By Diego Bravo - Realtor® on March 8/2022

Since early 2020, we all have read articles and watched TV interviews and YouTube videos of people predicting that the US real estate market will be crashing “soon”. These authors have been pretending to be able to foresee the future based on analyzing previous economic cycles like the financial crisis from 2007 to 2009. Some of them seem to be honest wanting to warn the public about what they believe will happen. However, in most cases it is easy to notice their underlaying intentions of trying to benefit themselves by creating fear and confusion to potential real estate buyers: some, intending to gain popularity with their alarming presentations, for example, to increase the number of visits to their blogs or views to their social media channels. Others wanting to persuade their audiences to not purchase real estate but, instead, to invest in what they have to offer (e.g., stocks or other forms of trading, bonds, commodities, precious metals, minerals in high demand, or cryptocurrencies).  

In this article, I will share some facts that may help you understand better what is happening with the current real estate market in the United States, so that you can draw your own conclusions and make more informed decisions.

Disclaimer: This article is solely intended for informational purposes and in no way constitutes legal or financial advice. Each person should analyze their particular situation to determine if the information presented here can be applied. Looking for financial advice is recommended before making decisions!

FACTS ABOUT THE US REAL ESTATE CRASH AND FINANCIAL RECESSION OF 2007

Let’s, first, review some history. In October 1981, the 30–year mortgage interest rate reached to a ridiculous high of 18.45%. From then, the rates started to get lower gradually over the years, reaching 5.23% in 2003. Additionally, the Federal Funds (Interest) Rates reached 0.86% the same year. Therefore, instead of keeping their cash in the banks, developers started building new houses throughout the country and buyers decided to acquire their homes by using mortgage loans with the affordable  interest rates of those times. In the next years, interest rates started to increase slowly, which created a frenzy within buyers who wanted to get their homes and additional investment properties before the interest rates got too high. What made them think this? The economy forecasters that always swear everything is an infallible repetitive cycle. Their saying is, “after the trend is up, it goes down; and after the trend is down, it goes up; and generally returns to the same values”. So, if the interest rates in 2003 had been the lowest in past 22 years, it could be argued or predicted that they were supposed to go high again, even to the previous 18.45% from 1981 and, thus, buying houses when it was still affordable was the logical decision.

Therefore, an incredible high number of buyers were applying for loans to buy houses before the crisis. Some banks took advantage of their many clients through various lending unethical practices. Besides that, mortgage qualifying standards were lax. Let’s see:

· Arguably, loan originators did not spend enough time educating their clients about the implications of the type of loans they were getting into. More specifically, the risks and possible consequences of choosing a Variable-Rate Mortgage loan (also known as Adjustable-Rate Mortgage or ARM) in case the interest rates increased, vs choosing a Fixed-Rate Mortgage loan. Unfortunately, most clients chose Variable-Rate Mortgage loans to purchase houses as they were “too eager” to secure such low interest rates and low mortgage monthly payments of this type of loans at those times, and did not bother to ask enough questions about the risks. 

·  The loan approval processes were not strict enough to determine if their clients really had the financial capacity to pay the monthly mortgage loans. So, getting a loan was easy and fast. There was such lack of control in this matter, that if a loan originator denied a loan to a client due to insufficient income, low credit score, and/or not having enough savings for down payment, another loan originator would approve it, sometimes making up the numbers. In the most extreme cases, a few loan originators/banks were able to make fake mortgage loans.

· Because loan originators were permitted to contact and hire property appraisers for the loan approvals directly, this allowed some unethical behaviors that resulted in unreasonably inflated appraisals, sometimes much higher than the respective purchase contracts. Therefore, people were buying houses like crazy, thinking that they were getting them at bargain prices. All this favored a faster uptrend of the house prices at that time, as even the most qualified and honest appraisers logically priced the houses accordingly, based on the prices of comparable properties that had been sold recently.

SO, WHY DID THE 2007 CRISIS START? Based on the fast-increasing real estate prices and the low interest rates, many people did not want to pass the opportunity to buy their first home or to get a bigger, newer, and/or better located home than their current one. Others saw a business opportunity to buy multiple properties with the idea to make a quick profit. However, because the majority of mortgagors (home buyers) had purchased houses using Variable-Rate Mortgage loans (ARM), as the mortgage interest rates increased in 2007, many could not afford to pay the new higher monthly mortgages anymore. This caused that millions of houses were foreclosed within a few years, creating four main devastating effects to the economy:

1) As the supply of houses for sale either through short-sale or bank auctions increased, the home prices started to drop dramatically in most cities nationwide, but the demand to buy houses was low. For the years to come, this was an investors’ market because they could buy houses for low prices and rent them easily to one of the millions of families that had lost their homes and had no access to new loans to buy another home. Why? Keep reading…

2) According to the U.S. Department of Housing and Urban Development (HUD), the waiting period before a person can buy a home with a mortgage loan again after a foreclosure range from 3 to 7 years, depending on the type of loan. So, for years, millions of families were not able to buy a house again, but to continue to pay rent.

