I think we could actually be aiming at a repeat performance of at least some of the financial upsets that occurred in 2007 and 2008. Here’s why.
Home buyers must qualify for mortgage loans. The higher the price the higher the down payment amount. The higher the interest rate the harder to qualify. Remember that every half percent of interest rate increase adds somewhere around $100 to the monthly payment.
Today’s 30 year fixed rate is approximately 4.25% Of course there are a variety of rate programs available but the point is nothing will get cheaper at least in the short run.
Lot and material prices are all increasing. Supply chain delays cause longer build-out times. Longer build-out times combined with higher land and material prices increase the carrying cost of a construction loan. In the 2007 – 2008 period many developers and builders saw any equity they had in projects erode and go away. Loan defaults and bankruptcies followed.
Some lenders took large losses or at minimum had to reserve more for loan losses thereby compromising income.
Could all that happen again? You bet it could.
What’s different now?
On top of increased costs we have an unstable world situation. Can that have an impact on supply chains? Certainly. What about fuel prices? How much will they affect material cost? I don’t know exactly but it’s safe to say that increased costs will be passed on from the top to the bottom of the consumption scale.
The last time around, at least in our area, there were many of spec houses on the market. If that happens again we can expect weak financial conditions to repeat themselves. Also the last time around, house prices dropped very rapidly. So, on top of equity erosion from high costs, developers and builders sustained more equity erosion from decreased asset values.
This article has been aimed mainly at home builders. BUT, it’s important to recognize that the same fact set also applies to every other branch of the real estate tree. Right now, the office and retail segments are very soft.
Quite a few people have expressed optimism about the multi-family segment. I don’t share that enthusiasm. If we go into a prolonged slump, this segment will join the others that aren’t performing well.
If you would like to discuss any of this, please drop me an email at email@example.com.