America's Housing Market: Is the Bubble About to Burst?

America is experiencing an extremely competitive housing marketplace, reminiscent of the Great Recession. Because of this red-hot market, folks who need to buy or sell…and others who don’t…are still trying to determine whether now is a good time to do one or the other – or both. The $64,000 question: Should you sell your home during this frenzy, and you I do, then what? NOTE: Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.

Pandora's Box

Seventeen months (and counting) into the Covid-19 pandemic has completely disrupted normal home-buying patterns with fewer homeowners listing their properties for sale. Why? There's a variety of reasons topped by health risks associated with the virus itself. In addition,the new construction housing market slowed due to higher lumber prices, and increased labor costs – all of which drove up building costs. As a result, demand for homes is high and listings for sale are low. On the flip side, low mortgage interest rates and the growing interest in working remotely increased demand for single-family housing.

When demand goes up in a short-supply situation, higher prices result. No surprise there. This is good news for folks who need to sell their homes right now, but there’s that lurking caveat for most of those sellers. They need a replacement home, which means they’ll likely become part of the crowd competing for the few home currently available.

Change doesn’t appear to be at anytime soon. The question is: Why is it continuing?

Supply Stats

Estimates vary regarding the supply problem. Mortgage finance company Freddie Mac estimates that the deficit of single-family homes approached about 3.8 million units at the end of 2020. The number of existing homes on the market fell to just over 1 million at the end of January 2021.Folks who were planning to sell in two or three years may now be accelerating those plans to realize their newfound gains in equity. According to NAR, the median U. S. existing home sales price in May 2021 topped $350,000, 24% higher than a year earlier – to some folks, a mouth-watering increase in value.

Signs of Stability?

A few positive trends offer faint glimmers of hope for buyers. The number of US homes listed for sale in June 2021 was almost 7% higher than the number listed one month earlier (May 2021), which is the largest increase since COVID-19 took hold. That's moving in the right direction, but available home inventory is still down 38% from a year earlier.

Why the change? Lockdown relief and vaccinations have reduced homeowners' concerns about exposing family members to the virus during potential buyer visits – improving sellers’ willingness to list their homes. And, significantly, there are recent signs of fissure in the exploding price of lumber according to Random Lengths pricing service. Lumber prices that reached over $1,700 per thousand board feet in May 2021 are expected to trade more in the range of $700-$800 in 2022…a far cry from the less than $400 average in 2015-2019 (Source: FactSet). Though still high, these recent declines suggest that the lumber price bubble may be rupturing.

Still, a stiff “reversion to the mean” in construction costs isn’t necessarily imminent due to a major shortage of homes in the marketplace. The National Association of Realtors (NAR) reports that 5.5 million residential units need to be constructed to keep up with demand and to maintain affordable home ownership levels over the next decade.

Demand Signals

Many potential sellers of homes are retirees with newfound perspectives on where they want to live…perhaps closer to their families. Others are homeowners looking to take advantage of current high prices and who are willing to move to lower-cost areas for home replacement purposes. And demand has started to cool as more potential buyers find themselves priced out of the market …and as appraisals trail local price increases, impacting loan availability.

Also, indications are that demand for newly built homes is beginning to ease (Source: Zonda, a homebuilding data provider). Mortgage applications fell 17% from a year earlier in the week ended June 11 according to the Mortgage Bankers Association. Recently, the Federal Reserve made noises about sooner-than-expected interest rate increases – maybe in 2022 rather than late 2023, which would affect demand if mortgage rates rose.

Political Pressure

The influential NAR is also getting involved in the housing supply conversation by pressuring the federal government to view housing as “critical infrastructure" - to boost resources available for more home construction, making new construction an integral part of a current national infrastructure strategy maneuver. They recommend providing incentives to convert underutilized commercial space to residential units and to more effectively use federal resources to address bubbles in construction costs and labor and material shortages.

Cautious Optimism

This confluence of mortgage rate increases, political influence by NAR, reduced lumber prices, elimination of government disincentives affecting labor supply, a growing willingness of homeowners to list their properties, and the unexpected surge in retirement (inspiring folks to sell appreciated property) might well coalesce more quickly than expected. It often works that way, particularly when price bubbles are involved. But the competition for new and used homes is still in a state of frenzy - it's still a time for buyers to be cautious.

