Bubble Probably Not. Am I Still Concerned Yes

Between reading The Denver Post article concerning record low inventories, visiting listings and chatter at open houses we seem to be in a Goldilocks period for home sellers and a Draconian period for buyers.

I will be the first to admit there is a severe lack of inventory at all price levels which based on the laws of supply and demand will raise prices. Thus why should I be concerned? As a broker I should be thrilled! Let me preface the following with the disclosure that my market niche is deluxe and luxury.

Irrational Pricing and Exuberance: Last week I went to look at a listing in a very in-demand neighborhood in Denver where average prices are triple of the average of the Metro area.The house I felt was priced on the upper-end of the Per Square Foot for the neighborhood. Granted great location, well-kept yet some design issues and so forth (yes no house is perfect). Within 2 days of my visit I received a note from the listing broker advising the sellers recieved a strong offer and if my client were interested, they needed to get an offer in ASAP. My client and I both felt the house was not for them and it was in our humble opinion overpriced. 5 days later I receive a notification from our MLS service that the house which received a strong offer suddenly had a price reduction.

Even earlier today I went to a public open house. The house was not correct for my client i.e. larger lot than they desired; however there was the appeal of some unique features including a carriage house and the perfect 1st level of entertaining. As assumed the house was not for my client. The 2nd level was two bedrooms with a shared jack and jill bathroom. Thus realistically a two bedroom house. Basement was OK, nothing out of the ordinary. The carriage house, while a rare amenity was basically a dated studio sized apartment and advertised as the 3rd legal bedroom (I saw income rental potential both long-term and transient) .

The Open House was packed. I heard one of the brokers mention the listing already had 15+ scheduled showings before the open-house . Yet across the street were two houses which sold last summer, comparable size, more conventional bedroom layouts, slightly smaller lots and more traditional design. Both sold for almost half of what the listing price on this listing. Now I am not suggesting the larger lot and carriage house would not increase the value, yet by double? Coupled with limited bedrooms, unconventional design and double the price in one year, sustainable? Probably not.

Are Stock Market Paper Gains Sustainable? It is no secret the stock market has been hitting new records and the market usually looks to the future; thus we may believe the overall economy will continue to expand. The Federal Reserve believes so i.e. advising a rise in interest rates is forthcoming. However is a sell-off in the immediate future?  Most real estate brokers know a downturn in the market also challenges confidence concerning real estate purchases as the wealth effect is psychologically proven.

Interest Rates Will Continue to Rise: Interest rates can only go up assuming no major shock to the overall economy i.e. war, terrorist-attack. Granted we have been within a historically low interest-rate environment for way too long. The low-interest rates naturally raised housing prices as many buyers were purchasing a payment and not necessarily underlying equity. Yet this is a dangerous precedent. Except in markets with rampant inflation; in general higher interest rates translate to lower housing prices as the cost to borrow money increases.

This is worrisome; as interest rate hikes usually impact the first-time home buyers, yet the ripple effects can impact all facets of the market as move-up and move-down buyers are also impacted concerning the distribution/inventory within the overall system.

A healthy housing market is usually considered fluid corresponding with life and circumstance changes. When supply and demand is disrupted and housing becomes challenging to either acquire or sell, the ripple effects are felt within all aspects of the local economy. Few may remember the late 1980’s in Denver when the HUD Foreclosures insert in the Rocky Mountain News was literally as thick as the newspaper it was included in. More recently between 2007 and 2009 For-Sale signs dominated the landscape during the “Great Recession”. Those buyers will eventually be sellers, sooner than later?

Investors Having Realized Gains Begin Selling: One of the reasons we have such low inventory is from past investor activity plowing cash into the housing market during the tail-end of the Great Recession. However with recent gains in the stock market, higher interest rate yields in fixed-income markets and weakness in some rental markets do not be surprised if those investors having enjoyed equity appreciation and now having owned long enough to just pay ordinary capital gains on appreciation we may see investors begin to relinquish their inventory sooner that later.

Reduced Equity Can Happen: For buyers who purchase at the top or pinnacle of the market cycle the ramifications can be challenging. One of the hallmarks of the Great Recession was the Negative Equity associated with many purchases made at the top of the market assuming housing prices do not go down. Granted I am advising clients if they plan to stay in residence for 5 years or more they usually can ride out a cycle. However if one is purchasing investment property at present, my more experienced clients are literally selling or sitting on the sidelines and looking at alternative investments.

Fix and Flips Less Common: With the boost in prices, fix and flippers are having challenges fining acceptable inventory and foreclosures. While this may be a sign of a healthier market the ripple/multiplier effect can be worrisome i.e. general/sub contractors, building material suppliers, retailers such as Home Depot and Lowe’s and so forth may be challenges ahead. While the service economy may continue to hum along, blue-collar trades and related industry may be challenged.

The Next 12-18 Months: While I do not have a crystal ball and I have been told I am a pessimist I do have the luxury of the knowledge of history having been in the real estate trade since the late 1980’s in Metro Denver. I do not believe business cycles have ended and while at present demand outstrips supply, I do not believe this market is sustainable. What I feel we need to look out for is as follows:

Challenges to the Luxury Market i.e. $600K and Above: The luxury market is usually the first markets to show weakness. Due to the uniqueness of the market i.e. cash buyers, not necessarily dependent on income ratios, experienced buyers and sellers, this is where I would watch for issues pending. If we suddenly see an influx of luxury listings hitting the market and absorption slows, this to see is a signal that astute and more experienced buyers are sitting on the sidelines waiting for prices to correct somewhat.

Glut of Deluxe and Luxury Condominiums: Based on underlying ground prices new condominium construction is usually oriented to the deluxe and luxury buyer.  However what are the depths of this market? Seeing the skyline of Cherry Creek and Downtown leads me to be a bit concerned. Denver for the most part has been a home market. Yes the aging population may desire condos for the ease of maintenance and younger buyers may desire condos for the same reason. However younger buyers may begin having families; will they remain in the condos or eventually sell or place on the rental market. With the majority of new construction in the one and two bedroom range, these condos are not oriented towards emerging families or longer-term retention.

Rent Prices Coming Down Incentives Increase: Part of the downturn in rental rates is due to the glut of luxury rentals. Cherry Creek is a perfect example (just look at the east-side of the Steele Street and 1st Avenue intersection); the same trend is happening in Downtown. Is our influx of millennial and others with disposable incomes sustainable?  Are these renters now suddenly purchasing? Yet with low inventory it’s a challenge.

We shall see what the traditional Spring Selling Season brings to market. Will there be a controlled flow of inventory hitting the market or will we witness a glut or continued tightness i.e. lack of inventory.

If I were considering selling, I would be placing on the market immediately to take advantage of the low supply and high demand. With interest rates on the rise future prices will be challenged. While interested rates on borrowing money continues to be attractive, lower rates will not last forever (when I purchased my residence in 1989, I paid 12% interest on a 15 yr. mortgage with 20%+ down-payment!).

If I am a buyer and I had the option I would probably sit on the sidelines and consider renting for the immediate future. Granted if one’s dream home hits the market, go ahead and purchase it. However if settling or to purchase just to purchase, I would suggest take a step back and reassess and take the emotion out of the process.

 

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