Sarah Jarvis Team at One South Realty

at One South Realty

Rick Jarvis

Free Beer, Inflation, and Real Estate

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Feels a bit odd right now doesn’t it?

  • We have war going on.
  • COVID is lingering / re-surging. 
  • Supply chains are still nowhere near functioning properly.
  • Inflation is raging.
  • The Fed has proclaimed inflation is ‘Public Enemy #1’ and seems hell bent on wringing it out of the system, regardless of the damage it does.
  • Mortgage rates have come close to doubling in the past 90 days. 
  • The stock markets have shed trillions in collective value.
  • Crypto is down by more than half.
  • NASDAQ is down about the same.
  • And the Supreme Court is now leaking documents.

Did I miss anything?

Real Estate

So I did miss one thing –– real estate. 

Right now, if you read the blogs and reports coming about Q1 of 2022, you will hear nothing but things like ‘prices set new record’ and ‘inventory at all time lows.’

But if you also ‘doom scroll‘ Twitter, or listen to CNBC, you hear a far different story. Inventories are rising, traffic is down, and price reductions are becoming far more common.

So which is it? Is real estate going to continue its torrid price rise despite rising rates, rampant inflation, and all of the other upheaval brought to us compliments of Covid and Putin?

Or should we brace ourselves for 2008 Redux?

Here is what to watch.

Lending Update

On January 1, 2022, the 30 year mortgage rate was hovering around 3%. 

By May 15, 2022, the 30 year rates stood at 5.5%.

Not only did the rates nearly double, the rate at which they jumped was particularly jarring –– never in the history of the capital markets have rates ever risen this quickly. 

And, yes, it is having an impact.

Qualifying vs. Underwriting

But while most of the messaging is that buyers now no longer qualify, in reality, what it means is that they simply qualify for less. The uninformed conflate mortgage rates with underwriting –– and they are two different things. 

Underwriting removes people from buying pool because of things like credit scores or how income is counted –– rising rates simply move a buyer down the ladder.

That is a key distinction. 

Unlike 2008, when buyers were removed from the buying pool because the loans went away, today, the rising rates has made owning more expensive. The buying pool is still the same size, they just qualify for less.

The takeaway here is that the most intensely contested segment of the market –– the entry point –– won’t change that much. 

Might we see weakness at higher price points where homebuilding is more common? Perhaps, but unless we see a spike in additional homes coming to the market at or near the median price points, the buyer / seller imbalance is so dramatic that I still don’t think we will see much slowdown. 

Inflation

Low rates didn’t just drive housing prices higher, they pushed all asset values higher.

Additionally, the response to COVID (give everyone money to stay home) flooded the system with free excess cash.

So what happens when you give away money and drop rates to nearly zero?

Remember ‘The Hangover? ‘ Yeah, that.

Inflation.

When COVID hit and we went into lockdown, the Fed flooded the system with currency in an attempt to keep everyone flush with cash until we got the pandemic under control.

It can be argued that the stimulus had the desired effect –– at least initially.

The Monetary Hangover

But free money is a lot like free beer, it sounds like a great idea at the time but comes with a severe hangover later –– especially if you keep drinking it well past when you know you should.

Well, now is later and we drank WAY too much. 

Currently, Inflation is just over 8% and the cost of goods and services are far higher than pre-pandemic, with not a lot of relief in sight. 

Killing Inflation

The good news is that the Fed has already begun to change its policies in order to stave off inflation. The bad news is that it only really has two levers to pull and both have the impact of driving up ALL forms of interest rates –– mortgage rates included.

As most everyone now knows, rates shot skyward faster than at any point in history –– from roughly 3% at the beginning of the year to 5.5% by mid-May.

While the last week or so has brought some stability to the mortgage rate environment, it hasn’t meant that rates have decreased, only that they flattened for a little while to allow the market to assess the impact of the last rate jump.

Until data shows that inflation is slowing dramatically, expect rates to keep ticking up. 

The 3% Mortgage’s Legacy

Which brings us to the unanticipated –– and extremely problematic –– part of the hangover.

