were large tailwinds for housing prices:

1. Economic conditions have been the best ever with very low unemployment rate, very high consumer savings driven by pandemic stimulus measures, high consumer confidence and low inflation (up until 2022)
2. Mortgage rates hit an all time low in 2021, making it basically free to borrow money to buy a home
3. Supply of homes is at historically lows as the 2008 Financial Crisis led to a slowdown in homebuilding
4. Demographic trends were the best ever with the highest percentage of millennials entering into the prime age to buy a home
5. Migration have led to a greater boom in southern markets
6. Governments and central banks continued to have policies in place to encourage home ownership through large purchases of MBS

As of result, everyone experienced FOMO on owning a home just like the crypto craze that happened at the same time. Usually in the past, anytime prices rise very quickly and everyone starts talking about buying a certain asset, it is very likely that the gains in that space have already happened. The opposite is true as well – assets that drop a ton in value because hated just like post the 2008 Financial Crisis. Looking back, that was the perfect time to buy a home as nobody was looking to buy a home then.

Extreme conditions don’t last forever, and usually what goes up very quickly will come down at some point in time.

Will Home Prices Start Declining in the US?

Starting in 2023, the trend in home prices started to reverse. After years of double-digit gains, home prices are starting to fall in most cities across the US.

Is this change in trend to the downside going to continue or is it a temporary blimp? Most realtors take an optimistic view that housing supply is at an all-time low and once inflation tames down over the next year, the Fed will start to lower rates, causing mortgage rates to go down and increase demand for housing.

Sounds reasonable, but doesn’t take into account all the other factors that impact housing demand and supply. In 2022 and 2023, most of these factors that were tailwinds have quickly reversed and are now major headwinds to home prices.

1. Deteriorating Macro Factors

The unemployment rate is by far the biggest factor that will determine whether we have a large 20%+ correction in home prices. The unemployment rate has stayed at a very low 3-4% level now for over a decade, which has led people to buy first and second homes due to increased confidence.

If unemployment suddenly shoots up to 6%+ over the next year, then not only will the supply of homes for sale will increase but the demand will decrease as well. Right now we live in a goldilocks environment where supply is really low as people have purchased first and second homes over the years as they have a job that pays the bills, can rent out their second home on Airbnb and don’t want to lose their low mortgage rate.

What do you think will happen if that person loses their job and travel demand declines in a recession? All those homes will hit the market for sale and lower prices as that person can no longer afford all the payments on their mortgage.

2. Mortgage Rates at All Time Highs

Mortgage rates have been in the 2.5-5% range since 2010. Rates stayed so low for so long which was a huge tailwind to housing prices.

Now, mortgage rates are almost 8%. That means for most people interest will cost you more than double what you would have paid a few years ago when purchasing a home. If rates stay at these levels for an extended period of time, demand for housing is guaranteed to be impacted.

3. Housing Affordability at an All-time Low

With higher prices and higher mortgage rates, housing affordability has become a big issue in most markets in the country. Skyrocketing prices have placed homeownership out of reach for many first-time buyers. The only fix for affordability is lower prices otherwise there will be no buyers left to keep prices elevated, especially if unemployment increases.

4. Home Prices are Overvalued Globally at a 5% Risk Free Rate

What most non-finance people don’t think about is how the cost of capital impacts how you spend your money. When the Fed funds rate was at 0%, you couldn’t make any interest on your savings. In a zero rate environment, it doesn’t make sense to save money since the money just sits there without accumulating any interest – so most people invested their money in assets over the last decade (houses, stocks, etc.).

Now the environment has completely changed. You could buy a 30-year treasury bond and make over 4.5% every year for the next 30 years. Just think about that. If you had $5 million saved, that is $225K of risk-free guaranteed income ever single year for 30 years. Why would someone spend a lot of money on a house that is going to cost them money through taxes/insurance/interest when they instead could get guaranteed income from investing in a treasury bond?

There are so many safe cash investments that you could make today that makes you question whether you really need to own a home at these price levels.

5. Lack of Government/Monetary Stimulus

Governments worldwide have implemented various measures to cool down overheated housing markets. These measures include quantitative tightening (Fed no longer buying MBS or bonds), stricter lending standards, foreign buyer restrictions, and increased taxes on property transactions. With the gap between the rich and poor increasing, politicians are looking for ways to tax the rich even more. The easiest way to do that is through increasing property taxes.

Home Price Decline Will Likely Happen Overtime as Real Estate is an Illiquid Asset

You may ask, with all these headwinds on home prices, why have home prices only declined slightly thus far? Real estate, especially single-family homes, is an illiquid asset that is only sold when the owner 1) moves or 2) can’t afford the monthly payments.

If macro conditions deteriorate, it will take a few years for home prices to decline (depending on the severity of a potential recession). If we look back in history during the 2008 Financial Crisis, it took until 2012 for home prices to finally bottom even though the economy started to recover before then.

Time will tell what happens to home prices, but with all these headwinds I find it really hard for home prices to continue to increase from here over the next few years.

The likely path for home prices is downward.

Housing Prices Can Be Very Market Dependent

Now you need to know that housing prices, just like prices for all types of real estate, is a very localized phenomenon. Trends can differ depending on the demand/supply factors for any given city/geography.

A good example is the migration shifts that happened and continue to happen post COVID. Like I mentioned before, there has been and continues to be a huge influx of people leaving high tax states like California and New York into lower tax states in the South like Florida and Texas. As a result, demand and prices have remained very resilient in those southern markets while demand in CA/NY is starting to weaken significantly.

That is just one factor that can cause discrepancies in price trends between two states/cities. All the other factors mentioned above can lead to higher demand and higher prices in certain regions versus others.

So keep all this in mind if you are thinking about purchasing a home.