3) Additionally, after having a foreclosure, a person’s credit score drops dramatically; actually, the higher the score is, the more it drops after a foreclosure. So, because the credit scores of those millions of people whose properties had been foreclosed dropped, their ability to use financing to buy goods and services also was reduced. That is why the real estate crisis migrated to most economic sectors and affected the economy negatively for a few years ahead. This created a snowball effect because, as all businesses were losing customers, there were layoffs everywhere and, thus, more people could not afford to pay their mortgage and other bills. 

4) All this had another serious effect in the real estate industry and the economy in general. The real estate developers and builders stopped building houses for years in most areas of the United States, which caused two more consequences:

a) Jobs in the various building supplies industries and the construction business were reduced suddenly to minimum numbers. This was a terrible hit because construction is one of the greatest engines in every country’s economy.

b) New houses were not built for years in most areas of the United States, which is a paramount factor of what we are experiencing in the real estate market right now. 

FACTORS THAT HAVE FAVORED THE CURRENT U.S. REAL ESTATE MARKET 

The uptrend of the real estate market in the United States from 2019 to date has very different causes to those of the real estate bubble before the 2007 recession explained above. Actually, one of the most important reasons for the current real estate market is a direct effect of that. Let’s see why.

1) The greatest key factor for what we are experiencing right now is that after the 2007 recession the construction of new houses stopped almost completely for many years. But the US population still continued to grow. Therefore, today there is shortage of houses nationwide that creates a high demand for both new and used houses. 

In 2007, the US population was estimated to be 301.2 million and in 2021 was estimated in 332 million. This increase of 30 plus million people within those 14 years was caused by two main factors: first, a higher number of newborns than the total of deaths every year; second, the arrival of millions of immigrants who have entered the country either legally or illegally. So, here we are 332 million people, who, as an important part of the American dream, all want to own the best possible house that we can afford. 

As a result, according to various reports, in 2021 there was a lack of 3.9 million houses in the United States. The same reports mentioned that all the real estate developers and builders together nationwide would be able to build a maximum of 1.1 million houses per year granted that no shortages in construction supplies occurred. Based on these numbers, if we divide 3.9 million houses needed into a maximum of 1.1 million houses that could be built per year, the result is 3.54. A raw interpretation of this suggests that the real estate market should continue its uptrend for the next three and half years, just because of supply and demand laws. That is why the biggest developers and builders in the country have their yearly plans already in place until 2025 (included), with a specific number of houses to be built per year in each area.

The reality, however, is that due to the Covid-19 pandemic, various key construction supplies have been scarce at different times since late 2020 and during most of 2021. The list includes framing lumber, engineered wood, plywood, appliances, windows, doors, and some parts for air conditioning systems. This has two serious effects: first, a price raise of these supplies and its logical effect of increasing the cost to build new houses, which must be paid by the final consumers; second, the shortage in construction supplies may slow down the expected pace of building those 1.1 million houses per year mentioned above, which may cause delays of building the 3.9 million houses that are needed today.

2) And who said that the population in the United States will not continue to grow in the following years? Two elements should be observed about this: 

a) There is a great chance that we will see more newborns in the upcoming      years nationwide because the “millennials” have a good buying power right      now, for which they are starting new families and purchasing their first              homes, if not the second homes, already.

b) Besides that, all we know, this amazing country that we enjoy and love so    much, will remain as a very attractive destination for immigrants from all            corners of the planet. Now, maybe the previous sentence made you think that illegal immigration should be controlled more efficiently than in the past to avoid a population increase with illegal immigrants. And this is a reasonable argument. But, even if this was possible to achieve, legal immigrants still will continue to move to the United States from various sources: talented professionals from many countries seeking for better salaries and lifestyle, investors from Latin American countries escaping the political instability and insecurity in the region, investors from various Asian countries diversifying their portfolios and expanding their businesses, and Canadian citizens looking for a milder weather, to mention just a few examples.

Based on a) and b) above, it is predictable that the US population will continue to grow, and this will cause a greater demand for new and used houses. So, if a demand for houses continues to increase but the supply (new houses being built) cannot keep up the same pace, this will cause the prices to continue their uptrend.

