Has the Real Estate Market Reached The Bottom Yet?

The End of the Free Fall.

Over the past 12 months, the real estate market across the country took a literal beating as rising inflation forced the Federal Reserve to rapidly (and belatedly) raise interest rates. Home mortgage rates spiked in unison, hitting a high of 7% momentarily in October. The sudden change in interest rates coupled with employment uncertainty was the equivalent of a cardiac arrest for the local housing market as the number of sales and corresponding prices imploded, especially in high-priced markets like San Mateo County.

The San Carlos real estate market certainly did not escape unscathed. As I documented in the 2022 Year in Review, home sales prices in San Carlos plummeted over 20% from the peak in the Spring through the end of the year, and the number of homes that sold in the second half of last year was the lowest amount for that period in many years.

The most common question I'm being asked now is, “Has the market reached the bottom yet?” This is an impossible question to answer, because we won't know if we hit bottom until it's already behind us. It's no different from trying to gauge the bottom of the stock market. But there are signs that indicate the free fall that we saw last year is coming to an end. Consider the following:

Home Prices Are Stabilizing

The graph below shows the average sales price for single-family homes in San Mateo County. The data size was too small in San Carlos to draw any meaningful conclusions, but the market behavior here tracks pretty closely with the rest of the County, so the analysis is pertinent.

Home prices were actually up in February, reversing a nearly year-long downward trend. Of course, I will be the first to tell you that one month's data does not constitute a trend. But based on the intensity of the sales activity that we're seeing in February (more on that below), I would not be surprised to see similar numbers when the March and April revenue numbers are tabulated.

Mortgage Rates in Check.

As mentioned above, home mortgage interest rates spiked in October to around 7% after the first rate hike by the Fed in September. What's super interesting about this is that the Fed raised the rates again three times after the September hike. And what happened to mortgage interest rates after these 3 hikes? They went down, not up. Why? It's very simple. The banks overreacted.

When the banks hiked their rates to 7%, one economist smartly noted that at that exact point, the gap between what interest rate the banks borrow from the feds and what they then lend to the public was the largest gap ever recorded. Even more than in the Great Recession, or any other period where interest rates experienced volatility. The shock factor on the real estate market to such an abrupt rate hike was very real – loan applications dried up overnight and buyers stopped buying. From Econ 101, if the banks don't make loans, they don't make money. So they had to immediately cannibalize their own margin to get buyers back in the game, which is why you saw the perplexing drop in rates.

Today, after 4 rate hikes, that same 7% 30-year fixed-rate mortgage is closer to 6%. I've even seen a few lenders touting it in the high 5 range. It's still pricey, but it's enough of a concession to entice buyers to start looking again. Smart buyers know that they can buy now and refi later when rates come down further.

Activity is Up, While Inventory is Down.

One behavior that is evident since the beginning of the year is the sales activity is picking up significantly from the fourth quarter of last year. Many homes that were re-listed in the first quarter after not selling in Q4 have sold, often within the first week or two after re-listing. And multiple offers are becoming more frequent again — I heard reports of two different homes in Belmont that each got over 15 offers. We were definitely not seeing that in the second half of last year.

Part of the reason for the increase in prices and activity can be attributed to another rule from Econ 101: Supply and Demand. Inventory across the County is down significantly in all price ranges, and that knocks the supply versus demand balance out of whack. For the past several decades, there have always been more buyers on the Peninsula that there have been homes for sale. That has not changed, even in the face of rising interest rates and economic turmoil. It's why house prices are so high here.

Why are listings suddenly drying up? Capital gains liability has always been a deterrent to selling a home, and that hasn't changed. What has changed is that sellers are reluctant to “trade up” on their mortgage when they move. Unless they were asleep at the wheel, most home owners locked in super low mortgage rates from the free money days and they simply don't want to exchange a 3% mortgage for a 6% one. That's eliminating a number of listings that would have been on the market had the rates been a bit closer together.

We Are Not Out Of The Woods.

While this change in buying activity that we are seeing in the first quarter is refreshing, it's important to note that the market is still going to face some stiff headwinds in 2023. Namely:

• More Rate Hikes. The Fed has already made it clear that there will at least two more rate hikes this year as it tries to rein in inflation. Remember, their target for inflation is 2%, and despite recent declines in the inflation figures, we're still a long way from that 2% goal. These Fed rate hikes could force banks to raise their rates again.
• Economic Instability: There are a growing number of economists that are predicting a widespread stock sell-off as early as this spring, as stock prices get realigned with lower corporate earnings. Since many buyers in our local market have their down payments tied up in equities, that could weaken their buying power.
• Employment Uncertainty. For the first time since the Recession, local high-paying jobs are being cut in non-trivial numbers. While getting laid off certainly sucks for those who are impacted, the number of jobs cut is still a minuscule fraction of the overall number of jobs in the Bay Area. But the emotional impact is huge for potential buyers. Nobody wants to buy a home that they won't be able to pay for.

These 3 factors will play a key role in our market in 2023, and may ultimately pull home prices lower if they all come to fruition. But even in the worst-case scenario, I can't see home prices dropping another 20+ percentage points again. I actually see prices oscillating up and down by a few percentage points this year, factoring in the points above combined with the normal ebb and flow that's tied to the calendar.

That oscillation is far different than a free-fall, and is analogous to a rock skipping across a lake… or a market skipping across its bottom. So while it's impossible to call where the bottom of the market is, the activity we're seeing is telling me we're getting pretty darn close.

I'd love to hear your perspective — leave a comment below!