We Skipped A Key Phase In The Real Estate Cycle! | How will Real Estate React?

July 7, 2022

We Skipped A Key Phase In The Real Estate Cycle! | How will Real Estate React?

It looks like we’ve skipped a phase, out of the four, in the typical real estate cycle that we see in normal markets.

Let me explain: we’re coming out of a pandemic where the government threw a whole bunch of money at fixing it. Things have been pretty crazy, and yes, it is easy to look back now and say it is the Fed’s fault, but who knows how things would have turned out, right? But, this is where we are right now, so where are we heading into?

I was doing some research when I came across a great article from Business Insider. I recommend you read the whole thing there.

What happens if we skip a key phase in the typical real estate cycle?

The Insider says, “The homebuying game is changing. Despite waning demand, home prices remain high in housing markets across the country.”

This is what a typical real estate cycle looks like, according to the article: expansion, hyper supply, recession, and recovery. These are the four phases that we’ve seen over the last hundred years. So what happens when one is missing?

According to Todd Metcalf, the Senior Economist at Moody’s Analytics, told Insider, the current lack of housing inventory our country is currently experiencing has thrown that cycle off. This is what we’ve been saying since day one: this is a supply and demand issue.

A lot of you want to compare it to the crazy stuff that happened in 2008, but a quick reality check shows us the greatest difference: SUPPLY. Specifically, the lack of it. So, throw the words “crash” or “bubble” out the window for now, because at the moment, they don’t exist. This is a totally different world from what we experienced in 2008.

During the Great Recession, we saw the typical narrative of a hyper supply before a recession. However, today we are still seeing a severe housing shortage at a national level. This year, things are much different (Insider, 2022).

How? “Residential construction has fallen to its slowest pace since April 2021, and the housing market needs to build millions of homes to meet buyer demand,” Insider says.

We’ve seen the confidence level for new construction go down. They were building so much that it started slowing down over the last few months, so now we are seeing homes being delivered at a slower pace. Right now, we are still significantly (by millions!) behind in building homes to meet the existing demand.

Metcalf says in place of hyper-supply, the housing market is now entering "demand exhaustion." In this phase, home prices don't fall due to a surplus of inventory, they instead decline as buyers' ability to afford them wanes. (Source: Insider)

Interest rates are a massive challenge right now in terms of affordability. It has fallen a little bit in the past few days, but it is still affecting buyers’ ability to afford homes today.

The falling home prices, according to Metcalf (2022), aren’t happening because of a decrease in demand for housing, but because the people who want to buy it can’t afford it. And according to Insider, “This sort of buyer burnout doesn't lead to dramatic price drops but instead modest declines — and that means home prices aren't tanking like they did in 2008.”

What does this mean?

It means we are not crashing as we did in the Great Recession; we are just easing into a normal market. In fact, in some areas, we are already starting to see that.

Some sellers are freaking out because their homes aren’t selling within weeks, but in a normal market, the average DOM (days on market) for a home to sell is around 2-3 months.

“So while the pace of growth is slowing, home prices are still rising in several pockets of the country — and that means demand exhaustion is just getting started,” Insider says.

In a tweet by Mike Simonsen, owner of Altos Research, you can see a graph showing home prices ticked down slightly to $453,800. It is pretty nuts to see how unaffordable housing has become over the years. Obviously, inflation also played a big role in it.

“While it's too early to call the next phase of the housing cycle, Larson says the housing market is likely to remain challenged for the rest of this year and well into 2023,” continues Insider.

I think it is too early to tell what will happen in 2023. We can speculate, but we can barely tell what happens tomorrow, so there’s no way of being sure yet. From the data we do have though, there’s no crash right now. It’s just a regular market. You might hear some people talking about crashes, ignore them.

Just keep an eye out on the data, and don’t let what others say or speculate stop you from buying or not buying. If you can buy, go buy. If you can’t afford it right now, don’t. Wait a bit. But don’t make decisions based on emotions, especially when you are in the middle of a freak-out. At the end of the day, it comes down to the data. Pay attention to it, decide from the facts, and you’ll be okay.