Closing on a home and officially entering the real estate market as a homeowner is like that moment on a roller coaster when you’re buckled in, you’ve lowered the bar, and coaster is slowly pulling away from the station with nothing but open track ahead of you. If home values are the track we’re riding on then we’ve spent the last ten years climbing the first hill. That is until last year when we crested the top and, for the first time in a long time, started rocketing down the other side.
The fun part about this particular ride is that we’re basically in the dark and it’s hard to tell where the track will take us next. We know there will ups and downs and a few turns that press us into our seats but most importantly, we know that we’ll make it back to the station again safely.
In other words, it’s our understanding about the larger picture that gives us a sense of security and allows us to embrace the uncertainty. This isn’t just a convenient analogy – it’s the perspective we need as homeowners to be able to stomach the natural volatility of home values.
First, some context
The second half of last year saw a massive halt to real estate activity in our area. The Federal Reserve acted aggressively raising the Prime Rate in order to combat extremely high inflation resulting in mortgage rates more than doubling in a span of months. When inflation is high, our dollar doesn’t go as far – people spend less, business suffer, employment increases and the economy suffers.
Combine that with fears of the economy diving head first into a recession, and the real estate market came to a screeching halt. Home sales all but stopped and, for the first time in a long time, we began to see price reductions, homes sitting on the market, buyer hesitancy – the tell-tale signs of a significant market correction on the horizon.
Fast forward to today and over the past six weeks, interest rates have not only stabilized, they’ve dropped from their high of over 7% to closer to 6%. The Fed has signaled that they’ll be less aggressive going forward and the economy seems to be stabilizing as long-term fears of a deep recession are waning.
The result? The number of homes on the market has dropped, buyer activity across most price range are back with a vengeance and roughly 70% of homes being listed are going under contract within the first week; many with multiple offers.
The challenge here is that the real estate market in our area has appreciated at an enormous rate over the past decade due in large part to the historically low rates we’ve seen since pulling out of the 2008-2010 housing crisis. This means that when volatility hits, we are going to feel it in very a big way. Next month I’ll be writing about the 30,000 foot view of the current market followed in April by a closer-to-home analysis of the first quarter locally. In the meantime though, I think it’s important to first shift our perspective, and hopefully allay some fears, around what it means when home values fluctuate.
Short-term vs. Long-term value
My first rule of value for real estate is that it is time-based. Why? Because market values change constantly. For those of us working in the market, and for anyone actively buying and selling, it’s much easier to see and feel what’s happening on a weekly and monthly basis but for most homeowners, it’s difficult, if not impossible, to keep a real time connection with the pulse of the market.
However, even though we’re riding the waves, the data is always well behind the curve because homes take 3+ weeks to sell. That means, at best, our “real-time” data for what buyers are willing to pay, is at best 30 days old at any given time.
This means, that to determine your home’s value, the best we can do is take a snapshot in time that reflects all of the different forces at play on the price of your home at that time. Yes, interest rates play a big role but so does everything else impacting that market. Consumer confidence, our local, state and national political cycles, natural disasters, instability in the geo-political environment, schools, crime, unemployment, technology, and the list goes on.
FYI – this is why, IMHO using statistics for predicting the market is dangerous. A historical market trend may look similar at face value but the forces at play now will always be significantly different than those in the past. It’s like using a photograph of you as a kid to predict who you would become as an adult. All the photo can accurately tell us is who you were when the picture was taken. There’s no way it could have predicted everything that would happen during your life to shape who you are today.
Short-term value is largely driven by what we think and feel because that is what informs our decision making and, consequently, supply and demand. The market is really just a response to what is going on around us. COVID forced companies to solve the virtual-workforce challenge in a hurry so now we can keep our jobs and work from anywhere? Colorado here we come! There are so many people here now who need homes but we don’t have enough so appreciation is skyrocketing? We better move while we can in case this continues and we’re eventually priced out. And on it goes until something shifts.
And shift it will. As interest rates increase, buyers drop out of the market thereby lowering demand. Some people will still need and want to sell their homes but with less buyers, homes will spend more time on the market and supply will increase. For those buyers still in the market, more to choose from means softer prices as sellers are forced to be more competitive and prices soften. Although rates have dropped a bit and we’re seeing stability, the cost of money is still significantly higher than it has been and it looks like we’re not too far away from our new (and historic) normal of 5%-6%.
Here’s the conundrum: at the heart of any shift in short-term value are buyer’s expectations. When the cost of money rises, they are getting less home now for the same cost and that doesn’t feel good. For many, it’s not that they can’t afford the same monthly payment or they can’t buy a house at all, it’s simply that the same payment will no longer buy the house they want and have come to expect they could get. Definitely a bit of a kick in the teeth after buyers have already been grappling with the same changing expectations because of rapidly increasing home prices over the past six years – now the cost of buying those homes is higher too. Ouch indeed.
Long-term value on the other hand is mainly driven by location which works in our favor. We live in a highly-desirable area here on the Colorado front-range, largely because of the natural setting but also because our local economy is driven by a diverse mix of industries. Other areas that are heavily reliant on one industry are more at risk of decline if that industry shifts. Factories close, people leave in search of jobs elsewhere, local economies fail and real estate values are wiped out.
