My 2017 Forecast
2016 in Review:
I am sure you agree – this has been a year of surprises. The Chicago Cubs won the World Series for the first time since 1908, Britain approved the Brexit and will leave the EU, and the U.S. Presidential Election shocked the world (except for Peter Theil). Additionally, the Fed did not raise the interest rate in 2016, as anticipated. Call it election year jitters or market instability, but the Fed’s decision caused mortgage rates to stay relatively unchanged all year. To many, 2016 was almost surreal, but looking towards 2017 we cannot ignore the decisions that will ultimately impact our new year.
My Market Observations:
As I discussed in December 2015, the market pressure experienced this year has impacted values. It wasn’t clear to everyone in early 2016, but there were signs of changes on the horizon and those who didn’t see them or know to look ended up overpaying for homes. I saw this happen time and time again and by fall, it was more mainstream conversation.
Two good examples come to mind: a Palo Alto house sale and resale in the same year, and two comparable Los Altos homes. The homes in these examples sold in early 2016 for premium prices and by summer were put on the market for sale again. But this time, it was clear those prices were not attainable anymore. The Palo Alto property resold this October and ended up almost 10% off the property’s early 2016 price. The two homes in Los Altos are very similar properties on the same street and experienced the same result, February over June. The net result: The buyers who purchased in early 2016 overpaid because they didn’t realize the market had been shifting.
Once people started seeing this data in late summer, it became more apparent that something was happening. Still, the conversation wasn’t mainstream. I discussed this shift in my June article and how coming months of data would support this change. And guess what? We’re seeing that now. Year over year data is supporting what I’ve been experiencing, albeit not the 10% drop in average prices that I am seeing on a more micro level. The data is misleading and I caution you that real estate is very specific, therefore, it is imperative to understand what makes each property and location different. This has been a top-down adjustment; like the dot.com run, the higher-end communities have seen urgency wane and price adjustments increase faster than the lower priced communities. However, now it has trickled into the lower priced regions such as South Bay and East Bay so it is more a universal norm. Some will argue the lack of inventory as a driving force of our market, but based on my day-to-day activity, I see the inventory volume and demand consistent with typical seasonality.
Talk Around Town:
It’s official, most real estate professionals and appraisers are now accepting the market is off peak and something is changing, but the root cause is up for discussion. Even the Oracle of Omaha, Warren Buffett, said in an interview after the election that “it’s [the market] softer than I think people think it is.” He continued to say that he thought the GDP numbers were not accurate and should be lower. This is another example of an overall change to the market and how the conversation is more mainstream.
I am constantly talking with professionals across industries and have heard a shift in their sentiment of the market. Quality appraisers that work our region are acknowledging prices are off and Sellers need to price right to sell their home for the best price. This is a change of tune because in 2015 I couldn’t even get most of these people to agree with my perspective of the market. You know something has changed when neighbors and random people you meet tell you the market has changed. This fascinates me and I always immediately follow up asking why they think it has changed. I have been hearing this for about 60 days and the main observation is either their neighbor’s home didn’t sell right away and/or has seen price reductions, or they are seeing homes on the market longer online. This is such a fascinating observation because in my mind, the follow up question is whether the house was just overpriced when originally listed. In any market condition, if you over-price a home it typically does not sell, but when the market starts changing it is held up as proof of a new climate.
Events Impacting 2017:
There are so many critical events coming over the next several months that it is sure to draw attention and impact the market:
- New administration— The presidential inauguration is sure to bring increased uncertainty, but the short-term impacts are unclear. We are in a wait and see approach and will make decisions accordingly.
- Brexit – Britain’s move to leave the EU and the overall health of the European Union (upcoming referendums in Italy and France) are sure to cause uncertainty through the global markets.
- Federal Funds Rate Increase – the cadence of increases and direct impact to real estate values are unclear, but sure to be a variable to watch carefully. When mortgage rates increase 1%, a $1m loan interest payment will increase approximately $800 per month.
- US Corporations overseas cash – will these companies bring back to U.S. at a lower tax rate? Eight of the biggest U.S. technology corporations are currently stashing $2.1 trillion overseas, according to Bloomberg. If this occurs, which some anticipate, it will generate billions of dollars in tax revenue, which can be used for infrastructure projects. It will also enable companies to reinvest in technology and talent, distribute to shareholders, etc.
What Will Happen When the Fed Rate Rises?
