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Friday, February 23, 2024

A Window Of Opportunity Emerges

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If you’re looking at buying a house in 2023, I believe a window of opportunity has emerged. Let me share the reasons why with some background to start.

In my 2023 housing predictions, I forecasted an 8% decline in the national median home price by around summer. The reasons include:

  • Higher mortgage rates
  • The Fed’s insistence to hike the Fed Funds terminal rate to 5% – 5.125%
  • A bear market in the S&P 500 and NASDAQ in 2022
  • A potential recession

Latest Housing Price Situation In 2023

Due to the above factors, housing price appreciation has indeed slowed.

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According to Redfin, the median U.S. home sale price fell 3.3% in March to $400,528, the largest year-over-year drop since 2012. That follows February’s 1.2% dip, which was the first annual decrease since 2012.

Median home price appreciation rate 2023

The slowdown in housing price depreciation was an inevitability given how aggressively homes appreciated in 2020, 2021, and 1Q 2022. A 5% annual housing appreciation rate is more par for the course.

But the tricky thing about measuring national home prices is that it is not an exact science. Nobody knows exactly what the national median home price is.

Median Home List Prices

For example, here is the median home list price for single family homes according to Altos Research. It shows the median asking price of $439,900, still up fractionally year-over-year.

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Here is the St. Louis Fed data, which only has data through Q4 2022 so far. However, I bet when the 1Q2023 housing price data comes out, it will show a dip. The housing market has been frozen since October 2022 until now.

median sales price of houses in America, St. Louis FRED

Home Price Changes By State In America

Based on the Zillow Home Value Index, home prices have declined the most out west, but have stayed stable or even increased slightly out east.

Given I live in San Francisco, I may be seeing more deals than those of you who live in Virginia, for example. More deals will, therefore, bias my outlook about buying a house in 2023. So please take this situation into account.

regional home price changes in America 2023 - Zillow Home Value Index

The Default 10% Discount Mentality When Buying A House

Here’s the thing. Whether you’re buying a house in a bull market or a bear market, your default mentality should always be to try and get a discount to market. My mentality has always been to aim for a 10% discount and settle for around a 5% discount.

A saying that captures this mentality well is, “Money is made on the purchase, not on the sale.” The ability to negotiate is one of the main reasons why I like buying real estate versus stocks.

Here are some strategies I’ve written about on Financial Samurai:

There are so many things a real estate investor can do to get a better deal. As minority stock investors, we can’t effect change. However, as real estate investors, we can also remodel, expand, market, and find new tenants to enhance the value of our properties.

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If you want to buy a house in 2023, start with a 10% discount mentality from last year’s prices and see what you can find. It’s no different than in 2022, starting with a 10% discount mentality to 2021’s prices and so forth.

A 10% discount mentality is the sweet spot because it’s not so low as to insult the seller. It’s also low enough to make the buyer feel like they’ve gotten a good deal. To make a successful transaction, all parties must feel good about their decisions.

Why A Buying Opportunity Window Is Open In 2023

To quantify my buying opportunity conviction, I give 2023 a 6.5 out of 10, with 10 being the highest conviction score. In comparison, my buying opportunity conviction in mid-2020 was an 8.5 out of 10, which turned out to be a 10/10 in retrospect.

In other words, 2023 is not a table-pounding buying opportunity, as we used to say on Wall Street. But my conviction is strong enough that I do think buying now will lead to a positive outcome, especially the greater the discount you can get.

I’m personally on the hunt for a nicer home because I have children. And the best time to own the nicest house you can afford is when your children are living with you. But I’m not going to buy another home unless I feel like I’m getting a good deal.

Here are the reasons why homebuyers should have more confidence in buying a house in 2023. These are my reasons why I feel it’s safer to go back into the water.

1) Pent-up Demand And Growing Cash Balances

Thanks to a surge in mortgage rates, the housing market has essentially been frozen since October 2022. As sellers don’t want to give up their sub-3% mortgage rates and buyers didn’t want to pay 7%+ mortgage rates, both parties decided to take a wait-and-see approach.

Seven months of lower-than-average monthly transactions ultimately leads to pent-up demand for housing. Housing inventory in 2020, 2021, and 2022 was already tracking below pre-pandemic levels each month. The longer there is pent-up demand, the more capital will ultimately be unleashed into the housing market.

While potential homebuyers wait, they’ve been buying 3-month Treasury bills and earning higher money market deposit rates. But the good times for high risk-free rates is ending. Hence, money will start looking for new investments.

Meanwhile, people were still getting married, babies were still being born, and families were still relocating for jobs as they waited for the economy to settle. Therefore, the “need to buy” has been building as well.

new housing listings single family 2023, 2022, 2021

Personal situation on cash

Since the beginning of 2022, I’ve been jacking up my saving rate in preparation for another recession. Further, I’ve invested the majority (60-70%) of my cash flow and savings into Treasury bonds as rates went higher. The lure of 4% – 5%+ risk-free returns has been too great to ignore.

