Mortgage Lending

I have to admit, I would love to see another recession.

Uhhhh …. you are in the real estate business. Why in the world would you want to see another recession?!?

The real reason? So we can stop talking about it.

Talk. Talk.

The talk of the next recession has been on the lips of every naysayer since 2015, as home prices spiked and bidding wars became the norm. ‘Oh no!’ they all said, ‘Here it comes again. It is just like 2008!’

The recession of 2008 was unprecedented, at least in my lifetime. I am sure that those who lived through 1929 might argue, but what happened to not just our economy –– but the world’s economy –– was unlike anything we have ever seen. To see a repeat of 2008 so soon feels unlikely –– especially when the fraudulent behavior that was at the root of the crash is not anywhere as prevalent as it was.

No, it is nothing like 2008. Not only are the conditions wildly different, but no two recessions are the same.

Disclaimer 

Now, I am not for all of the negatives that come with recessions –– I don’t want to see anyone lose a job, lose a house, lose their savings, or even their sanity. The last recession caused all of those occurrences and caused them in spades.

I also hate that in the last moments before a recession, fraud tends to be at its highest, and many of our most vulnerable are left holding the bag –– with little to no recourse against those who committed the acts (but that is another post for another day.)

So, no, I am not for the traumatic impact that a recession can have. I am only for the idea that once we have the next one, we can go on with our lives and stop living in fear of its arrival.

F-1 / Category 5 / 7.0 Richter

One of the problems with recessions is that no single definition of a recession exists. Well, that is technically incorrect, one does –– 2 consecutive quarters of negative GDP to be precise ––  but, absent of that, we don’t really have a way distinguishing one from another. There isn’t a recession severity meter like there is for earthquakes, hurricanes or tornadoes that tells us what to expect.

We all know that a Category 5 Hurricane is really, really bad –– flooding, strong winds, loss of utilities, massive property damage (and this was written before Dorian struck the Bahamas, btw…) –– and thanks to modern weather modeling, we have a pretty good idea when one is coming, where it will land, and how severe it will be.

In other words, we get ample notice and have time to prepare –– oh, AND we have the ability to insure our property against the event.

Imagine if we could predict a recession like we could a hurricane –– ‘Next Tuesday expect to see a plummeting stock market, sagging house prices, accelerating unemployment, and declining wages. We expect the recession to make landfall in the lower Manhattan area late in the afternoon and last until September 15, 2026, at 2 p.m., before finally moving back offshore!’

Unfortunately, nothing exists to tell us when the bad economic times will arrive, what segments will be impacted, or how long they will last. There is no way of telling if it will be a true ‘Category 5 level’ event that leaves destruction in its wake or more of a Tropical Re-Cession (see what I did there?!?) that never makes it to shore.

And rest assured, when it comes, we can’t just call our friendly State Farm agent and ask for a check.

Therein lies the fear. 

How Scared You Feel = How Old You Are

For those who are 40 years old or younger, the only recession that they have lived through was a humdinger. The Great Recession was the worst recession on record –– rife with bankruptcy, foreclosure, fraud, and collusion. House prices fell by 30-40% and new home building essentially ceased. 

But ask a ‘50 something‘ (and, yes, I am now a ‘50 something.’) if they remember the Recession of 2000?

Wait, there was a recession in 2000?

Yes, there was and it lasted for two years. I think unless you worked for a tech company and your millions in stock options became worthless, you really don’t recall much of a hiccup in 2000. But according to the definition, we had one. 

Ask the ’60 somethings’ about the 1987 crash and subsequent 5-year malaise –– and they will remember it vividly. It was sudden (Black Monday, anyone?), pronounced, and eventful with great consternation in the Savings and Loan industry (again, led by fraud) that led to a fall in other segments. It also featured a great deal of overbuilding in the speculative office market.

Each Recession is Different

But do you know what happened to house prices in 2000? Nothing really. They actually went up, albeit at a slower pace. 