Pretty much anyone who purchased a home prior to January of 2022 has more than likely refinanced their mortgage as rates dropped –– and is now sitting on a +/-3% mortgage. Depending on the study you read, something like 75% to 80% of all mortgage debt is now at or below 4%.

Think about it –– who in their right mind is going to give up that rate? And then turn around and buy into a market with 5.5% rates and less than 1 month of inventory? 

I doubt there will be many –– and therein lies the new problem. Inventory is already at record lows, and now anyone with a 3% mortgage is probably not going to sell unless they absolutely have to –– further depressing inventory.

The economic idea that rising prices leads people to want to sell, at least in this case, is not accurate. The increased cost of capital is proving a far stronger deterrent than rising prices are an incentive.

Gotta be honest, I didn’t see that problem coming.

Inventory

So despite the idea that people with 3% mortgages are unlikely to sell, the rise in rates and the crash of the stock markets is removing liquidity (a.k.a. –– the free money) from the system.

As a result, housing inventories are starting to rise nationwide –– albeit at radically different regional rates. When the cost and availability of money changes, demand is impacted.

So how is Richmond being impacted?

A view inside of our MLS. When you exclude the new housing inventory (which is inflated by homes that are ‘To Be Built,), then you see that we are still well below pre-pandemic levels.

When we entered the pandemic (March of 2020,) we were already experiencing some of the lowest inventory conditions ever. Most of the US was in what would be considered a strong seller’s market with somewhere between 2 and 3 months of inventory.

After a brief lockdown-induced pause, the Great Migration buying frenzy bagan and inventories started to drop from ‘lowest of all time’ to ‘is zero inventory actually possible?’

For Richmond, we spent the large majority of the pandemic measuring our inventory in weeks, not months –– and that has not changed. As this blog is written, we are still less than a month (.80 to be exact) despite the rate jump and other economic headwinds. 

We created a chart to show how market conditions are a continuum. By tracking inventory, you really know just about everything you need to know about where the market stands.

So when inventories start to rise (and it is inevitable that they will,) realize that even pre-pandemic levels aren’t enough to fundamentally change the market. 

I’ll start to pay attention when we have 3,000 -4,000 homes for sale, not when we move from 500 to 600.

Rents, Migration, and Millennials

‘So I will just wait for the market crash and buy a home when prices fall and rates pull back,’ has been a common refrain amongst every renter who has tried and failed to buy a home. 

The biggest generation in US history is just now entering the housing market. and we are woefully unprepared for it

I am sorry, that was a poor strategy. 

Right now, rents are up somewhere between 20 and 30% depending on your market, vacancy rates are effectively zero, and the leading edge of the Millennial Generation is just now maturing home buying age.

And did I mention that Richmond’s population is growing at some of the fastest rates in the country? In the time period following the arrival of COVID, Richmond’s growth rate has exploded –– mostly due to migration from regions of far higher costs of living. 

All of the other financial stuff aside, the fundamental issue is that we don’t have enough places for people to rent OR own, and it is spiking the cost of both. 

Congratulations, Richmond! All of the good stuff we have been saying about ourselves finally paid off. People from all over this great land heard our message and moved here –– now if they could only find an affordable place to live…

Summary

I get it, you can’t (almost) double the mortgage rate in 90 days and not have an impact. 

I expect at some point we will see rates of price increases slow somewhat, especially if we don’t get the cost of gas and food down. 

But regardless of all of the complexities of modern monetary policies and inflation, the fundamentals that underpin housing are quite simple –– how many buyers are seeking housing versus how many sellers have one to sell?

Think building is going to help offset demand? Yeah, might need to rethink that.

Right now, the number of purchasers so far outweighs the number of sellers that I don’t really care much about rates, or the economy, or inflation, or Ukraine, or COVID. 

We don’t have enough of any kind of housing to satisfy the demand that is already here. 

This problem has been steadily building since the devastation of the construction industry on the heels of 2008. We should not be surprised that we are here.

The Sky Isn’t Falling

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Oh, I hear it, too –– ‘These house prices are unsustainable’ and ‘just wait until the interest rates rise’ or ‘remember what happened last time.’

