Afford Anything - PSA Thursday: How Is The Pandemic Affecting the Housing Market?

Episode Date: May 7, 2020

Before the pandemic, the U.S. housing market was strong. Home prices were at historic highs. Borrowers were more qualified than ever, with two-thirds of mortgage originations going to borrowers with excellent credit. As of January 2020, delinquencies (borrowers more than 30 days late on a payment) reached a 20-year low. How has the pandemic affected the market? Are we due for another spate of foreclosures? What's going to happen to housing supply? What about demand? Are buyers still buying? Are sellers still selling? And if you're thinking about buying a home -- either as an owner-occupant or as a rental property investor -- what do you need to know about the new pandemic landscape? We dig into depth in this short, researched-packed PSA Thursday episode. For more information, visit the show notes at https://affordanything.com/PSAThursday Learn more about your ad choices. Visit podcastchoices.com/adchoices

Welcome to PSA Thursday. This is a weekly segment in which we cover information, context, and tips that can help you make sense of these pandemic times. What does this mean for your wallet, for your investments? How do you manage your money in the middle of a crisis? These are the questions that we focus on in these PSA Thursday episodes. My name is Paula Pantt. This is the Afford Anything podcast. And today we will discuss how the pandemic is affecting the real estate market. Here's what we're going to cover in today's episode. We're going to talk about where the market was before the pandemic struck, where is it now, and where might it be going in the next six to 12 months? And although I'm broadly using the phrase real estate market, we are specifically going to focus on the residential market in the U.S. Real estate, as many of you know, can be residential or commercial, but in this episode we're going to focus on the residential housing market. All of the research and the data that I am about to cite is conducted by and attributed to Nima Wedlake, who is a principal at Tom Vest Ventures, in a report called the U.S. Housing Market Health Check. We will link to this report in the show notes, and the show notes will be available at afford anything.com slash PSA Thursday. So where was the U.S. residential housing market before the pandemic? What kind of situation did we start in?

Well, home prices had been rising steadily since the Great Recession. The price of homes have reached a historic new high. They've beaten where they were at their prior 2007 peak. So previously, right before the Great Recession, the peak of the housing market, the price peak, was in March 2007. Home prices, of course, crashed during the Great Recession. They've been slowly rising ever since. And now, using data that was collected right before the pandemic struck, home prices are are valued at 115% of their prior peak levels. So they have formed a historic new high. And from

2012 through the beginning of 2020, home prices grew by 5.8% annually. Now, why did home prices climb so much? Well, there were several factors. Number one was low mortgage rates. We've had low mortgage rates for the past decade and there's no sign of that letting up anytime soon. Number two is a decline in new home construction, which limits the housing supply. So before and during the Great Recession, housing supply flooded the market. Before the Great Recession, there was a big spike in supply, starting in 2005 due to all of the people who were speculatively building, and then continuing through 2008 with all of the foreclosures that hit the market. So in those years, from 2005 through 2010, there was a lot of housing out there on the market. But from 2010 through now,

the housing supply has been steadily declining. And real estate industry analysts often measure the supply through a metric that's called months of supply. Historically, if there's six months of supply on the market, then that indicates that homes will have moderate price growth. But if there are fewer than six months of supply, that indicates that homes, Home prices are going to rise quickly. Sellers may receive multiple offers. The number of average days on the market are reduced. So when supply is down, prices are up.

And what we've seen in the last decade is that the number of new homes that are being built has trailed the number of new households that are being created. And that has happened every year since the Great Recession. Partially the reason that fewer new homes are getting built is because of rising construction costs. the cost per square foot for new construction is pretty darn high, and in some places that squeezes the profits to the point where builders aren't interested anymore. So that drop in new home construction, which fuels the decline in overall housing supply, coupled with low mortgage rates, and coupled with wage growth and consumer confidence that comes from having an 11-year bull

market, all of those factors put together are some of the reasons why home prices have grown by almost 6% annually over the past eight years. And those high home prices have resulted in a lack of affordability, housing affordability, particularly in high cost of living areas, coastal cities, predominantly coastal cities. Now, one of the most obvious and immediate questions that people started asking, as it became clear that we are heading into a recession, is are we due for a surge in foreclosures? We all remember the massive number of foreclosures that we saw in the Great Recession. Is history going to repeat itself a dozen years later?

Will that happen again? Well, to answer that question, let's take a look at borrower qualifications. So prior to the Great Recession, between 20 to 30 percent of mortgage originations, went to borrowers who had excellent credit scores, credit scores of 760 or above. That means the other 70 to 80% of mortgage originations before the Great Recession went to borrowers with less than excellent credit. By the fourth quarter of 2019, this had very nearly flipped. Almost 66% of mortgage originations in Q4 2019 went to borrowers with excellent credit borrowers of 760 or above FICO scores. So most borrowers right now, two-thirds of borrowers, are extremely highly qualified.