What about 1987? House prices stayed relatively flat to slightly up.

Wait, what?!? House prices went UP in a recession?!?

Yep.

In the same way that each Category 5 hurricane is different (size, speed, rain, wind, path) so is each recession.

And therein lies the rub.

A Recession is ALWAYS a Fear

As a good and experienced veteran of the real estate business told me, ‘You should absolutely be worried about a recession … because you should ALWAYS be worried about a recession. That is what they do, they come and then they go. The question is not if –– or even when –– it is how prepared are you for its arrival and what do you do when it shows up.’

He’s 100% correct.

In the same way that you stock up on milk, bread, gas, and water when the hurricane is coming, you should do the same with your financial life. Dial back the speculative bets, become a little more liquid in your investments, and don’t go on spending sprees. 

At the end of the day, a recession is coming, in the same way that rain is coming, winter is coming, and old age is coming –– it is part of the cycle.

Down Market = Opportunity

Am I saying that you should sell everything you own, crawl down in the shelter, and hunker down until 2027?

No, of course not –– beyond its inevitability, don’t let the pending arrival of challenging financial times scare you into panic mode.

Fortunes (large and small) tend to be made in down markets and thinking about the strategies you might employ when you see the signs is the first step to not only navigating the down times, but thriving in them.

And above all else, remember that a good decision isn’t impacted in the long run by an up or down market –– a good decision in a down market is largely the same as a good decision in an up market, it just may take it a bit longer to pay off.

Summary

As we have written about many times before, the fundamentals that existed in 2008 and those of 2019 (and beyond) are completely different. When the next recession comes –– whether today, tomorrow, or March 3, 2024, it will start in a different sector, last for a different duration, and impact us all differently.

Don’t fear the inevitable –– be prepared to take advantage of it.

A Home is an Asset

For those who know me, I’m not about the ‘house of your dreams’ narrative – I am pretty objective in my approach. I want my clients to understand the underlying value of what they are purchasing and not allow emotion to override logic.

That said, I fully acknowledge there is a powerful emotional aspect to buying a home. Regardless of whether it is your first, third, or even the twentieth home, each connect you to a specific period in your life. Selling a home feels like closing a chapter, and when you buy one, a new chapter begins.

Sticks, Bricks, and a Vehicle for Wealth Creation

Yet despite the emotional attachment, in the simplest sense, a home is nothing more than a stack of sticks and bricks on some dirt that keeps your stuff dry. While we want to attach value to the colors of our walls, the shape of our exterior, and the brand of our appliances, in the grand scheme of things, housing is no different that any other asset whose value goes up or down given economic conditions.

And 2007 through 2011 notwithstanding, owning a home has created more wealth for the masses than any other asset class in history.

This is what has me worried.

No Crash on the Horizon

To begin, I am not worried about another crash. I have lived through two of them (1987 – 1992 and 2007 – 2011), and the current market looks nothing like the last two that crashed.

Currently, the economy is solid, employment is high, inflation is still shockingly low, and while the world is never fully at peace, there is relatively little global unrest (at least compared to prior periods) – and inventory is at all time lows.

Is there a correction coming? I think that some are beginning to predict a slight pullback at certain price points in 24 to 36 months. But I firmly believe that a crash is not imminent.

The Housing Divide

No, my worry is as follows — the price of housing is at the precipice of exceeding affordability for the average American, preventing an entire segment of the population from ever having access to home ownership.

[ And this recent article in The Atlantic seems to back the same narrative – especially Section 6 ]

In effect, a home is quickly becoming an asset that only the wealthy can afford, and, over time, will lead to a deepening of the divide between the ‘haves’ and the ‘have nots.’

Take a look at this chart.

The blue line represents home ownership levels. In other words, what percentage of the population owns their own home.
The green line represents the median price of a new home.

Notice a trend??