3) The lending practices have changed radically since the 2007 recession. The Dodd-Frank Wall Street Reform and Consumer Protection Act was passed by Congress in 2010 to prevent another recession that could be caused by the financial system. One of the goals was straightening some practices from banks, mortgage lenders, and credit rating agencies in the lending processes. One of the strategies from this Act was the creation of the Consumer Financial Protection Bureau (CFPB), an US government agency dedicated to protecting all consumers of the financial sector, including those interested in mortgage loans, credit cards, and student loans. 

As most parts of this Act were implemented, following, I will list three notorious differences in the current mortgage lending process opposite to what favored creating the real estate bubble and further recession in 2007:  

· All lending officers must educate their clients and make it easy for them to understand the financial products and services being offered before the customers agreeing to them. Officers must disclose the conditions in writing and show the different options a customer may have based on their financial situation (income, credit score, and cash availability for down payment and closing costs). Differences between a Variable-Rate Mortgage (ARM) vs a Fixed-Rate Mortgage and the possible risks and consequences of choosing either one should be explained, as well.

· The information verification and loan approval processes are more strict right now. The goal is helping customers to be successful in acquiring their own homes through mortgage loans that they can actually pay. That is why, sometimes, lenders verify the clients’ income, even the credit scores, until the previous day of closing. This may irritate some clients, but the intention is to keep them from failing in their mortgages.

·  Based on the “appraiser independence” requirements, banks, mortgage lenders, and loan originators cannot contact and hire property appraisers directly for loan approvals like in the past.  These institutions should hire the services of a third-party company which contacts and hires the appraisers for them. This makes the process more transparent for everyone involved in the transaction, especially for the buyer of the property. 

After these and other improvements to the lending process and because the overall population seems to have learned some lessons from the 2007 real estate crisis, current buyers are less willing to take unnecessary risks and are also more prudent on their mortgage loan amounts. 

4) The record–low mortgage interest rates that we have seen since 2020 (as low as 2.74% in January 2021) have been purposely maintained to boost the economy during the Coronavirus pandemic. This, plus several government incentives and regulations of different types seem to have been effective to strengthen the economy and to generate many employment opportunities nationwide. Of course, all this has been favorable for the current real estate market uptrend, as well.

Nevertheless, even if the interest rates for new mortgage loans were raised, buying a home instead of paying rent would usually be a wiser decision from a financial point of view. Watch this video to understand why. 

5) The most recent factor that has been favoring an uptrend in the real estate market is the interdependence between Inflation and real estate pricing.  We all have seen an inflation increase from January 2021 (CPI 1.4%) to February 2022 (CPI 7.5%). Inflation is a way to measure the tendency that prices of goods and services have had in a period of time (monthly and yearly average). In the United States, inflation is calculated based on two indexes: Consumer Price Index (CPI) and Personal Consumption Expenditures Price Index (PCE).

CPI is calculated by the Bureau of Labor Statistics based on the spending habits of thousands of urban consumers with different incomes nationwide. The prices of more than 50,000 goods and services are collected monthly. The most relevant are food and basic beverages, medical care costs (including prescription drugs), transportation expenses (including the cost of gasoline), basic home implements and furniture, work supplies (including apparel and computers), education costs (including college tuition), recreation (including the cost of tickets to parks and theaters), and housing costs (including both mortgage payments and rental prices). As it will be explained later, housing costs are one additional factor to the current inflation and, as a result, another cause for higher real estate prices.

So, what is causing inflation to raise? As the COVID pandemic effect seems to be a less important issue every day, unemployment has reduced to low levels again, and salaries are higher than during the pre-pandemic, people have been spending gradually more and more in almost everything. At the same time, the pandemic has created supply disruptions of some raw materials, components, and final products worldwide. This lack of supply and high demand for those items has caused a logical price raise and, thus, higher inflation.

As it was mentioned before, since 2021 some construction supplies have been scarce, which has caused price increases. For example, framing lumber and other wood-related supplies have increased their prices in more than 100%. Although a higher cost of construction supplies is only one factor that has increased the real estate prices among other factors mentioned above, this raise has translated into higher housing costs especially in the urban areas and, therefore, higher inflation.

To complete the picture, because one of the best ways to hedge against inflation is investing in real estate, a higher demand for real estate from investors, who usually have more buying power than the average family, favors real estate prices to raise even more. So, this becomes a “vicious circle”: as real estate prices raise, inflation increases; as inflation increases, investors want to buy more real estate which causes prices to raise due to a higher demand. 

In summary, are we experiencing a real estate bubble? The five factors explained above support the position that the real estate market of today is only the result of various logical circumstances combined, which may continue favoring an uptrend of the real estate prices for a number of years to come. 

Next article: MANY FORECLOSURES COMING UP SOON: MYTH OR FACT?