< yawn >

When it comes to housing, nearly everyone has become a Chicken Little and is predicting that the ‘sky is falling!’ As a matter of fact, the whispers of an overheated market date back to 2015 when home prices started rebounding quickly from the depths of the 2008 crash.

Doomsaying is an industry unto itself so forgive me if I don’t pay attention to the people who predict gloom for a living. If you keep saying the same thing for long enough, eventually you will be right.

Personally, I would prefer to be right more often than ‘eventually.’

The Real Deal

Instead of blindly assuming that prices are going to come crashing down because they went up, lets look at where the market actually stands:

Building

Inventory

Rents

Mortgage

Other Economic Factors

We’ve Never Been Here Before

No housing market has ever been exposed to the combination of factors that are in play today –– a rapidly expanded money supply, record setting inflation, disrupted supply chains, a pandemic, global unrest, a systemic lack of building, population growth, ‘Sun Belt-friendly’ migration patterns, and the decoupling of geography from employment (in other words, live where you want to and use Zoom.)

There is no precedent for this market so using using history as a guide is pointless.

Remember, market corrections occur when prices are overvalued, and not just because prices went up.

The bottom line is that if someone predicts a housing crash but doesn’t say why, when and/or by how much, then they should be ignored.

Millennials turning 34 + 5M homes undersupplied is driving today’s market –– and we can’t fix that overnight.

Is Your Realtor Buying Property? (Or just telling you to?)

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I am sure you have heard a Realtor say it –– ‘It’s a great time to buy or sell real estate!’

Yeah, it is rather obnoxious.

Admittedly, I don’t like the statement either, it feels not only very self-serving, but very thoughtless. It really isn’t saying anything at all –– just a recommendation to do something –– which flies in the face of legitimate thoughtful advocacy (but I digress …)

That said, it does beg an interesting question, what is YOUR Realtor doing? Are Realtors buying right now with prices as high as they are? Are they dumping everything they own thinking the market is about to tank? Are they telling you to buy but others to sell? Are they recommending what is good for you, or for them?

The bottom line is: Does their advice match their behavior?

Let’s discuss.

The ‘Agency’ Problem

The ‘agency’ problem is basically defined as follows –– it is when the representative for an individual (Realtor, stock broker, attorney, etc.) makes money regardless of whether the deal works out for the individual represented.

​​Don’t tell me what you think, tell me what is in your portfolio.”

Nassim Taleb –– Skin in the Game

In other words, if you buy a stock, or home, or car, and the value goes down, does the representative that recommended you buy it (the agent) feel the same financial pain? If they do not, then you (probably) have an agency problem –– one where the only the client suffers from the bad advice, not the agent.

As a very much younger version of myself, I remember a sage developer once telling me that he would be more than happy to build what I said he should, provided I covered his losses if it didn’t work out. And while I was taken aback by the statement initially, I quickly came around to understand what he meant. 

If he followed my advice and I was wrong, he was the one who lost –– not me. It was simply a way of saying, ‘Put your money where your mouth is.’ 

I never forgot the lesson.

Are We Buyers or Sellers?

So it begs the question, are agents buying or selling right now? And being even more specific, are WE buying or selling right now?

The answer is, yes, we are.

Wait, what, you said ‘yes’ to both. Are you buying OR are you selling?

The answer is more specifically, yes, we are doing both.

When We Are Sellers

We are selling a few things in our portfolio for various reasons, but they are not related to an expectation of a market crash.

Our house in OBX had extraordinary sunset views.

We are doing what is best for our portfolio.

The Beach House

We recently sold a vacation home we had owned for many, many years (in full disclosure, I LOVED the place, but it was time to let it go.)

Why did we sell it? For two reasons:

  1. We had a floating rate mortgage on the home, and due to the nature of vacation (2nd) homes, refinancing the property into a fixed rate mortgage was not feasible. We saw indicators that mortgage rates we due to rise and we didn’t want the exposure to an increased mortgage payment, regardless of the appreciation potential (or sunset!)
  2. The home was due for many deferred maintenance items that would have required significant capital investment. In other words, we had some expensive repairs on the horizon that would have required a lot of cash that we did not want to lose access to.

