What should you do and not do in this market?
Stock Market turmoil and impact on real estate:
The two main drivers of the recent stock market decline are interest rates and market uncertainty. This has led to huge swings in stock prices. Market uncertainty and rising rates have a significant impact on real estate, too – it just takes longer to show up.
For residential and commercial, rising rates raise the cost of capital and reduce buying power, ultimately resulting in lower demand and softening prices. For commercial properties, increasing rates also push up cap rates and decrease prices in the process.
Residential buyers in Denver are getting triple whammied by already high prices, increasing interest rates and investment losses. This is starting to show up in slower activity, longer marketing times and more price reductions – mostly across higher price ranges. Rising rates and stock market losses surely decrease consumer and business confidence as both businesses and individuals want certainty before making a large long-term purchases, which will only exacerbate the process. Mitigating factors in Denver are the continued strong economy and population growth.
What should you do?
- Buy now vs wait:
- Residential: If you are in a highly desired price point, for example in central Denver under 500k where there is little supply, you are likely still safe buying now now, but examine each neighborhood carefully. You might be better served by seeking a more stable neighborhood and sacrificing on size/features, vs. going after edgier neighborhoods which have started to enjoy demand in the past couple years. (Example – Choose a home in Baker that may not be as shiny or new as the fully remodeled home in Elryia/Swansea). If you are looking in a fringe market with ample or growing supply (any new subdivisions being built around?), you should exercise extreme caution. Builders may start to slash prices to unload product to avoid being left holding the bag. you’d hate to pull the trigger on that new home to find six months later it could have been had for $25k less. If you must pull the trigger now, negotiate hard.
- Commercial: Rising rates should ultimately raise capitalization rates which results in lower values, but market turmoil could cause a flight to quality assets which may stabilize prices for quality assets. If you find a high-quality asset at a good cap rate, it probably wont get any better. If you are looking for lower quality options, focus on opportunity zones to leverage favorable capital gains treatment as a hedge.
- Lock or float? Do not lock! Rates will be at or near their peak over the next 12 months. There will be some short-term upward movement in rates, but over the long terms rates will fall again as we enter the next economic cycle. As soon as the economy turns, just like in the last cycle, the federal reserve will lower rates in order to help “stabilize” the economy. Furthermore, long term rates will naturally drop as future growth cools. Over the long term you will have the ability to lock in a much lower rate.
What is driving the “market correction”?
The federal reserve is currently raising rates – that’s been clearly announced and known for a while. But the market may have anticipated a slower pace than has occurred, perhaps overly optimistically. This mismatch in expectations may have led to jump in longer term rates, catching the market off guard and pulling all rates up in the process. In the meantime, the President doesn’t like any rate increases as it stifles growth – hijinks ensue. The fed needs to raise rates to ensure that they have room to drop rates when the next economic cycle hits, but the President’s criticism may elicit a greater reaction from the Fed to illustrate their resolve and independence, which could be further exacerbating rate increases.
While rate gyrations foster their own uncertainty, other outside forces are also driving concern:
Trade wars are easy! No good outcomes here. Trade wars are increasing prices. Manufacturers either take the hit (declining profits), or pass on the increase to consumers (increases in inflation/slower demand). Not good either way. Manufacturers are like large ships. With their entrenched overseas operations and long lead times, they can’t react fast enough to any beneficial trade deal in a way that will provide any meaningful economic benefit in the next 2 – 3 years. Plus there seems to be a fundamental misunderstanding of the cost of labor for domestic manufacturing. Perhaps there is some long term upside to unilateral trade deals (5-10 years out?), but in the meantime, the result is a short term hit at a time when other forces are also weighing on the economy. Its likely too that beneficial trade deals that bring manufacturing back home will likely result in greater use of automaton due to higher local labor cost – or inflation. The lost jobs from the spread of automation would negate any benefit from bringing those manufacturers back home – other than for increased corporate profitability. Inflation is also not good for continued economic vitality.An un-forced error it seems to me….
Wage Growth – slowly ramping up, but not on pace with other previous recoveries. Plus not enough time for workers to build assets before next downturn means less margin for riding out a recession.
Inflation – discussed above, but it is pervasive and, in Denver especially, likely under counted. It is terribly expensive to live in Denver. While housing cost account for much of the inflation, everything seems to be going up, especially food cost. As the labor supply is still tight, wage growth is making it more expensive for many retailers, restaurants and service providers to conduct business without passing the cost on to consumers.
In a recent interview, Trump economic advisor Peter Navarro described the economy as being in a “Glodilox” state. If he meant the time right before the bears came home, he might be right….