Published by Think Realty | October 9, 2023
There’s no doubt the past year has been challenging for residential real estate investors. How daunting has the challenge been? What’s going on in today’s market? Let’s take a look back at the first half of the year and a look ahead to 2024, by attempting to answer a few important questions.
The Federal Reserve has set up quite a conundrum for the housing market—and the economy itself—during the past few years: implementing a zero-interest rate policy during and after the COVID-19 pandemic and then executing its quantitative easing (QE) program, buying billions of dollars of mortgage-backed securities (MBS) and flooding the capital markets with liquidity. These actions resulted in historically low mortgage rates, throwing fuel onto what was already a red-hot housing market, stimulating demand, precipitating bidding wars, and driving home prices to historical highs.
This was great news for real estate professionals, mortgage lenders, and real estate investors. Sales of existing homes soared to more than 6 million units in 2021; loan volume exceeded $4.5 trillion, driven largely by a booming refinance market; and there were a record number of fix-and-flip sales—almost 120,000—in the first quarter of 2022. Rising home prices increased homeowner equity to an all-time high of $27 trillion.
But escalating home prices, along with fiscal and monetary policies that overstimulated the economy, contributed to the highest rate of inflation in more than 40 years, forcing the Fed to take drastic measures to get inflation under control. So, it raised the federal funds rate more rapidly than at any time in history and began quantitative tightening, selling off billions of dollars of its MBS portfolio. These actions roiled the financial markets and caused mortgage rates to more than double in a few short months (the only time this has ever happened, according to Freddie Mac), peaking at a little more than 7% for a 30-year fixed-rate loan.
Predictably, the refinance market shriveled up, because more than 70% of homeowners with a mortgage had an interest rate of 4% or lower. The impact on home sales wasn’t quite as severe, but sales volume fell dramatically as well, from more than 6 million home sales in 2021 to just over 5 million in 2022. Homebuyers who missed their chance at leveraging those sub-4% mortgage rates were faced with monthly mortgage payments that were 45%-60% higher due to the higher costs of financing. Demand weakened and home prices understandably began to drift lower, which was part of the Fed’s inflation-fighting strategy.
But the combination of higher mortgage rates and weakening home prices discouraged current homeowners from listing their homes. The inventory of homes for sale today is down by more than 50% from 2019 levels, according to Altos Research. Homeowners simply have no incentive to sell their property and trade in a 3.5% mortgage rate for a new loan at 7%. Much to the Fed’s chagrin, this lack of inventory led to bidding wars on the few homes coming to market, causing home prices to begin to increase again. According to the National Association of Realtors, the median price of a home sold in June 2023 was only 0.9% lower than the median price at the peak of the market in June 2022. The FHFA reported that prices on homes purchased with loans backed by Fannie Mae and Freddie Mac were actually 2.4% higher than the prior year.
For investors, a triple whammy: extremely limited supply, unpredictable home prices, and significantly higher finance costs. The typical interest on a fix-and-flip loan jumped from between 7%-9% in 2022 to between 11%-12%, and many private lenders tightened credit requirements. Investors without an established track record of success or without preexisting relationships with lenders found it harder to secure a loan, as lenders looked to mitigate risk in what had become a much more volatile market.