The real estate market in the year ahead
2023 is shaping up to be yet another interesting year for real estate investors. Rapidly evolving market conditions have made it increasingly difficult to predict what is on the horizon for the housing market.
As a result US home price forecasts are all over the map. Some forecasters predict that prices will rise by 5% or more, while others project price declines of up to 20%. This wide discrepancy from highly reputable research teams speaks to the uncertain economic outlook driven by factors like geopolitical instability, high inflation, slowing global growth, and the current path of Fed policy.
So how is a real estate investor supposed to cut through the noise and navigate this fast-changing environment? Well, we don’t have a crystal ball. But we do have some thoughts on key market drivers to watch for, timeless advice for investing in real estate, and our outlook for potential investing opportunities in 2023.
Local and regional labor market health will lead housing market performance
The Fed is doing everything it can to keep the economy steady and inflation in check. But higher interest rates drove average monthly mortgage payments up by nearly 60% in 2022, creating affordability issues for many real estate buyers.
Meanwhile, sellers are increasingly stepping back from the market due to peak market price expectations and the prospect of substantially higher mortgage costs if they sell and pay off their existing low-rate loans.
Taken together, these buyer and seller dynamics have had a freezing effect on property transactions. This has caused a drop in home sales of 35% year-over-year, according to the National Association of Realtors.
The factors affecting the real estate market will trend in 2023
In the current economic environment, the housing market is still favorable to sellers (albeit less so than earlier in 2022) because they are well-positioned to “wait it out” for the time being. Unemployment is (for the moment) near all-time lows, wage growth is strong, and most current owners have low fixed rate mortgages with affordable monthly payments — all of which point to greater seller flexibility in choosing when to sell.
Assuming this trend continues, it is likely that the US housing market will see multiple years of reduced transactions as the market digests the large recent price gains and an equilibrium is gradually restored between buyers and sellers. However, there are gathering economic storm clouds on the horizon that could greatly impact these dynamics with cascading effects on the housing market.
According to a recent survey of economists across 23 large financial institutions, nearly 70% believe that the US will experience a recession in 2023. In this scenario, unemployment would increase, wage growth would decelerate, and a subset of US homeowners with reduced incomes would no longer have a choice about whether to sell their home.
The supply of homes for sale would increase substantially and market prices would come down as sellers become more motivated when facing the risk of potential credit damage or foreclosure. For this reason, we believe labor market health will be the key determinant of housing market performance in 2023.
OUR KEY TAKEAWAYS:
Stay connected to key news sources and keep an eye on employment data such as layoff announcements, unemployment filings, and continuing claims to get an early read on the direction of the overall labor market.
New property availability in 2023 will create greater real estate investment opportunities
No matter how the broader economic picture plays out in 2023, there will be an increase in foreclosure sales this year as COVID-era emergency measures sunset and the market continues to normalize. We expect a steady increase in inventory for sale throughout this year as 2022 foreclosures start coming to sale and over 400,000 mortgage forbearance plans expire.
This trend is likely to continue through at least 2024, when sales volumes are expected to get back to pre-pandemic lows seen in 2019. This gradual return to normalcy should increase the supply of potential investment properties for sale and create substantial opportunities for committed real estate investors.
OUR KEY TAKEAWAYS:
The combination of an increased supply of investable properties and reduced competition from volatility-averse buyers will create a strong backdrop for long-term real estate investors to find value in 2023 and beyond. Our advice? Take a page out of Warren Buffett’s book and seize the opportunities that arise when others in the market might be hesitant.
Diligence and discipline will be key to navigating the changing market conditions
If you have invested in real estate in the last decade, there is a high likelihood that it has been a good investment given the rising tide across the market. But in an environment of increasing uncertainty, investors will likely need to be more discerning in their investments going forward.
We recommend that investors keep these two key themes in mind to help ground their growth strategies and position them to take advantage of the changing conditions:
Housing markets are primarily driven by local factors
Thankfully for real estate investors, the US housing market is a compilation of many smaller local and regional housing markets, each with their own unique economies, geographies, and demographics. These localized drivers can create a wide disparity in home price performance across the country and present savvy real estate investors with opportunities in even the toughest of markets.
According to data from Redfin, the median sales price for US homes is down 10% from the market peak in Q2 2022. However, individual market outcomes have varied greatly with larger declines in tech-centric areas such as San Jose (21%), Austin (19%), and Seattle (16%) and smaller declines in areas with more diversified economies and positive migration tailwinds such as Raleigh (4%), Tampa (5%), and Nashville (5%).
OUR KEY TAKEAWAYS:
There will always be pockets of local and regional opportunity, even in times of broader market turmoil. Try targeting regions with more diversified economies and positive migration trends, as these factors will make their housing markets more resilient in an economic downturn.
Investment in residential real estate market is a proven long-term strategy
While it is likely that your portfolio will have to withstand short-term market gyrations, residential real estate investments have performed extremely well over the long-term due to strong underlying demand fundamentals, advantageous tax treatment, and the ability to act as an inflationary hedge via increasing rents.
Market timing is much less important in generating solid investment returns than the ability to stay disciplined and committed over the long haul. For example, say you bought a median priced house with a 20% down payment at the pre-bubble peak in 2007. If you sold that house at today’s median price, you would’ve generated capital gains (not counting rental returns) of nearly 2x the return of the S&P 500 over that time, despite the huge initial decline in house prices in 2008 and 2009.
OUR KEY TAKEAWAYS:
Don’t let the potential volatility ahead drive your decisions for the short-term. Develop a real estate investment strategy based on sound fundamentals and then commit to holding for the long-term.
The overall outlook for the coming year
Despite the uncertainty of the future, 2023 is likely to offer a great amount of opportunity for smart real estate investors who are dialed into what’s happening in the market and coming to the table with a sound strategy.
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