And so we sold it –– in a weekend.

Replacement and the 1031 Exchange

We then used a 1031 tax-deferred exchange technique to shelter the gains, and then bought both an office property (near Willow Lawn) AND a single family rental home in Kilmarnock (near the River) ––  and we were able to secure long term fixed-rate financing at a very low rate. 

From a strategic standpoint, we were able to remove a poorly financed property from our portfolio (that also was extremely unpredictable in its yearly maintenance costs) and replace it with two low maintenance properties financed at a 3.1% fixed rate.

And did I mention we actually upped the cash flows at the same time?

Great outcome.

So, yes, we technically sold one property (which made us a seller) but subsequently purchased two others to replace it (which made us buyers.) And we did so to reduce the risk in our property portfolio for reasons relating to mortgage finance, cash management, and tax impact –– not for fear of a market crash.

The Family Rental

In addition to the sale / purchase referenced above, we are also considering selling a property that we had owned for years as a single family rental (it is currently under contract.) 

The reasons we are doing so have less to do with a bet on the market dropping (we will simply go and buy something else similar with the proceeds, so we are still betting on appreciation) but more for a reason related to family. The home was leased by a family member and when they moved out, it felt better for all parties involved to find a new owner. 

So the reason we are selling is not to take money off the table in fear of a market collapse, it is due to a what is best described as a ‘non-economic’ reason.

The fact that we will be purchasing a home to replace it indicates our belief.

We are Naked Buyers, Too

OK, not actually naked per se –– I mean we are also buyers even we when don’t have things to sell.

In the past few years, we have added to our portfolio, over and above replacing the properties we sell.

Specifically, we have purchased a home with each of our eldest children, and are actively seeking to purchase more for investment purposes.

What did we buy, you ask? One is located in the ‘VCU Bubble’ and will always rent well (so the downside is extremely limited,) and the other is a super cute brick cape cod in the near west end (again, location and size make it very low risk.)

And yes, just like our clients, we had to win a bidding war ($40K over ask, btw) with a waived inspection clause in order to secure it –– what is good for the goose is good for the gander, right? We get the pain and uncertainty of the process.

Why put ourselves through the pain of a bidding war and the risk of potentially buying something with a lot of repairs in a market that seems overpriced? Because we are bullish on housing and we wanted to make sure that our kids had a chance at ownership in the same way that we did when we were their age.

So, yes, we are putting our money where our mouth is and we are making the same bet with our own children that we are asking our clients to make.

Other Strategies

We are also actively seeking land to develop or properties in need of renovations.

Buying housing does not scare us.

In addition to residential property, we are also looking for small office properties where we can find ‘value-add’ opportunities such as building on more space, carving off lots for development, and / or undertaking aesthetic upgrades.

We are lucky in that we have the benefit of experience to see how all forms of properties can be improved and thus our search box is bigger than most, but we are still buyers –– regardless of the asset class.

Again, we see demand well outstripping supply for the foreseeable future and nearly all forms of ownership (especially when financed at today’s rates even though they are up 25% from last year) are still a phenomenally safe play. 

The Bet We ARE Making

So to answer the question above, are WE buying or selling? The answer is that we are only sellers when we can replace what we sell.

And when we do sell, we are selling for reasons NOT related to a market crash, but rather for other strategic reasons, and we are replacing what we sell using the 1031 tax deferred exchange provision in our tax code. 

In other words, we don’t want to relinquish property at this juncture and give up the potential appreciation on any portion of it because we see more upwards pressure on pricing than we do the opposite. 

As a matter of fact, with inventory levels hovering where they are currently, the monthly appreciation is expected to be 2-3% per month (and no, that is not a misprint.)

Furthermore, we see not just property values rising, but rental rates rising as well. 

Focus on the Facts

Regardless of the events in Eastern Europe, or the interest rates, or inflation, or COVID –– the housing stock of our country is shockingly below where it needs to be and the 20 – 40 offers per listing indicates that demand is nowhere near abating (and yes, we track the number of offers, it is a phenomenal measuring stick for market momentum.)