And that is one major distinguishing factor between where the housing market was at the start of the Great Recession versus where the housing market was at the start of 2020. During the Great Recession, a lot of foreclosures were triggered by homeowners who had over-leveraged. They'd borrowed against their home equity and often use this money for consumer purchases, such as unnecessary upgrades like building a deck or building a basement home theater. system. Now, not everybody did that, of course. And there was also quite a bit of mortgage fraud and predatory lending. But the bottom line was that a lot of underqualified people were taking out far too much debt, and they had loans that they couldn't afford. Fortunately, that is no longer

the case. After the Great Recession, cash out refinances dropped by 75%. And that remains at a substantially historically low level. On top of that, fewer people are delinquent on their mortgage payments. In January 2020, the rate of delinquency for 30 days or more was only 3.5 percent, and that is the lowest rate for the month of January in the past 20 years. Foreclosures are at historic lows, bankruptcies are at historic lows, and more people own their home free and clear. In 2007, 68% of homeowners had a mortgage, but in 2020, as of February 2020, only 62% of homeowners had a mortgage. So fewer people who own homes even have mortgages, a lot more people own their homes free and clear. And of the people who do own mortgages, the ratio of

housing payment to income is much better than it used to be. In 2007, the payment to income ratio is 32%. In 2020, the payment to income ratio is only 21%. So it dropped from 32% down to 21%. I know I've just thrown a lot of numbers at you. So let's recap the big ideas. The housing market as we are going into the year 2020, as we are first going into the pandemic, is an incredibly strong and healthy market. We have more qualified borrowers, fewer subprime mortgages, low delinquents, and lower borrower debt-to-income ratios. So we're going into the pandemic starting strong. Now, let's talk about what's happened since the pandemic began.

So far, we have not seen a significant rise in delinquencies. It's early. This episode is being recorded in the first week of May 2020, which means we've been living in pandemic conditions for less than two months, so it's still very early in the game. But so far so good, there has not been a significant rise in delinquencies, but we do know that the biggest risk is unemployment coupled with a lack of protections, such as mortgage forbearance programs. So right now the unemployment situation looks fairly bleak. 30 million people have applied for unemployment. And programs that are meant to protect paychecks, such as the SBA's Paycheck Protection Program, are underfunded.

These programs are designed to keep workers on the payroll. the PPP has already run out of funds once, and while it's now in its second round of funding, half of that money has already been earmarked and claimed. So if the PPP runs out of funds again, then the number of unemployment claims could increase. Now employers who do not get PPP funding could qualify for the employee retention tax credit, and they could claim this tax credit in advance, so rather than having to wait until filing, they could claim. it right away. So there are some options for employers who don't get PPP funding, but it's quite clear that the PPP and other forms of funding that's designed to keep workers on the payroll,

the success of those programs are going to play a very large role in whether or not the number of unemployment claims continues to increase, and if so, by how much? So how does that impact the housing market? Well, if lenders offer mortgage forbearance programs or other types of similar programs that can alleviate the payment burden during unemployment or can alleviate the payment burden when people have had their hours reduced or have experienced a drop in income. If those types of forbearance programs are available and accessible, then we won't see a big spike in delinquencies and foreclosures.

But if those protections are not there, then we might. And if those protections are made available only to owner-occupying, we're. or to people who hold primary residence mortgages, then what we may see is that among residential real estate investors, residential rental property investors, the ones who are over-leverage, the ones who placed far too much of an emphasis on cash-on-cash return and borrowed the maximum amount,

they are, of course, over-leveraged and therefore most vulnerable, whereas the residential real estate investors who maintained very moderate, conservative levels of leverage, the ones who by and large ignored the cash on cash return metric and instead focused on cap rate, those are the ones who are poised to do best. There's the expression, in a bull market, everybody thinks that they're a genius. But when the tide goes out, you see who's been swimming naked, and that is what we're about to see.

These are the moments that separate those who over-leveraged from those who took a moderate, slow and steady approach. Now, what else have we been seeing since the pandemic began? Well, there's a huge drop in demand from buyers as of January 2020. And remember, January was before a lot of people had even heard of coronavirus. As early as January, the number of home showings, the number of buyers looking at homes, had already dropped by almost half as compared to January 2019. Again, comparing data from January 2019 to data from January 2020, the number of buyers looking at homes dropped by almost half comparing those two months. And that was January. It only got worse from there. By the first week of April, pending home sales had fallen

