WINTER 2021 QUARTERLY BLOG
Going into the new year it is important to first reflect on the previous 12 months. This year started off at a relatively nominal pace, but once it got going, it really got going! I saw single-family homes jump 20-30%, which was difficult to watch if you were a buyer. But sellers had a great year! Don’t fret – for those who didn’t buy this year, your stock portfolios likely exceed expectations, so you win either way.
The market really catered to single-family homes since it was clearly the real estate fan favorite. Amongst the market pace it became clear that locally based real estate experts really added value to their clients, both for buyers and sellers. For example, even Zillow CEO Rich Barton said this year that “determine[ing] the unpredictability in forecasting home prices far exceeds what we anticipated.” What could be a stronger statement than one of the top tech real estate companies acknowledging how real estate is local and knowing the micro-market is paramount?
Fundamentals are still relevant – properly preparing your home still nets you the highest price. Those houses that are prepared for sale and highlight what current buyers want far exceeds recent sale prices on average. You know all of those HGTV home flipping shows – why let other people flip your home and recognize the unlocked value instead of you doing it? That was my mantra as I spent a great deal of time making sure my listings were prepared and showcased, and that netted greater results for my clients. Alternatively, finding the gems for my buyers and working within my network to find opportunities was instrumental to my clients’ success this year.
Economic Picture
A lot can change in the new year. Coming off such a hot year in most asset classes one must wonder how much runway is in front before cooling. The Fed has already set a course on their plans and I’m sure people are listening. The Fed plans to taper purchasing mortgage-backed securities starting this month at a rate of $15 billion per month and ideally waned out by mid-2022. They have indicated that they are not planning to raise the overnight interest rate at this time (which is still hovering near zero), but I bet they are waiting to play out the asset purchases rollback so not to have a one-two punch economically. If the economy continues to chug along overall, and I expect it to, I think you will see them reevaluate the pace of interest rate increases. For example, if inflation continues to rise and is not temporary, they will need to take action. A major concern is having a runaway economy that’s too hot. Just look at the current Consumer Price Index (CPI) index that has the highest 12-month gain since 1990 at 6.2%. That’s a huge bump and something to take note.
How will the economy impact real estate?
As you know, real estate is local and we have a few key components currently at play: 1) affordability, 2) scarcity, 3) necessity. Affordability tends to be a theme in Bay Area real estate, which in part is due to our chronic problem of the scarcity of inventory. But there is no getting around it – our valley has a fixed amount of space, not to mention a water crisis, so adding housing to accommodate population demand is not a simple fix. I’m more interested in necessity since I’m hearing a lot of chatter about the necessity, or lack thereof, to be near corporate headquarters and how this may change the overall paradigm. I think this year will be a serious gut check for both corporations and employees whether there is value in proximity. I think the answer is clear – collaboration and creativity are fostered in face-to-face interactions.
Nick’s Thoughts
Adjust our thinking and financial strategy to work in our favor
We are feeling inflation all around us, but is it temporary, or here to stay? According to the Fed, we are experiencing temporary high inflation because of supply constraints and bottlenecks. They tell us it is temporary, but I think once people become acclimated to higher wages and higher prices of goods, it’s highly unlikely prices will decrease significantly. If my assessment is correct and higher inflation is with us for the foreseeable future, we can adjust our thinking and financial strategy to work in our favor. For example, in higher inflationary periods it is typically better to have value stocks than growth stocks and the stock market is more volatile. Additionally, fixed assets and debt, such as owning real estate, is typically a hedge in an inflationary period. But you also need to be mindful of the correlation between rates and prices because there is an inflection point where affordability is dramatically impacted.
I think it is clear mortgage rates will increase as the Fed tapers its mortgage-backed securities purchases since they were buying these securities and creating an artificial demand. As the largest buyer of mortgage-backed securities gets out of the market you will likely see mortgage rates increase since the artificial demand will vanish and the secondary market adjusts accordingly.
Real Estate Facts
Single family homes increased 20–30% this year
This year was one of the hottest markets for single family homes I’ve experienced, fueled by insanely cheap money, a rocket ship stock market which dramatically increased wealth and high confidence across markets empowering people to make aggressive real estate decisions. Most buyers asked for similar home attributes: elbow room, home offices, larger yards, pools and move-in ready. Those homes recognized record sale prices and the inertia in the market was intense throughout most of the year.
