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I’m Very Nervous

Here is the median price of a home for the last 20 years in the Denver-Lakewood MSA – which I am referring to as the Front Range / Denver Area.
Here is the median household income for Colorado over roughly the same period:
What do you see?
In case you don’t like reading charts I will sum it up: household income has mostly stayed flat. The price of a home has more than doubled. And its getting worse. Way worse.
This spring the market is in what could be a precarious position: hyper-price appreciation. There has never – never ever – never, been this much pressure on our housing market (that I can recall over the last several decades). There are simply too many people who want to buy and not enough homes. Over the last few weeks it was not uncommon to see many homes sell 10% or more over asking – at any given price point. February ended with the median price up 20% year-over-year. We could be adding another 10% per month for the next several months. Seriously. That could happen because it already seems to be happening.
A house comes on the market and you/the buyer wants to go see it – if you even can – because sometimes the house “books out”, with no open slots for viewing. The home receives multiple offers, and sells over asking. The house doesn’t just sell over asking, it sells with waived inspection contingencies and appraisal contingencies. It becomes desperation for buyers. They feel they must get a home, therefore they will do whatever they can to “win.”
This situation is similar to when a hot new toy comes out during the holiday season (Play Station 5 – PS5 – last year) and people are knocking each other over in the aisles to get the last one. Subsequently, on the resale market the prices hyper inflate. Eventually, the supply catches up with the demand and one thinks, “Why did I overpay for that toy??? That was so silly!” We got caught up in the emotional frenzy.
Now, houses are not the same as PS5 game consoles. For the many reasons I have outlined in previous posts, supply of housing is far from catching up to demand unless demand falls away. How could demand fall away when it is so crazy hot? When buyers can’t afford these prices anymore – which, is already happening. It also happens when the cost of borrowing – i.e. mortgages – goes back up. The 10-year U.S. Treasury, which is what guides 30-year mortgage rates, has been steadily increasing this year. Additionally, the Federal Housing Finance Agency (FHFA) just announced new guidance limiting the number of second and investment home loans it will have under its portfolio, which seems like it will result in significant cost increases to those kinds of loans (starting April 1st, it appears that there will be additional origination fees of 2%-5%, with potentially higher interest rates).
By the way, this housing crunch appears to be happening all over the country. At least double-digit price increases occurred in 88 of 161 metros during the 4th quarter of 2020 (as reported by the National Association of Realtors).
The last housing crisis, which was more of a financial crisis that affected housing, was caused by (and I am over-simplifying) financiers trading mortgages in the form of collateralized debt obligations (CDO’s) (watch this video from The Big Short for a cinematic description).
This current potential crisis could be caused by the combination of the Federal Reserve, the U.S. Treasury, and the U.S. Congress. By the way: I am not one of those extremists that hates the federal government. I am just saying the current policies might have created a time bomb/accelerated an asset pricing bubble.
  • Keeping mortgage rates excessively low (Fed buying the government’s own bonds and mortgage-backed securities)
  • Not allowing the housing market to function properly (preventing foreclosures and rent evictions)
  • Printing money (and pretending inflation does not exist – that’s my snarky comment)
You could argue about any one of those points. You could say but what about all the people who have hardship, or what about ___ . Fill in the blank with your “yeah but.” Totally get it. I am not saying we should evict people from their homes. I am not saying we shouldn’t help people who need help.
What I am asking: Is it unfair to say that there is a line, a tipping point where intervention steps too far? We could all disagree where the line is, but could we agree that there is a line? I am saying that it feels like the line has been crossed. Feel free to disagree.
Or…one could say that every well-intended action has unintended consequences. We live in a complex society in a complex universe. We cannot control for all variables. While it may have seemed like a good idea at the time for all the stimulus and bond-buying, the economy is too big and complex to know how it plays out across the country. Some of these federal programs have laid the fuel for a giant wildfire – at least in the case of residential real estate.
Eventually, it might catch on that there really is inflation. The bond market and stock markets will react accordingly (not well – just look at the first week of March when inflation fears started to surface).
The average house in Denver was $250k in 2011 then it was over $500k in January 2020, and now it is over to $600k. In the scenario I am describing ahead of us, instead of interest rates being 2.75% and a payment of $1,960, the interest rate might be up to 5% with a payment of $2,577, or an interest rate of 6.5% with a payment of $3,034. And that’s in a best-case scenario that does not take into account the 20% down payment – buying a house at $600k requires $120k down vs. 2011 when it required only $50k. Furthermore, if buyers don’t have the extra down payment at the higher dollar amounts, then they are getting loans with less money down, which means more money being financed and mortgage insurance = even more monthly cost. What happens if interest rates went above 6.5%?
But Steven“, you say, “this is fear-based thinking. You made some pretty big assumptions and you don’t know how it’s all going to play out“. Quite true. I could point to Los Angeles or San Francisco and say that the ever-decreasing affordability made no difference in the ever-increasing cost of a home. Sure, it made it harder and harder for certain people to buy homes. It created exclusivity. It made it hard for people to move – they couldn’t afford to re-purchase in their own locale. It also meant people needed dual incomes to buy a home and were still house-poor.
Anyway, back to the Front Range. Even if people stopped migrating here for a short time, and we had some people leave (cashing out on their equity and going somewhere less expensive), that will only bring temporary relief. Long term, the Front Range is going to be a destination for people. It is a great place to live and there are many business reasons for people (and companies) to be here. That is simply not likely to change any time in the next 10+ years.
I have made many assumptions here and didn’t define them all. I could be totally off the mark. On the other hand, what is irrefutable is the current imbalance in the housing market. What is absolutely true is that many homes are selling significantly over the asking price, and these new prices are significantly higher than not only a few years ago but a few months ago! Many buyers are beyond exasperated – okay, that’s not an irrefutable fact – but close: many buyers are writing offers on homes and not getting them. Multiple times. Those repeated losses can lead to potentially irrational behavior to avoid losing again, or rather, “I must have this home at any price!”
The 10-year Treasury yields have been moving up since the end of last year, all the while “experts” were saying interest rates wouldn’t get above 3% until the end of 2021 (I was yelling b.s. the entire time). I am not “the expert” on television or in the newspaper. I am in the trenches watching a lot of frightening behavior.
I have no idea how this is going to turn out. Maybe it will be nothing. Maybe there will be a correction. Who knows? On some level, it probably doesn’t matter. Long-term things will likely work themselves out (remember how bleak things looked in 2009?). It’s the near term that makes me nervous.
There is a silver lining. With all the progress being made against the virus, maybe sooner than later we can all get together and give each other a big group hug.

Steven Ross

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