Your monthly payment will be impacted quicker than you expect. As the Federal Funds Rate increases, the 10-year Treasury Note will likely follow suit. As the 10-year Treasury Note rises, so will mortgage rates because the banks must stay competitive in attracting investors to purchase their mortgage-backed securities instead of the 10-year Treasury Note in the secondary market. For example, a bank may group several loans and sell them as a package (mortgage-backed security) to an investor looking for a certain return. If the 10-year Treasury gives a better return, the investor will obviously buy that investment. So, banks need to sell you an interest rate that is high enough to be competitive and sold to an investor after the fact. This is one reason there is a correlation in the rate movement. When mortgage interest rates are higher, your affordability will decrease and your monthly payments will be impacted quicker than you may anticipate.
How Are Prices Impacted?
Expect to see continued weakening to prices. Despite interest rates being relatively flat, prices in 2016 are down approximately 10% in many regions and the tide of urgency has shifted towards a calmer demeanor. Can you imagine where prices would be today if rates had risen 1% this year as predicted? You are not seeing the 10% adjustment across the macro data level, but when you look at specific types of homes you can see the pullback. With the current pressure on the market without a significant rate increase, all things equal I think we should anticipate a price adjustment when we experience a noticeable Fed Rate increase. The rate is one variable that impacts buying decisions, albeit an important one. Purchasing power is driven by income to price, affordability, and there is an inevitable balancing act.
How to Capitalize on the Current Market?
Make calculated decisions. Despite the market changes this year, we had a surprisingly high number of high-end home sales. However, the transactions are still minimal compared to the average transaction. Therefore, the few buyers may have very specific buying needs that require them to purchase today. These transactions can skew the data because the overall volume is so small. Specifically, in August, Los Altos Hills had an average price of $6.5m, but unless you drill down you wouldn’t know that it only included 7 transactions, three of which were: $12m, $10.25m, $9.95m, all dramatically higher than most typical sales. It is important to understand the overall market dynamic to avoid data pitfalls, often found in headlines and real estate websites. Opportunities are around and I have helped many families in 2016 buy and sell property and am very pleased with how we strategized a quality plan of execution for each family’s needs.
If you’re a Seller:
It is not the best time to sell if you want top dollar. That ship set sale in 2015 (or in some cases early 2016 before mainstream noticed the shifting market). However, if you are considering selling there are more variables that you need to consider: if not now, when? What is the next move – are you upgrading to another home, relocating, retiring? These decisions will impact your selling decision and the timing of the market isn’t necessarily the most critical. Some families may wait to sell until the market is at a peak again; if you are in that camp, you may be waiting awhile. I recall specific examples in the past few corrections when homeowners wanted to upgrade to a larger home that better fit their family’s needs, but chose not to because they didn’t want to sell their existing home for “less than peak.” If they would have absorbed the difference and moved into the more appropriate home at the time, their overall happiness would have increased and the new home would have appreciated more in the market upswing. Instead, they stayed in the existing home and when the market swung up, they were still in a house that didn’t fit their family and the value didn’t increase enough to get the new home they desired. I think it is more prudent to consider your options today and the foreseeable future, and make decisions that best influence your overall health and financial picture.
If you’re a Buyer:
Here’s a personal example: My wife and I bought an investment property this fall, not because we thought it was the lowest price, but because the price was reasonable for the property, the interest rate was attractive and we plan to own this rental for a long time. Many of my clients wanted to know when we got back into investment-buying mode as a good indicator for when to start looking. So…YES, I think it’s a good time to start looking to buy investment properties. Even in a slow market, a quality property and location will demand good tenants and rates. Vacancy is the biggest killer to cashflow, so you want a property that is rentable and that tenants like to call home. Take advantage of fear in the market. You may not buy at the lowest point, but consider spreading out multiple investment purchases to dollar cost average the risk. Good properties will always be good properties. Cheap does not mean good, and I’m sure most people prefer a blend of cashflow and a quality product. The interest rates are attractive even on investment properties, so let’s capitalize on it and find you a quality, local investment property. Remember, if you can’t drive by it, don’t buy it.
Review your overall financial plan and buy accordingly and don’t be anxious. Patience is a virtue and my clients can attest that we will work together diligently until we find the right property and price for you. Don’t settle. It seems so simple, but I can tell you I see examples of families settling all the time. I want each of my clients to purchase the best property for them!