We foothills dwellers have the opposite problem – we want to be here for the lifestyle it provides AND we have many different industries that contribute to our economy so generally employment opportunities are abundant, unemployment is low, and our supply of housing will, by nature, remain relatively scarce; all of which support property values.
This is why the value of the house my parents bought when I was a year old, has doubled no less than seven times in the past forty plus years – through various economic downturns, environmental disasters, recessions, and the like. Why? Simply because people still love living here.
But there’s no way it will double again right? Really? I guess I’m not so sure. Every time I hear someone proclaim this as fact I wonder how many times people in areas like San Francisco have said the same thing. Even with some questionable statistical analysis (aka “fuzzy maths”) it’s very difficult to find any 10-year period over the last 40 years where home prices in our area haven’t outpaced both average inflation and the national average for appreciation. Most of the time we’ve done far better. At the very least, I think we can say that the long-term value of our real estate is a relatively safe bet.
That’s all fine and good, but what about the value of MY home?
Here’s the thing: value is only tangible at two times while you own a home – when you buy it and when you sell it. As long as it’s worth more when you sell it than when you bought it, you haven’t lost any actual value. In fact, you’ve increased your wealth as long as the difference in value has outpaced inflation.
Are there times throughout the life of owning your home when you may have been able to get more for it? Probably because the potential value changes constantly with the market. However, it doesn’t become actual value until you actually sell it and have the money in-hand.
So then why doesn’t everyone sell when the potential value is highest? Because there are so many tangible and intangible benefits that we get from owning a home apart from the financial benefit. This is what makes residential housing a unique asset class. Homes provide shelter thereby meeting a basic need. They give us a place to gather or to be alone. They provide safety, community, comfort, enjoyment, emotional security, hope. Whether consciously or not, all of this factors into your decision of when to buy and sell making is a far more complex decision than it is for other investments.
Our answer to whether your home is losing value comes down to one thing and one thing only: will it be worth more when you sell compared to when you bought it?
In the past, the homes in our area which have lost value are those that were purchased in rapidly appreciating markets and then sold soon after those markets corrected.
This is the single best way to describe the loss of values during the housing crash of 2009. Essentially, the loss of value was caused by a large number of people that had no other option – they HAD to sell.
The less exciting story from that time, which most people don’t talk about, is that the vast majority of homeowners simply stayed in their homes and prices eventually recovered as they seem to be doing now after only a few months. For the vast majority of homeowners in our area during the Great Recession, their homes didn’t lose any actual value, they just had a period of about three years where they didn’t gain anything.
What about the opportunity cost during this period? If you had the means to invest the same money elsewhere for a better return then there was likely an opportunity cost. However, remember that we’re talking about people’s homes here, not an under-performing stock. It’s difficult to imagine you selling your home solely based on its financial performance especially if it is your primary residence. Long story short – if you’re concerned about losing value, the best strategy is often to sit tight until things even out and the potential value recovers.
I’m not planning to sell but what if that changes?
If you bought in first part of 2022: First of all, you didn’t make a bad decision, you made the best decision you could with the information that was available. This market shifted far quicker than anything we’ve seen in the past twenty years and that includes when we shut down for COVID in early 2020. It might seem like your timing was off but again, remember that we’re not day trading here. You made the move because of life, not just because of an investment. It may take a few months yet to get to a point where you’re seeing some appreciation so settle in and enjoy the fact that you are where you are. If you need to make a move in the short-term we’ll still have options.
If you bought in the last two years: You likely have some equity but more importantly you likely have a loan with a low fixed interest rate. Hopefully you like where you are because you’re well positioned to sit tight and enjoy your home plus you’ll still have some flexibility if it’s time for a change. In fact, it may tough to consider a move because of what it will cost. More on this “lock-in” effect next month.
If you bought prior to the start of COVID: you’re likely sitting on some pretty solid equity, have a low-interest loan, and have quite a few options. You’re ideally positioned to take advantage of the softer times in the market if you decide it’s time to make a move or invest in a rental property.
Many of you have heard me say this but real estate markets are truly hyper-local. Market conditions can be vastly different, not just city by city, but can vary significantly from one neighborhood to another, by price segment within the neighborhood, and even based on how one home, its lot, improvements, finishes, layout, and condition compare to the home next door.
As a quick aside – this is why a certain company’s algorithm’s for estimating home values is largely unreliable and caused their home buying and selling program to lose hundreds of millions of dollars in one of the most seller-friendly markets we’ve seen in decades. Okay, I’m off that soap box…for now.
It sounds clichéd but each piece of real estate truly is unique. And every house is a home, even if it’s also an investment. That gives it value. The fact that it’s located here gives it even greater value. Markets will fluctuate and with it, potential values will change. Change breeds insecurity and tapping into that insecurity sells subscriptions, entices clicks, engages readers, keeps people from changing the channel, and keeps you scrolling through social for hours on end.
The best advice I have is to breathe deep, stay focused on the bigger picture, and if you need help or simply want to explore where you’re at, that’s what I’m here for.
Until next time! -S