Single family homes increased 20–30% this year
This year was one of the hottest markets for single family homes I’ve experienced, fueled by insanely cheap money, a rocket ship stock market which dramatically increased wealth and high confidence across markets empowering people to make aggressive real estate decisions. Most buyers asked for similar home attributes: elbow room, home offices, larger yards, pools and move-in ready. Those homes recognized record sale prices and the inertia in the market was intense throughout most of the year.
As mortgage rates increase, purchasing power decreases
There is no magic here – assuming employee compensation stays constant, higher interest rates directly impact the amount of a qualified loan. For example, for every .25% of interest rate increase on $2mil it costs you $416.00 more per month in interest. So if your loan is $2mil, a 1% increase in interest rate costs you $1,666.00 more per month. That’s real money.
The Condo Comeback
Contrary to single family homes, the condominium market was quite slow. Shared living spaces are not popular in a COVID environment, but call me bullish, I think condos are currently one of the few opportunities in the overall market. You hear people say things like “condos are not a good investment”, but just prior to COVID, the condo market was on fire. Additionally, there are still thousands of people working remotely and the need to be near the office or along an urban corridor for transportation just isn’t there right now. But I’m starting to see life coming back as people are thinking into the new year. Once there is a clear path to in-person working and COVID management, I think you’ll see the condo market come back.
Commutes are not front of mind—right now
In-office working seems like a lifetime ago for many, but as the shift into the office happens you will see the uncomfortable commute come back. I’m already seeing increased traffic on some freeways like US-101, but not much on HWY 85 yet, which since the shutdown in 2020 I’m now calling the tech freeway. It is so clear that freeway is used mainly by the tech community since even now the traffic is light. I spoke to a client this week that had to go into the office on the peninsula and he commented about the terrible commute – we forgot what life was like in our cars before and after work. Don’t forget about the commute because it will be back.
Real Estate Unknowns
Are we going back to the office, if so when?
Most people agree that at which point employees are back in the office there will be a hybrid model. So does that mean there is less necessity living local?
I accept my inherent bias on the topic and try to be mindful, but watching and listening I still don’t see a world today that doesn’t benefit from face-to-face interaction (i.e. collaboration, creativity, growth) though I appreciate productivity being at an all-time high in some functions. I personally am not sure if productivity is the best gauge of company or individual success. For example, there are contractors who rate themselves on how fast they can remodel a home and quality never comes into the conversation – is that considered productive?
How will real estate prices far as mortgage rates increase?
As mortgage rates increase, three things can happen:
- Prices decrease: As the cost of borrowing increases the overall purchasing power (affordability) decreases. Prices may decline to adjust for this change just as prices rose dramatically in part because of increased purchasing power thanks to low interest rates. In this scenario the net monthly mortgage cost is unchanged, relatively.
- Prices stay the same: If prices stay flat as rates increase, the net monthly expense will be higher assuming same loan amount. The cost of borrowing increases quickly especially on higher loan amounts.
- Prices increase: This is the worst-case scenario. Higher mortgage costs and higher prices – a double whammy. Affordability is dramatically hit and many buyers will have to reevaluate their home purchasing strategy.
Is it time to raise rental rates?
I’m not seeing rental rates back to pre-COVID rates, but overall I am seeing rates up from the 2020 drops. This year I’ve been working with clients to bring their rental rates back from the COVID discounts that were adjusted last year. I’m guessing there will be a correlation to increased rates when companies are back to in-person.
Takeaway
In the long run it is unlikely you will look back and regret owning local real estate, but that doesn’t mean you should go out and buy just any property. They is so much value in working together to find the right blend of home and community. The majority of time what my clients think they want when we first start ends up being very different in the end and they are so happy they went through the journey to find the right home. It’s a pleasure getting to know my clients and being part of the process knowing that in the end they can make years of memories for their family.
If you are selling real estate there is likely a reason, such as upgrading, retirement or relocating. Timing is usually determined by a life change, but it is crucial we prepare your home properly to recognize top dollar. I will continue to work closely with my clients and be their advocate in order for them to attain that top price.
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