As a matter of fact, since the beginning of 2022, the increase in interest rates has not impacted pricing whatsoever –– despite the predictions otherwise.

Am I being myopic and ignoring market crash indicators that will become obvious after the fact? Perhaps, but having lived through 2008, I am acutely aware of the conditions that caused that market to crash last time and none of those conditions exist today. 

When your market is 5M houses undersupplied, it is hard to see how things change.

The bottom line is that we see pricing continuing to escalate, with only a soft landing and flattening when the market returns to balance sometime in 2026 or 27 if we are lucky –– not the 30% drop of 2008. The lack of inventory makes a huge adjustment highly unlikely.

So just to reiterate, my money and my mouth are in the same place –– and we lived through 2008.

Have? Have Not?

The bottom line is that property ownership is increasingly becoming the dividing line between haves and have nots.

It isn’t fair, but it is an unfortunate reality (you can read more about my opinions here.)

The policies and decisions that led us to this predicament are long standing and incredibly tough to reverse. And even if they are ever reversed, the time required to build enough homes to satiate the demand is well over the horizon –– especially at the market’s entry price points. 

Housing has never really been, nor should it ever be, a short term thing –– like 1,000 shares of Apple or Bitcoin. You buy housing to own it for a years.

So yes, we are both buyers and strategic sellers –– but more than anything, we are owners and will continue to be so for the long haul. 

The Danger of the Unsolicited Offer

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The phone rings –– you don’t recognize the number, so you answer.

On the other line is a Realtor, who says that they have a buyer who is interested in buying your property, and that they have a written offer in their hand. Would you consider selling it?

Well, you know that the market is good and that prices have gone up, so you engage.

‘How much?’ you ask. 

The Realtor on the other end of the phone tells you a number that is way above what you ever dreamed your home could fetch –– AND you wouldn’t have to pay a listing fee. 

You do some quick math –– sales price, back out a small commission for the agent, subtract what you owe –– and try to contain your excitement. 

You hadn’t planned on selling, but that is a pretty big number. 

You say, ‘Send it to me …’

The Money You Missed

A large chunk of money is hard to resist when offered –– especially when you aren’t expecting it –– and it can catch you off guard.

But do you know what is better than a high sales price? A HIGHER sales price with better terms. 

‘And how exactly do you propose that one turns a large payoff to an even larger one?’ you might ask.

Easy, you leverage the greatest invention in the history of mankind when it comes to housing –– the Realtor Multiple Listing Service (MLS.)

How to Harness the Power of MLS

So how exactly does MLS create value for the seller?

Simple –– it harnesses the power of the network and amplifies it to your benefit.

MLS tracks somewhere between 95% and 99% of all real estate transactions –– meaning that anyone who is serious about purchasing a home uses it as their primary mode of finding a home.

Yeah, I get it. Zillow, Trulia, Realtor.com have the same info and better user interfaces yadda yadda yadda, but guess where Zillow et al get their information? You guessed it, MLS.

So when you offer your home for sale and put it into MLS, you immediately broadcast its availability to a network of 6,000+ Realtors working with 95%+ of the buyers in your market (as well as ZIllow, Trulia, and Realtor.com, too.) 

The impact is nearly instantaneous –– everyone who needs a home comes rushing all at once to try to buy yours. 

Creating an Auction is Simple (if you know how)

If you have ever been to an auction, you’ve seen the impact.

If you only have one person who wants the item up for bid (which is rare), well it typically doesn’t get top dollar.

However, all it takes is two people vying for it –– and the price escalates quickly.

If you have three or more, you can guarantee the price will escalate well in excess of the item’s value –– and thus, the goal for any auctioneer is to tempt three or more people into a simultaneous bidding war. 

That is why sellers love (and buyers hate) auctions. Multiple buyers keep one another honest and force everyone to dig deep and pay up. 

Auctions identify the most desperate buyer and make that individual defeat everyone else to win the prize. And when there are hordes who all want the same thing, prices and terms reflect the fact that demand is well in excess of the supply.

