Last week, real estate firm Zumper reported that rents in Boston had jumped 20% year over year. The median cost for a one-bedroom apartment now sits at $3,060 — a figure that would consume 45% of a median worker’s salary, or afford about 340 servings of avocado toast.
Renters have responded by hoping… even praying… for a real estate crash. Online searches for the term have quadruped in 2022, and even faith groups are stepping in to help. (Perhaps the Satanic Temple will be next?)
Yet, the prospect of a housing crash has made things worse, not better, for homebuyers. Weakening prices, declining inventory and higher mortgage rates are now all saying the same thing:
Investors should wait until 2024 to buy a house.
Housing Crash 2023: Careful What You Wish For
In mid-October, I warned investors how wild housing prices had become. The median American home now costs around $450,000, up 60% in real terms since 2000. And 31% of women and 37% of men between ages 25 to 29 now live in multi-generational households… a phenomenon also known as “living with Mom and Dad.”
These are the same types of observations that drive my quantitative stock-picking method. When current data gives a poor probability of future returns, it’s better to fold your hand than hope for the best.
Since then, the probabilities have begun to play out as expected. Despite Boston’s surge in rental prices, the sale value of homes across the U.S is finally on the decline. Two weeks after my initial warning, real estate platform Knock reported that 98 of the top 100 U.S. real estate markets saw prices drop from their spring 2022 peaks. Knock expects that Austin, Texas will see a drop of 9.3% through 2023, while Las Vegas will experience an even larger fall of 14.2%. This is why I rely so heavily on my quantitative systems.
These figures are compounded by mortgage leverage, a hidden source of home equity volatility. The average mortgage debt now stands at over $230,000, according to credit firm Experian, suggesting that homeowner equity has shriveled by 20% to 25% this year.
But much like stock markets, real estate prices take time to reach fruition. Prices can overshoot for months, and then undershoot for even longer. During the 2008 financial crisis, investors needed to wait an additional two years for home prices to start recovering. And in 2022, they’re only now starting to react to rising mortgage rates. History suggests that home prices will continue weakening through 2023 before rebounding in 2024.
Much of real estate’s pricing lag relates to home seller psychology.
“The ‘downside stickiness’ of house prices is unique,” notes Mark Fleming, chief economist at First American. “In the housing market, sellers often withdraw supply rather than sell at lower prices.”
Unlike equity investors, homeowners can live in their assets while waiting for better prices.
Another factor is the relative illiquidity of the real estate market. The average home takes 100 days to sell, split between time spent for listing and closing. By the time a home’s final sale price is made public, several more months may have elapsed.
But no matter the reason, one thing is clear:
Home prices have further to fall in 2023.
Insiders Are Foreshadowing Lower Home Prices
Nowhere is negative sentiment clearer than at America’s largest homebuilders, the bellwether of the residential real estate market. On Oct. 25, CEO Ryan Marshall of PulteGroup (NYSE:PHM) warned of “softness” in homebuying demand.
“The pullback in [Q3] demand was widespread across geographies and consumer groups as potential home buyers move to the sidelines,” Mr. Marshall noted. “Some because they can no longer afford a home and others because they were unsure if now [is] truly the best time to buy a home.”
The company has responded by drastically cutting production targets for the remainder of the year. PulteGroup has already walked away from almost $800 million of future land acquisition spend, and reduced its guidance to closing 8,000 homes in Q4.
These cutbacks are not enough. The average time that homes spend on markets has risen 60% since May and housing inventory levels are now as high as in September 2007.
The overoptimism will spill into oversupply. PulteGroup’s 8,000 expected home closings in Q4 marks a 13% increase over its Q3 figures — almost twice as high as its usual Q4 boost. Unsurprisingly, the largest U.S. homebuilders earn relatively poor scores on my Profit & Protection scoring methodology, especially in the areas of growth and momentum.
|Ticker||Company Name||Growth Score||Value Score||Quality Score||Momentum Score||Total Score|
|DHI||D R Horton||C||A||A+||B||B+|
Mortgage Rates Will Fall by 2024
First-time homebuyers are also facing peak mortgage rates. On Oct. 26, average 30-year mortgage rates in the U.S. passed 7% for the first time since 2002. All else equal, the typical 3-bedroom homebuyer can now only afford a 2-bedroom in the same market. Put another way, a $500,000 mortgage now costs $3,509 per month, up from $2,068 last year.
The yield curve, however, suggests that these rates will fall by 2024. 1-year Treasurys now trade at over a 50-basis-point premium to 10-year bonds, compared to a more typical 150-basis-point discount. All else equal, credit markets are now forecasting anywhere from a 1% to 4% drop from current rates.
As for refinancing, homebuyers are also better off waiting. Refinancing can cost up to 6% of the remaining principal of a loan, adding risk to buying an unaffordable home today with the hope of refinancing down the road.
In other words, unless you’re a real estate investor looking to rent out properties for income, volatile mortgage rates are saying to rent a cheaper apartment now and consider going back into the market in 2024.
Stocks vs. Real Estate: Why Investors Should Buy Stocks Instead
Meanwhile, prices of non-real-estate stocks are already bouncing back. Today, I released my list of 23 top penny stocks to buy. Unlike housing prices, penny stocks are early movers relative to Fed policy, rather than laggards. Some of my new picks are already up double-digits in the past month — and it’s not even Christmas yet.
A similar move happened in March 2009, when stocks began to bottom out. It would take housing prices another two more years to begin their slow recovery, an eternity in the investment world. It’s why my quantitative Profit & Protection system has begun to favor penny stocks instead of anything related to real estate.
Consider Sabre (NASDAQ:SABR), one of the four firms that operate a global oligopoly of the Global Distribution System, a network of programs that control airline and hotel bookings. Shares of the Texas-based company have fallen from $15 in 2021 to under $6 today, placing it squarely in value territory.
Yet, the firm has continued to earn a solid A+ for quality in my stock-picking system. Analysts expect that Sabre will generate $100 million in free cash flow by 2023 and for revenues to return to pre-pandemic levels by 2025.
A similar story is brewing for companies like SoFi (NASDAQ:SOFI), a firm that saw shares plummet 75% over the past year. Though the company isn’t as cheap — earning a B+ in that category — its bank-like status makes temporarily high rates a good thing for net interest income.
I get it. Renting is awful right now. But the alternative of buying is far worse. You’ll either end up with an unaffordable home, or a cheap one that’s too small for your needs. Best to keep praying that the housing crash will soon end.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.