After two years of living in the basement, interest rates have skyrocketed in the first part of 2022 and show no signs of stopping anytime soon. The implications for real estate have been ferocious.

The Federal Reserve (the Fed) is the main culprit behind the sudden rate jump. Its fight against high inflation has induced Fed members to raise their benchmark rate and cease their mortgage-backed bond buying program which had kept mortgage rates artificially low during the 2020 recession and pandemic response.

Now, where before mortgage money was plentiful, would-be homebuyers are left grasping at air.

Pictured above is firsttuesday’s Buyer Purchasing Power Index adjusted to show the change from when fixed rate mortgage (FRM) rates were at their historic low in December 2020.

As of April 2022, the average 30-year FRM rate has increased such that the amount of mortgage money available to a typical homebuyer had fallen nearly 25% from December 2020. Absent other changes in circumstance — say, income increases or sudden cash windfalls — homebuyers today are at a major disadvantage compared to those who bought just a year ago.

For example, a typical individual who qualified to purchase a home with a maximum mortgage of $500,000 in December 2020 now only qualifies for a maximum of $375,000. Over the same period, home prices have also increased rapidly. Since December 2020, California low-tier home prices have increased on average 23%, with mid-tier prices up 28% and high-tier prices up 31%. This double whammy has left mortgaged homebuyers unable to compete.

The rapid and dramatic cut to mortgage principal available has pushed homebuyers to:

  • exit the market (a sound financial decision);
  • settle for a smaller/lower quality, but less expensive home (a sure-fire way to catch buyer’s remorse); and
  • offer less money for the same standard of home (unlikely to work in today’s still competitive market — but just wait a few months and sellers will soon be eager to accept lower offers).

Together, these actions translate to reduced demand for high-priced properties — and while the drag on home prices is not yet perceptible in mid-2022, the decline is imminent.

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Home pricing in the coming recessionary market

Historically, when the Fed begins to consistently increase its benchmark interest rate, a recession follows 18-36 months behind.

Thus, even as the job losses of 2020 have yet to be fully recovered, the economy is heading for a second recession, which firsttuesday forecasts to arrive in the latter half of 2023.

Already, the feeling of economic dread is trickling down to the average consumer and end user homebuyer and seller. Alongside higher consumer prices, news of the stock market’s downfall and the readily apparent escalation in interest rates are difficult to ignore.

The result will be fewer homebuyers interested in buying at what they rightly sense is the top of the market.

As homebuyers quickly bow out, sellers will be eager to toss aside their investment like a hot potato and will increasingly accept lower home prices. As prices decline, recent homebuyers will soon find themselves underwater, weighed down by negative equity. Unable to complete a traditional sale, some of these homes will head toward foreclosure and become real estate owned (REO) properties.

How will real estate professionals fare in the coming downturn?

Real estate agents who wish to continue making a decent living in the years to come will prepare now by becoming a(n):

  • broker, expanding their income stream by opening their own brokerage or even just increasing their fee split within their current brokerage;
  • REO specialist, building relationships with key players in the REO industry;
  • real estate syndicator, gathering investors to profit from the lower home prices ahead;
  • property manager, a recession-proof career; or
  • specialist in seller financing, also known as carryback financing, which will undoubtedly become more popular as interest rates continue to rise.

The housing market won’t stabilize until after 2025, with buyer-occupants, speculators and long-term real estate investors returning in greater numbers beginning in 2026-2027.

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How to prepare for the REO resurgence