With the remaining 30% – 40%, I’ve been buying stocks and private real estate funds. In general, I am always dollar-cost-averaging into risk assets every month. It’s just the percentage split and the amounts that change.

As a result, I’ve accumulated the most amount of cash plus Treasury holdings I’ve had in the past five years. This large cash hoard enables me to be a competitive buyer for another home. Meanwhile, I can easily dollar-cost-average into Fundrise and public REITs in the meantime.

Homebuilding stocks like DR Horton, Toll Brothers, and KB Homes are significantly outperforming the S&P 500. Another indicator of the strong demand for homes this year. However, VNQ, the Vanguard Real Estate Index Fund has lagged.

existing home sales months supply NSA 2023

2) The Stock Market Has Rebounded

At the time of this post, the S&P 500 has rebounded by ~8% and the NASDAQ has rebounded by ~16%. As a result, investors are feeling richer.

After closing -19.6% in 2022, plenty of investors and Wall Street strategists were worried about 2023. The median S&P 500 forecast was ~4,033 on the S&P 500, while many strategists predicted 3,900 on the S&P 500 or lower.

With better-than-expected stock market performance so far, not only are stock investors feeling richer, but they are actually richer on paper. As a result, there should be a higher propensity to buy real estate given stocks and real estate are correlated.

Real estate prices generally lag stock prices by about six months. And the Oct 12, 2022, bottom of 3,577 in the S&P 500 was a little over six months ago. Although there are doomers like Mike Wilson from Morgan Stanley who believe the S&P 500 will collapse to 3,000, I think this scenario is unlikely to occur.

As a result, buying real estate from April 2023 onward is looking like a safer bet. You get the benefit of being able to buy at a 5% – 10% discount, despite the S&P 500 having already rebounded by ~8%. If the S&P 500 stays flat, six months from now, you may experience real estate price appreciation as the real estate market catches up to the stock market.

Personal situation on stocks

My stock portfolio has rebounded along with the stock market. As a result, I feel calmer and richer. I now want to convert more funny money stocks into real assets to better preserve my wealth. It feels like I’ve been given a second chance.

I’m reducing my public stock exposure from ~30% to 25%. For the past 10 years, my exposure range has been between 25% – 35%. I will reinvest the 5% into real estate, other hard assets, and Treasury bills yielding 5%.

There is an artificial intelligence boom happening in the SF Bay Area which will bring in more homeowner demand again. The earnings results from big tech have been coming in better-than-expected, as tech stocks continue to rebound.

3) Mortgage Rates Have Peaked And The Fed’s Rate Hikes Are Coming To An End

It is clear, summer 2022 was the peak of this recent inflation cycle. Meanwhile, the odds are greater than 60% the Fed will hike one last time in May 2023 and start cutting within the ensuing 12 months.

Homebuyers have been waiting to see how far the Fed will hike rates before buying. Now that homebuyers have greater confidence the Fed rate-hike cycle will end by summer 2023, the housing market will see a wave of pent-up home buying demand.

As a savvy homebuyer, you don’t mind paying a higher mortgage rate if you can get a greater discount on the purchase price. After all, you can always refinance your mortgage but you can never change your purchase price. As mortgage rates continue to decline in 2023 and beyond, there will be more purchase and refinance opportunities.

By buying a house in 2023, you get ahead of the curve if mortgage rates do indeed continue to decline.

U.S. CPI index inflation peaking

Personal thoughts on mortgages

I believe the long-term inflation and interest rate trend is down. Therefore, I expect CPI to reach 3.5% by end of 2023, and 3% by end of 2024. With declining inflation comes declining Fed Funds rates and mortgage rates.

Longer duration bond holders will profit. Meanwhile, the vast majority of homeowners who took out Adjustable Rate Mortgages from 2019 – 2022 will see insignificant upward adjustments in mortgage rates once the fixed-rate period is over.

For example, my 2.125%, 7/1 ARM I took out in June 2020 will reset in June 2027. I have zero worries about a potentially higher monthly mortgage payment. By 2027, at least 15% more principal will have been paid down to help buffer against potentially higher rates. By then, my total income should be higher as well.

adjustable rate mortgages as a percentage of total mortgage loans

Risks Of Buying A Home In 2023

Although a window of opportunity to buy a house has opened, there is no guarantee buying in 2023 will be profitable for you when you finally sell. Always do your own due diligence as investing is your decision alone.

My base case assumption is to buy now with prices down 5% – 10% and then ride a 5% – 10% recovery over the next twelve-to-twenty four months. Here are some risks to buying a home in 2023.

1) The Risk Of Another Recession

A deeper-than-expected recession will likely cause further declines in housing prices. But even the definition of a recession seems to be fluid. We technically already had a recession in 2022 with two consecutive quarters of GDP declines. We also had an earnings recession with two consecutive quarters of declines in earnings in 4Q2022 and 1Q2023.

To me, the key economic variable to look out for is the unemployment rate, which currently stands at 3.5%. If there are mass layoffs by year-end that bring the unemployment rate above 5%, then housing demand will likely soften.