And I have some good news –– good Realtors know to leverage MLS to create auction-like conditions. So if you know how to make MLS function as a de facto auction, you can create the most value imaginable for your selling clients. 

Unless, of course, someone sells their home without using MLS.

The Impact of Buyer Competition

When you bid at an auction for a piece of art, or maybe some other rare artifact, generally the price that is paid is the only thing that matters. 

Central Virginia Mls - Fill Online, Printable, Fillable, Blank | pdfFiller
A real estate contract dedicates one paragraph to price and another 10-15 pages to the remainder of the terms. A good listing agent knows how to shift a great deal of performance risk to the purchaser’s side.

When you sell real estate, price obviously matters, but so does the structure of the financing, amounts of the deposits, the terms of the inspections, the terms of the appraisal, any rent backs or other extended possession agreements, closing dates, personal property, etc. –– all of which create seller value over and above the price. 

So, while the competition will drive the price up, a shrewd seller (or more specifically, their agent) will leverage the competitive environment to simultaneously shift the remainder of the contract’s terms in favor of the seller. 

Examples 

An offer that is bid up to say, 10% over the asking price, but with an appraisal contingency that could bring the price back down if the appraisal is less than sales price, then the seller is at risk for the price to be reduced in the event of a low appraisal (happens all the time, by the way.)

An appraisal contingency is a contractual right the purchaser wants to maintain in any offer. However, if a competitive offer waives the appraisal contingency, it forces everyone’s hand and you typically see other offers follow suit.  

Similarly, if the purchaser offers a $10,000 deposit that returns to the purchaser in the event that their loan is denied, but someone else makes the deposit non-refundable, well the seller is in a far stronger position to leverage both offers to make the deposit non-refundable. 

When the seller has leverage, nearly all risk in the contract can be shifted from the seller to the purchaser.

Without multiple offers, the seller’s position isn’t nearly as strong.

Multi-Offer is Key

When you fail to expose a home to the market, you don’t allow competition to do its job.

In 2021, nearly 60% of the homes in all of our MLS received multiple offers –– an all time high. But, when you dig deeper and examine specific segments where inventory is especially low and demand is especially high, such as the affordable segment in Richmond’s West End, the number is even higher. 

Not only did 70% of the West End’s affordable homes sell for more than ask in 2021, look how far above the asking price they sold for …

So, when you cut a side deal with a tenant in your rental, or with your neighbor who has always coveted your private back yard, or you accept the unsolicited offer brought to you by an agent with ‘cash buyers from NY,’ you are squandering the leverage an MLS-inspired ‘auction’ creates to not only drive the price higher, but to shift the remainder of the terms well in your favor.

The bottom line is when buyers compete, sellers win. 

Summary

I fully acknowledge that sometimes taking an unsolicited offer or off-market sale makes sense, but the cases are far fewer than people would believe. The public just doesn’t understand the power they are giving up when they don’t let the world know that they are willing to sell. 

If you get an offer on your home but have not exposed it to MLS, please resist the urge to sell it –– even if you feel the price exceeds your expectation. You are leaving significant value on the table. 

Yes, saving some commission dollars may seem like a good idea, but I can guarantee you that the commission you save pales in comparison to the leverage you forfeit by not selling through the MLS in such an inventory-starved environment.

Perhaps in the future, when the market balances itself again, the ability to create a bidding war will subside and the commission you might save could make a back channel sale makes sense.

Today, however, is not that day. 

2022 Market Housing Market Forecast

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Each year, we try to push out our thoughts about the housing market in the coming year.

2022 is no different.

The presentation we did this year we feel is one of the most important ones we have ever done.

Why?

Because the market conditions are quite frankly, unprecedented.

At no time in our history have we had so many extreme inputs to the market –– from inventory to stimulus to mortgage rates to inflation to migration –– everything.

To offer you a taste of what is in the presentation, here is a sample of what we see coming:

  • prices should continue to increase –– even possibly spike again
  • mortgage rates should rise
  • inventory conditions will continue to be near historic lows
  • migration to our region has never been higher
  • 2008 vs 2022 price analysis
  • new housing difficulties

And so much more…

Enjoy!

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