https://www.financialsamurai.com/what-if-you-buy-a-home-at-the-top-of-the-market-and-a-recession-hits/
Are you thinking about buying a home today? Then you need to also envision a scenario where you buy a home at the top or near the top of the market and a recession hits. If there is a downturn, will you be able to afford the monthly payments? If a bear market comes, can you continue to pay the ongoing insurance and maintenance expenses as well?
The housing market is still strong right now. Inventory is still low, but prices are beginning to fade given the Federal Reserve is aggressively hiking interest rates and mortgage rates are 2% higher than they were in 2020.
Even if there’s an 80% chance the property market could continue to go up, there’s still a 20% chance it could get knocked down. Stocks have declined in 2022 and interest rates have gone up.
If you lose your primary source of income, usually your job, will you also be able to afford your home? Buying a home with mortgage debt is a big decision. Therefore, please treat a home purchase with the utmost respect and buy with discipline.
Everything was feeling pretty incredible in 2006 and 2007. Then the housing market crashed and burned for the next three years as people borrowed too much and banks lent too much. Plenty of homeowners didn’t know what hit them. As a result, thousands of homeowners lost their homes to foreclosure and short sale.
It is exactly when times are great when we all need to think about downside risk. Despite a pandemic in its third year, real estate continues to be a highly coveted asset class.
One way to tell whether buying a home right now is a good time or not is seeing what the stock market is doing. The stock market reflects earnings expectations 6 – 12 months in advance.
Right now, earnings expectations are getting declining again. The S&P 500 closed up an incredible 27% in 2021 after a strong 2020. But 2022 has been rough for stocks, cryptocurrency, and bonds so far. So is real estate the next sector to fall? Probably.
You can investigate further and look at sectors in which your location has large exposure. For example, check out tech sector performance as it relates to the San Francisco Bay Area. Or take a look at bank sector performance as it relates to NYC. Tech performed incredibly well in 2020. Meanwhile, banks and other old economy stocks are performing well this year.
Stocks correct swiftly, while real estate corrects slowly until everybody knows real estate is weakening. Then liquidity dries up and the floor drops out. If the stock market is correcting, it’s time to pay closer attention to any investment you make, especially with leverage. So far, the stock market is holding strong.
What we do know about the real estate market is that it moves in cycles due to the desire for economic profits, i.e. new construction to meet new demand.
Peak new construction tends to occur past peak demand, which ultimately leads to temporary oversupply and lower prices. This is what we call: boom and bust. This bust phase usually lasts between 1-3 years before a price floor is found.
In 2022, we are in a peculiar situation because input costs to build new homes have risen. Further, there is a shortage of home construction labor. Home builders want to build, but they can’t build fast enough. Inflation is also a big tailwind for property prices. As a result, I still expect further housing price upside in 2022. But the pace of appreciation is slowing and prices are actually falling in more cities now.
The utility of a home is way up since we’re spending more time at home. Add on local government regulations to build new units, and supply is severely lagging demand at the moment. But the supply of new housing is coming to some heartland cities where land is plentiful. Therefore, stay observant of the supply and demand dynamics.
Below is a chart that shows Market Cycle Quadrants. Back in 2006-2007, we were in Phase III – Hypersupply. In 2022+, it feels like we are at the end of Phase II – Expansion. This expansion phase should last for a year or two. But again, nobody knows for sure.