Pricing is accelerating despite historically low ownership levels. The obvious implication is that as prices rise, fewer people will be able to buy – and we can see this playing out right before our eyes. Right now, due to a host of factors which we will touch on below, housing prices are increasing at a rate that is pushing ownership beyond the reach of far too many people.

Never has the discrepancy been greater, and I think that is a tragedy.

Time to Build More, Right?

An economist would argue that the problem will solve itself: As prices rise, more producers will be attracted to the market and supply will increase.

But that simply isn’t happening.

Take a look at this chart showing the number of new homes being built:

Again, notice a problem?

Despite the fact that housing is undersupplied and pricing is accelerating, we are still drastically under-supplying a market that desperately needs relief.

The Problem is Systemic

Perhaps the underlying problems were already manifesting themselves as early as 2000 and we simply didn’t see it as the rapid price increases were masked by a insanely lax lending standards.  But the issues are more than visible now.

Effectively, the problem is about price AND location. We cannot add supply at anything approaching a reasonable cost, and we absolutely cannot do so in areas where the populous wants to buy.

Issue One – Construction Costs are at an all time high

Building costs are through the roof (no pun intended.) Construction material costs have skyrocketed and the construction labor market pool simply isn’t there, causing extreme wage pressure.

When your material costs are up 30% and your labor pool down 50%, costs spike. And I don’t see an quick solution.

Issue Two – Governmental Mandates Mean Higher Costs

Each bill that is passed to make housing better is done so with good intentions – I honestly believe that. No one wants the US to build substandard and inefficient housing – AND no one wants to see another financial crisis, either.

However, each time Congress, the state legislature, or our local board of supervisors adds another layer of regulation, the cost to build a home goes up.

• California Will Require Solar Power for New Homes
• Regulation Accounts for 25% of Building Costs
• Dodd Frank Costs the Taxpayer $36 BILLION in 6 Years

Each increase in the building code or protection baked into the financial markets is done so with the aim of increasing the quality, safety, accessibility, and energy efficiency of our housing stock. But with each mandate comes increased expense. A percentage point here and an increased fee there never seems like a lot on its own, but over time, the collective increases become substantial – and the end user ends up footing the bill!

Issue Three – Demographic Shifts

Demographics show a population that increasingly wants to live in cities. Urban schools are getting more funding, the commutes are shorter, public transportation is expanding its reach, and the entertainment districts are improving. But yet, the city is the hardest place to build houses.

To give you a sense of the problem – per the 2010 census:

• The population in the city of Richmond increased 9.3% from 2010 to 2016, or by roughly 20,000 residents.
• In the same time frame, MLS tracked 854 new home sales within the City of Richmond.
  • Stated differently, 854 new homes / 20,000 new people = 4.2%
• For comparison’s sake, Chesterfield built just under 5,000 new homes in the same frame, or closer to 17% of their need.

Somehow, I don’t think 4.2% of the overall need being satisfied by new housing is going to fix the problem.

Issue Four – Gentrification

If you really want to see a mind-blowing statistic, look at these screenshots straight from the Richmond MLS.

The northeast section of the City of Richmond (Highland Park, North Church Hill, Union Hill) is in the midst of one of the most rapid price increases in the history of the city.

Inside of this zone:

This happened to prices in 5 years:

While that benefits some owners, it leaves many others wanting.

The New Normal

Am I saying that everyone should own a home? Hardly. We tried that once (2007) and it didn’t seem to work out very well.

But I do believe that a housing model in which ownership is reserved for only the elite is an equally dangerous model. America is the land of opportunity and when the idea of owning a home becomes an unattainable pipe dream, that is not a good answer either.

Look, it is easy to build another million dollar home on a cul-de-sac in the latest community 10 minutes further out than the last one – but that is not the cure. We have got to solve the need for reasonably affordable / attainable housing in neighborhoods that aren’t 45 minutes from the urban core.

The next generation of potential homeowners deserves the same opportunity as prior generations did to use housing as a fundamental way of building wealth. Everyone wins when our population has the ability to determine their own financial destiny.