54% as compared to the same time that prior year. Buyers are not in. interested in buying houses right now. Now, there's also been a drop in supply by about 25%. So back in April of 2019, there were 1 million homes for sale. In April of 2020, there are 750,000 homes for sale nationwide. So the drop in home sale supply is 25%, but the drop in interest from buyers, buyers who are looking to buy, is 50%. So demand has fallen twice as far as supply, which means for the first time in a decade, the supply demand equation has flipped into the buyer's favor. Remember how we just talked about how during the last decade we had this issue of inadequate housing supply, and that was causing prices to rise? Well, now the tables are turned, which means that if we look at

where might this market be going, what might be the future of the residential real estate housing market in the next six to 12 months, this might be a damn good time to buy. If you want to buy real estate, there's not going to be a lot of competition. Back in 2019, I had a lot of students who are saying a home goes on the market or a duplex or triflex or fourplex goes on the market and it has multiple offers on the same day. It ends up going under contract 24 hours after it's first listed. there were a lot of buyers who were feeling frustrated by the fact that sellers were receiving offers so quickly, they were getting multiple offers, and they felt like basically you blink and this home is under contract already. That's not going to be happening again anytime soon. Homes are going to be languishing on the market for much longer periods of time.

Sellers are unlikely to receive multiple offers. People simply are not buying right now. The natural inclination in a time of uncertainty is to hold onto your cash to not make any purchases, so people aren't buying, which means this could be a great time to pick up on some housing sales. There's no competition from other buyers. You know the expression, be greedy when others are fearful and fearful when others are greedy. Well, in that same vein, be buying when no one else is. I bought my first rental property at the end of 2010 beginning of 2011.

That was a time when most people were still too scared to buy. And that was what set me up on a path that led to reaching FI through real estate. I didn't know that that's what I was doing at the time. I'd never even heard of FI, the financial independence movement. But in hindsight, that first property gave me both the income and, more importantly, the confidence to then buy the second, the third, the fourth, the fifth. And that all started in a recession when nobody else was buying, when sellers were not receiving multiple offers.

And therefore, I could bid competitively. I could submit an offer that was significantly lower than asking price, and the seller would say yes. So right now in 2020, given the fact that demand has fallen at twice the rate of supply, if you have the ability to buy, this is a great time. And of course, make sure that you yourself are taken care of first. What I mean by that is don't stretch yourself too thin in an effort to buy now. Don't raid your personal emergency fund.

Don't borrow more than you can afford. The classic principles of personal finance are evergreen and universal. So make sure that you have a strong financial foundation. Don't chip away at your foundation in order to try to grab a momentary opportunity. don't rack up credit card debt, keep a personal emergency fund, all the basics of personal finance 101. But if you've done that and you are in a position to buy, 2020 could be your year. So that is my report on the state of the housing market, where we were, where we are, and where we seem to be going.

That is today's PSA Thursday episode for May 7, 2020. If you want to learn more, we have a free e-book called Seven Expensive Mistakes that rental property investors make. You can download it for free at afford anything.com slash mistakes. It talks about some of the most common mistakes that rental property investors make, including over-leveraging, which we touched on in today's episode, as well as other common errors, many of which I've made myself, and how to avoid them. Again, you can download this book for free at afford anything.com slash mistakes. I teach a course on rental property investing.

It's called Your First Rental Property. It's a 10-week-long course that covers everything from how to find properties, how to finance them, how to analyze them, to make sure that they're a good deal, make sure that you're buying the right thing. We talk about how to make renovation decisions, how to build a team, whether you're in-state or out-of-state, whether you're house hacking or buying something. something that's 2,000 miles away. We talk about how to screen tenants and manage tenants. All of that, the A to Z of rental property investing is all in this course. It's called Your First Rental Property, and it only is available open for enrollment twice a year. So on May 18th, we're going to open our doors for enrollment. May 18th, 2020, we will keep those doors open for one week. We close the doors on May 25th. And after that, our whole class goes through it together. We have live Q&A on Zoom,

where you can bring your questions, we have forums, we have small group discussion, we have alumni from the course who now work as TAs to provide each student with one-on-one attention if they need it. So if you want to buy residential rental property in the U.S., this is a comprehensive course that will get you prepared for that. To find out more, you can go to afford anything com slash enroll and sign up for our VIP wait list. And again, the doors open for enrollment on May 18th and close on May 25th. Thank you so much for tuning in. If you enjoyed today's episode, please share it with a friend or a family member. As I mentioned, all of the data that I cited in today's episode comes from a report called the U.S. Housing Market Health Check by Nima Wedlake, Principal at Tom Vest Ventures. We will link to this in the show notes.

Show notes are available at Afford Anything.com slash PSA Thursday. Thanks so much for being part of the Afford Anything community. I hope that you are staying safe and healthy in this time of pandemic. And at all times, make sure that you hit subscribe or follow in whatever app you're using to listen to this show so that you don't miss any of our upcoming episodes. Because we have some great stuff coming up ahead. And with that said, I will catch you in the next episode. Take care until then.