A 5% unemployment rate will likely spook homebuyers into waiting again. Inventory will likely also increase given more people will need to sell their homes to pay their bills. If the unemployment rate gets above 6.5%, expect to see home buying demand dry up as budgets get cut.

unemployment rate

2) The Risk Of Another Stock Bear Market

It feels great to have rebounded off the October 2022 bottom in the S&P 500 and NASDAQ. Stock investors all feel better as a result. We feel we can spend more and buy more things we don’t need.

However, if the S&P 500 gets back to its October 2022 low of 3,577, then housing demand will likely stall out once more. And if the S&P 500 declines by more than 20% to 3,000, we can expect median home prices to decline by 10% – 15%.

I only assign a 20% probability the S&P 500 gets back to its October 2022 low of 3,577. But there is certainly a risk that it does. The bank runs provided a big scare and I’m sure there are plenty more banks with precarious loan books.

The positive of a much higher unemployment rate and another crash in the stock market is that Treasury bonds will get bid up. As Treasuries get bought, Treasury yields decline, and so will mortgage rates.

Hence, there is a counterbalancing mechanism during difficult times. There may also be a flight to safety as investors buy more real assets like housing as well.

Recession, Fed Funds rate, CPI

3) Inflation No Longer Declines

CPI peaked at around 9.1% in June 2022 and has since come down to 5%. There’s a risk CPI stays stubbornly high at around 4.5% – 5.5% given energy prices are rebounding again and consumer spending remains strong.

If CPI stays sticky from here, average mortgage rates will likely also stay range bound as well. Without the average 30-year-fixed-rate mortgage declining below 6%, there won’t be a tailwind to bring in more homebuyers.

But I assign only a 15% chance CPI doesn’t decline below 5% over the next 12 months. The biggest reason why is due to national rents rolling over.

Shelter accounts for about one-third of the CPI index and sixty percent of core CPI, which excludes food and energy. Given the CPI index is a lagging indicator, we can expect CPI and core CPI to come down even further.

Below is a chart that highlights rent growth compared to overall CPI. Where the Zillow Index and ApartmentList lines cross the rising CPI line shows that rents will bring down CPI in the coming months.

4) Risk In Commercial Office Buildings

The return to work movement is progressing, but it may not be as strong as commercial office building owners and lenders like.

A survey by Kastle Systems, a security company, found that the average occupancy rate of offices in 10 select cities was 50.4 percent on Jan. 25, 2023, the first time that occupancy has been more than 50 percent since March 2020. The cities surveyed were San Jose, Calif.; Austin, Texas; San Francisco; Washington, D.C.; Dallas; Los Angeles; Houston; New York City; Chicago; and Philadelphia. 

Austin had the highest occupancy rate last Wednesday at 67.7 percent, followed by Houston with 60.3 percent. San Jose had the lowest with 41.1 percent and Philadelphia was second lowest with 42.7 percent. 

Given more commercial office loans are floating, there is a risk some commercial office building owners will default on their loans if mortgage rates don’t decline far enough. More defaults mean more downward profit pressure on lenders. A wave of commercial office building defaults could cause more bank runs and tightening lending standards.

A Buyer Of Real Estate In 2023

In conclusion, I believe there is a favorable risk-reward ratio to buying real estate in 2023. The rebound in real estate prices won’t be quick, but I do believe median home prices will be higher by the end of 2024.

A housing crash is unlikely given the high percentage of homeowners who’ve locked in low mortgage rates or own their homes outright. The home equity cushion is massive compared to 2007. Almost half of mortgage borrowers have 50% equity in their homes.

If you’re waiting to get a steal in the housing market, you could end up waiting a long time. I know plenty of renters who’ve been waiting for 20 years now!

U.S. homeowner equity versa mortgage debt outstanding

Bargain aggressively and be willing to walk away from a deal. Don’t get emotionally attached to a home because there is ALWAYS another great home around the corner.

Follow my 30/30/3 home buying guide so you minimize your chances of blowing yourself up. Run a realistic worst-case scenario to see if you can truly withstand future downturns. Having buyer’s remorse feels terrible. I know after buying a vacation property in 2007.

If you plan to live in your home for at least five years, preferably ten, I think you’ll do fine. And if you don’t end up making money on your home, that’s OK too. At least you will have had a nice place to live all those years.

Reader Questions and Suggestions

Do you believe 2023 is a good time to buy a house? Why or why not? What are some other risks to the housing market recovery? How are you not putting your life on hold while waiting for the right house to buy?

Take a look at Fundrise, my favorite private real estate investment platform. Fundrise invests in single-family and multi-family homes in the Sunbelt, where valuations are lower and rental yields are higher. It’s easy to dollar-cost-average into Fundrise given the minimum is only $10.

For more nuanced personal finance content, join 60,000+ others and sign up for the free Financial Samurai newsletter and posts via e-mail. Financial Samurai is one of the largest independently-owned personal finance sites that started in 2009. 



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