Buyer Beware

In a marketplace like today’s, where many homes sell within a week or so at rapidly escalating prices, frantic buyers’ tend to overlook hidden costs in their quest for a new or replacement home. This is all the more reason why buyers – especially new buyers – should consider all of the costs of homebuying – not just the traditional down payment.

In addition to that 20% front money…a current norm…consider lenders’ mortgage origination and underwriting fees, agent commissions, property taxes, appraisal costs, homeowner’s and title insurance, and miscellaneous filing fees. Heard enough? Well, there’s more.
When shopping for a new home, there’s usually a condo or HOA fee lurking in the background. Be sure to also inquire about any pending special assessment. If overlooked in your haste to lock down a home, these could emerge as possible large, unexpected expenses.
Remember, as part of closing, those pesky lenders always get homes appraised before lending money. When home prices are rapidly increasing, differences in asking prices versus lagging appraised values often soar into the thousands or tens of thousands of dollars. What to do? One thing prospective buyers should anticipate is that their friendly (steely-eyed) banker is not going to make the loan without the buyer putting up more money – alas, another demand for additional cash at closing.
Under “normal” circumstances, a buyer might ask the seller to cover or share in certain transactional items, but with so many homes selling above asking price and because sellers are already expected to pay more than 5% or so of the total sale price in fees, commissions and other expenses, few of today’s sellers are likely to agree to any additional sharing of fees. More likely, they’ll be asking the buyer for greater participation than normal in closing costs.

Join the Crowd

So where does that leave prospective buyers in today’s housing market? For existing homeowners, sell if you must and reap the rewards of the current frenzy. But if you need a replacement home, know that you’ll be joining a parade of buyers on the other side of the equation, and be ready to shell out some or all of those recent gains unless you have the benefit of time or location on your side. Even though there are faint signs of equilibrium in the air, the current supply imbalance will simply take a while to correct.

If you decide to or have no choice but to join the thundering herd of buyers, following are some tips to enhance your competitiveness in that effort:

Gain an edge over other buyers by previewing homes in your price range using virtual home tours…even before enlisting the aid of an experienced agent knowledgeable of your area of interest (e.g., an agent who will alert you to listings as soon as they hit the market).
Before starting the pre-approval process, make sure your credit score is good. Get pre-approved to enhance your ability to move quickly (pre-approval means you are approved for full financing).
If applicable, transfer gift or loan money from family or friends into your bank account. This ready access is part of the pre-qualification process.
Be aware of what you’ll be paying beyond down payment (property taxes, appraisal fees and homeowners insurance, etc.).
Because of the current competition for homes, you’ll likely be facing unexpected tradeoffs. List those you’ll be willing to make ahead of time if a bidding war should ensue. In short, know the desired home features you can live without.
Consider an escalation clause in your offer…which means you'll automatically outbid any offer by a given amount (say $500) up to a certain point. A word of caution: an escalation clause can result in you paying more than you originally intended. As a safeguard, it might not hurt to limit your shopping to homes below your maximum price point).
And finally, to avoid major hidden problems, spend some upfront money on an independent inspector to smoke out major issues like dry rot, pests, mold, or structural damage. Be able to back out in the event of major issues, but don’t nickel and dime the seller on minor concerns. In short, move forward without asking for minor repairs. Sellers will appreciate that, and in a competitive situation, it just might be the difference between you or someone else landing the house..

In Sum

Have your ducks in a row. Be flexible regarding your own expectations. And be willing to consider a closing schedule that works not just for you, but for the seller as well – perhaps even a rent-back agreement if your own current state of affairs permits it. And finally, as with any major investment, be patient. Granted, losing numerous bids can create a sense of desperation, often resulting in buyers bidding too much, possibly ending up “house poor” or with a home they simply don’t like…or one with major “hidden” issues.

Patience will help avoid such miscalculations. Yes, you might be staying in your current home or renting longer but exercising patience just might allow you time to save more money, work more on that credit score, and even fine-tune your home-buying skills. Remember, this will likely be one of the biggest investment of your life. Approach it with caution.

Evidence of change is in the air, and it may come more quickly than you expect.