REAL’S OCTOBER MARKET REPORT 2023
Prepared By Steve Curran
Hi Everyone, I hope that you are recovering from eating too much candy on Halloween! We have been on our street for 13 years so we have a pretty good idea on what our Trick or Treater headcount will be. That still doesn't mean you can't pick up an extra 50% just in case! Our local real estate market is still firmly entrenched in the "gridlock" that we discussed back in August. Neither buyer nor seller has any discernible advantage right now. I referenced back then, that for every positive scenario or statistic one could use to describe the market, it would not be difficult to counter it with an equally accurate negative statistic. The main change since August is that the statistics are now starting to lean towards the negative side of the board. Most notably, this has to do with mortgage rates piercing the 8.00% level and the subsequent impact on affordability. Let's take a look at the charts and numbers.
Since the end of summer, mortgage rates have continued to rise, reaching a 23-year high at 8.00%. This is one of the more powerful charts I have seen this year, that clearly summarizes the impact higher rates have on affordability. If mortgage rates are at 3.00%, 50 million households are able to qualify for a $400,000 mortgage. At 8.00%, that number is cut down to 22 million. Just since my last update, 5 million households have been priced out of a $400,000 mortgage.
As you might suspect, the correlation between mortgage rates and pending home sales (homes under contract) are very strong. If you remove the drastic drop in pendings during the Covid lockdowns, you can clearly see how closely they follow one another.
This also holds true with the number of home purchase mortgage applications banks and lending institutions are currently processing. The number of applications are back to levels not seen since 1994, the year that Ken Griffey Jr would have broken the home run record if not for the baseball strike! Of important note, this index is not adjusted for population. The population of the United States is currently estimated to be 335 million. Back in 1994, it was estimated to be 263 million. The same number of mortgage applications and 72 million more people, wow.
Well, if home affordability and pending sales are falling, surely home prices must now be falling as well, right? The short answer is no and here is why. That pesky supply and demand phrase you have heard me mention 137 times in recent years has come back into balance. Yes, there are fewer buyers than in recent years, however inventory levels, especially locally have also declined keeping the balance between supply and demand pretty even. The two charts below illustrate why. Chart #1 shows the number of existing home mortgages by interest rate. Look at how many mortgages have a rate at 4.00% or lower. Chart #2 shows the historic gap between today's effective interest rate on existing mortgages of 3.60% (blue line) and current mortgage rates (red line). This is why supply is so low: very few people are going to give up their 3.60% mortgage rate to replace it with a rate of 8.00% unless life is dictating that they have to move.
This is one of the more important charts today, not just for real estate but all aspects of economics. For close to 40 years, the rate on the 10-Year Treasury Yield declined. This rate is the benchmark for all types of interest rate products and investments, including mortgages. This is the annual interest rate that you will be paid if you loan your money to Uncle Sam, widely considered one of, if not the “safest," investments there is since it is backed by the full faith and credit of the United States. Now that rates have risen over the past two years and the 40 year downtrend has been broken, are we in a new era of "higher for longer" rates? We have discussed how higher rates have impacted mortgage demand, but what about smaller companies that need access to credit like tech startups? How does this impact auto loans and credit card rates? The change in the trend of the 10-Year Treasury Yield could be one of the defining themes for years to come.
The 10-year Treasury Yield impacts all forms of real estate investing: single family, multi-family, and commercial. The "Cap Rate" is the expected annual rate of return on an investment property. With the recent rise in Treasury and CD rates, it is now possible to get a similar annual rate of return from Treasuries or a CD (Certificate of Deposit) account at the bank than from owning an apartment or commercial building. Why would someone buy an apartment building expecting a 5% rate of return when the Bank will give you that same rate.....guaranteed?
Finally we conclude with the updated Case-Shiller 20-City Price Index. This is one of my favorites to reference because it measures price performance over both short and long term periods. As you can see, over the past 20 years, no market has outperformed Seattle. If only that were the case for the Mariners........sigh.
I am a big believer that financial markets often try to deliver you a message, if you are willing to be quiet (I know, I know) and listen. If you had told me on January 1st of this year that mortgage rates were going to rise another full 2% and reach 8.00% I would have felt strongly that real estate prices locally would have fallen 10% this year. I would have believed that not enough buyers would be able or willing to qualify at 8.00% rates and even though inventory would surely decline, there would still be enough sellers that needed to move, thereby pushing prices lower. As you can see, that prediction would have been wrong, just like my Mariner's prediction(s). Frankly it is pretty amazing that prices locally are close to flat given the continued rise in rates. So where does the market go from here? In the short-term, it is highly likely that both the local and the national real estate markets will have a very quiet November and December, a combination of seasonal factors and 8.00% rates. The trillion dollar question (pun firmly intended) will be, “How does the seasonally strong Spring market behave?" Who caves first, on the fence buyers or sellers? What happens if rates rise to 9.00%? What happens if they drop to 7.00% (or 6.99% in real estate broker speak!). The message the market is currently delivering is that despite the declines in real estate activity, residential real estate prices have been very resilient in the face of mounting negative data. I will do my best to keep quiet (as best I can.....) and listen so I can accurately report what is actually happening in the market, so you are not just left reading noisy headlines. Wishing you the start of a wonderful Holiday Season! Go M's, Hawks, and Cougs, Steve