Or, is there still room for higher values?

During most of 2020, as coronavirus cases heightened, some real estate investors were nervous, believing that after a seven-year run-up in residential real estate values, we were headed for lower prices and possibly even a bubble.

Uncertainty is not good for real estate investors. COVID-19 presented lockdowns, work-from-home situations, and other unknown factors that had would-be investors and potential homebuyers holding off real estate purchases. Mark Hanf, president of Pacific Private Money, noted a drop off in loan requests at the end of first quarter 2020 and the first two months of the second quarter.

However, the situation did not continue for several reasons.

Investors sitting on the sidelines, waiting for the bubble to burst, were flummoxed: Prices did not decline; they increased in most markets. Compass Realty, a major real estate sales company, reports the higher end of the market did better than other sectors because homeowners clamored for larger homes anticipating work-from-home was going to be a long-term situation.

For example, Compass reported that Marin County, an affluent county in the San Francisco Bay area, saw a 70% sales increase from 2019 in homes priced above $3,000,000, and a 35% sales increase in homes priced between $1,250,000 and $1,999,999. These were would-be homebuyers who had saved or made money during the previous seven years and had the means to make a move to a more expensive house.

The question a buyer always ponders is whether “now” is the right time to buy or whether to wait for prices to decrease.

Let’s consider a few factors that may impact the buy now/buy later decision.

Work From Home

With the economy opening back up and increasing confidence that we’re “getting back to normal,” homeowners are trying to decide whether making a real estate move is right for them. They are trying to answer questions such as “Will my employer allow me to work from home?” or “When will my employer ask me to come back to the office?” These types of questions consider the aspect of commuting to work. For example, workers who will need to return to the office must consider whether a longer commute is worth moving further away to get a larger or less expensive house.

Inflation and Interest Rates

Some economic pundits are also forecasting that we might start experiencing a sharp increase in inflation as well as interest rates hikes in the near future. In December 2020, Federal Reserve chairperson Jerome Powell acknowledged the economy could see some price pressures, perhaps from rising energy. Powell’s prediction has proven true. Oil, one of the leading indicators in the energy market, has increased from $45 to $63 per barrel, as of this writing.

These two economic factors may cause real estate buyers to pull the trigger earlier rather than later. Investors may attempt to lock in lower rates before they rise, and typically real estate rises during inflationary times. Such activity may drive real estate prices even higher. Compass reports a surge in prices of homes as well as volume, with multiple offers for houses being common in the current marketplace. The perception of a rising real estate market often pushes would-be buyers to purchase more hastily, before real estate prices increase beyond their reach. Conversely, as interest rates drop, real estate buyers typically try to ride the rates down before pulling the trigger, as we saw during the Great Recession.

Millennial Influences

One other factor at play is generational behavior. Many millennials watched their parents lose their houses or saw prices drop during the Great Recession and decided it was better to rent.

With the recession almost 10 years in the past, these millennials have started families and saved money during the pandemic. They are in a position to invest in real estate by buying their first home or purchasing a rental property. They see what appears to be a real estate frenzy, and they don’t want to miss out.

Other Factors

Factors such as unemployment, cost of materials, borrower credit and monetary policy may also play a role in causing real estate to decline soon.

Unemployment.  Unemployment may have crested, because it appears some employers are having a hard time filling jobs.

Building materials.  When it comes to building materials, as their cost increases, it stands to reason that real estate prices follow suit. Homebuilders must factor building costs in when pricing houses to buyers. Recently, the cost of plywood (as well as other materials) has doubled and even tripled in some markets.

In addition, delays on appliance deliveries have stretched for months in many cases. As a result, new home building prices are expected to rise and be delayed for delivery. This should increase the price of existing homes as well, as homeowners will likely choose to purchase an existing home in situations where time is of the essence (e.g., a change in job location).

Monetary policy. In terms of monetary policy and credit to borrowers, regulators so far have not eased up much on the credit issue. Credit was too readily available to borrowers during the Great Recession, which was the major reason real estate prices fell. During this period, banks were more interested in posting loans on their balance sheets rather than practicing prudent lending. When borrowers failed to make mortgage payments, especially when interest rates increased on adjustable loans during the reset period of the loan, banks were in the undesirable position of having to eliminate the challenged loans off their books and take tremendous write-downs. Unlike the Great Recession, borrowers today must prove their ability to repay, and qualifying for a loan is still taking a long time.

Many regions in the U.S. are reporting a housing shortage. In California, the fires in 2017 and 2018 removed over 10,000 dwellings. Replacement of those houses has been relatively slow. Texas has seen a surge in house prices, especially in metropolitan areas such as Austin. Thus, we are seeing more demand than supply, which is pushing real estate prices even higher.

Although during the pandemic we saw somewhat of an exodus from the cities to the suburbs (San Francisco, for example, looked almost like a ghost town), many people have been vaccinated and may start to feel more comfortable returning to the city. In addition, some employers are starting to request that employees return to the office rather than work remotely. Return to work should push the demand back to major metropolitan cities, because many people want a short commute.

Based on these factors—low inventory, expected inflation, higher material costs, and an expected rise in interest rates—we may see another run up in real estate prices across the board before we see prices heading lower.