The two most likely scenarios for the real estate market.
As I explained in my previous blog post, this market seems to be at the end of its course. Affordability is at a historic low, and the current level of prices is only sustainable due to the ultra-low inventory. What is going to happen next?
The current affordability crisis in our area was created by the combination of two factors. The first one was the increase in prices that started in 2020, right after COVID. It became the norm for price appreciation to reach 100% year over year. Between 2020 and 2022, prices doubled or even tripled in the valley. That mainly happened due to ultra low interest rates and an urge from people to move to areas where access to recreation, open space and privacy was abundant. Our valley and other small mountain towns obviously qualify for all these criteria and we saw massive appreciation materialize as a result. With most buyers being from outside the area, and on average wealthier than most locals, prices started becoming unhinged to local income and affordability started to nosedive.
After the COVID years and the fast appreciation that came with it, the FED ramped up interest rates to cool off the economy and created the second big factor that played into the affordability crisis. If the average price of a house in Glenwood Springs became $1,000,000 by early 2023, you also had to finance it at 6 or 7% interest rate. With a 20% down payment, going from 3% to 7% interest rate on a million dollar purchase makes the monthly payment jump from $3,372.83 to $5,322.42. Hard to keep up with it for most folks. Local workers are largely disqualified despite the economy and the job market playing to their advantage.
With local jobs being so far from allowing local people to buy a home, you could quickly jump to the conclusion that a crash is imminent. In my humble opinion, there are 2 mostly plausible scenarios on the horizon. I don’t want to pretend that I have a crystal ball, but I do have my finger on this market’s pulse and I closely monitor the economy’s trajectory.
Scenario 1: A “black swan event” disrupts the economy and a mighty crash happens. The definition of a black swan event is that no one sees it coming, so I won’t pretend that I do. But with interest rates being so high and the FED actively trying to slow the economy down, lending is becoming difficult and expensive. If they go too far in the tightening of monetary policy, a liquidity crisis could happen and crash values temporarily. Personally I find this scenario unlikely because I still see a lot of cash out there and especially in our area. For the supply to outpace demand in the Roaring Fork Valley, it would take a huge amount of pain in the economy. With a lot of homeowners having locked rates around 3% and living comfortably with that, I can hardly see a flood of distressed sales hitting the market. Nonetheless, historically the FED has created downturns more often than not during tightening phases and we can’t deny the possibility of such an event happening in the next 12 months or so.
Scenario 2: After plateauing for a few months due to high interest rates, the market goes back to its upward trajectory. The real estate market hardly cooled off during the steepest hike in interest rates in history, but there could be other parts of the economy that suffer from high interest rates and push the FED to lower rates before the real estate market is impacted. If rates go back down before the real estate market really cools off, the frenzy will start again and we could see some serious appreciation happening again.
What to do then?
If scenario 1 happens, the winners will be the ones sitting on cash and retaining access to financing when things go south. In other words: the rich. The funny part about this is that if too many people are sitting on cash waiting for a crash, it just won’t happen. It takes a cruel lack of money out there, and pain, for a crash to happen. And that’s why I don’t see a crash coming. A lot of people came out of the “free money” years that followed COVID sitting pretty financially and the job market as well as the consumer don’t show any signs of pain. There seems to be enough money out there to avoid scenario 1 to happen.
If scenario 2 happens, the winners will be the ones who get into the market now. If you can acquire a property that breaks even, or slightly cashflows now, ( or that you are satisfied with the monthly payments at today’s rate) and refinance your debt at a lower interest rate later, you will come out of this upcoming year in good shape. For scenario 2, the old guideline for real estate investors that says to“buy and wait” rather than “wait to buy” is probably what will allow some to win in tomorrow’s market. Especially in our area that seems to attract an endless flow of newcomers from the front range or from out of state.
