Recessions are the best times to learn the most about real estate.
Everything is stressed, tightened to their limits, and displayed in slow motion to best witness and absorb.
Thus, a tense orchestration of participants, property, government, transactions, agreements, ancillary services, income, wealth, demographics, and similar real estate fundamentals exist.
Recoveries are, by their nature, diametrically opposed. Everything becomes relaxed, tension disappears, and learning becomes a casualty. Everything gets a universal lift and everything is successful, like ships riding a virtuous incoming tide. In the recovery paradigm, what’s to go wrong with all this effortless synergy?
For 2023, welcome to an enhanced learning environment made available only by a recession. Now is the instructive period of a business cycle which positions talented, recent licensees to max out the good times in the recovery phase of a business cycle.
Recessions build and stay in power for the highly alert among us. And, in turn, sets up the longevity necessary to compile experience to competently advise consumers of real estate services.
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Economic recession or not, the housing market recession is here
The prospective agent and their supervising broker
Before an individual may act as a real estate agent and showcase a home in the flatlands, valleys or hills to earn a living – salary or fee – they first need to become a salesperson licensed by the California Department of Real Estate (DRE). Once licensed, a real estate broker may hire them to work in their brokerage as their agent.
To become licensed, the aspiring agent needs to pass the state licensing exam administered by the DRE. Prior to applying for the state exam, the DRE requires the aspiring agent to complete three real estate courses provided by private schools whose courses are DRE approved or public institutions.
Editor’s note – firsttuesday is a leading provider of California-specific pre-licensing courses.
The prospective agent who passes the state exam may become a salesperson — more commonly called a sales agent or simply an agent – in contrast to an individual licensed as a broker.
Once licensed, the sales agent is employed by a broker. Thus, the agent will perform services in real estate transactions as the representative leashed to their broker for supervision – all mandated by state codes and regulations. In this way, the agent is the agent of the agent – their employing broker.
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Any fees for services an agent performs in transactions are always paid to their employing broker. The agent may be involved in transactions to render services on behalf of their broker which generate fees such as:
- leasing and property management;
- mortgage financing and trust deed notes;
- sales of interests in real estate, business opportunities and previously-owned mobilehomes.
The employing broker who neglects to supervise an agent puts themselves and the agent at risk of a DRE licensing and sanctions review depending on the level of neglect.
As the 2023 recession approaches, brokers need to consider a higher level of supervision and oversight of their agents — including broker-associates — to prevent any misconduct by their staff. During recessions, oversight generally becomes less demanding of the broker’s time since prudent employing brokers eliminate — fire — the non-productive agents on their staff, leaving fewer agents (and branches) to manage.
Misconduct by agents during recovery periods, circa 2013 to 2021, are generally neutralized and thus “covered” by the increasing value of the real estate interest acquired or encumbered in a transaction. In stark contrast, the inevitable loss of property value in a recession is no longer available to offset the losses incurred due to agent errors and transgressions. Instead, it is about the dollar value lost.
Thus, the broker, the agent and their errors and omissions (E&O) insurance carrier will be covering collectible losses incurred by participants in transactions caused by the agent during the recession.
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The cycle of sales agent licensing
During the real estate recovery and transition into a virtuous half cycle, members of the public become aware real estate has the very obvious potential of being a lucrative occupation.
Motivated to switch professions as a source of greater earnings, these aspiring agents pile into courses to obtain a license.
Of this optimistic cohort, approximately half complete their pre-licensing courses, pass the state exam and proudly emerge as a licensed agent.
As always, the ripple effect of the wake created by the ever-greater pace of a recovery into boom time excesses becomes, descriptively, a recession – the other half cycle of real estate activity. It is then that the rush to enter the real estate profession peaks and enthusiasm for entering the profession quickly wanes, as it began in Q2 2022.
In June 2022, there were 223,381 active agents. However, a total of 308,093 individuals held DRE agent licenses — meaning 27.5% were inactive; unemployed by brokers. Compared to the more stable period of January 2020 with 204,392 active agents out of a total of 286,270 licensed as agents — meaning 28.6% were inactive.
When the 2023 recession passes and a recovery begins – likely around 2026 – the pace of new licensees will be about 40% of the peak experienced in Q2 2022. It happens in every regular business cycle, just as in 2000-2003 with its premature stimulus and 2007-2011 with its delayed stimulus.
Rather than just providing brokerage services to other individuals, the superfluous agents —active and inactive — often turn to speculating in real estate as principals or syndicators. Thus, they often operate as insiders participating as a principal to locate property for family members, acquaintances, and for themselves to buy for their own account.
In 2023, anticipate a rapid market adjustment in a return to core economic fundamentals. Consider the supply of inventory for sale or lease. Inventory will only stabilize when the demand by end user-occupants puts a stop to further buildup of inventories. Meanwhile, sales prices decline, a dead-cat bounce of activity from returning speculators and startups runs it short course, followed by several months to build up buyer confidence before buyers and tenants activity starts to shrink inventory.
Additionally, data indicating an end to a recession will be a return to rent-to-income and mortgage-to-income ratios in the residential markets at a third of gross income.
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California’s for sale inventory: a symptom of homebuyer demand
Pandemic distortions
The pandemic period created a seismic tsunami-style distortion, a three-year flood-and-drain event in real estate user demand and pricing. While COVID triggered the pandemic, the market conditions driving the pandemic demand and pricing were:
- low inventory of property for sale or lease;
- a low level of construction starts;
- massive business closing and job losses; and
- offsetting fiscal and monetary stimulus;
Riding the pandemic distortions, by the time we hit the end of 2022, the active agent-to-broker ratio swelled to an average of 2.4 active agents for every active broker. This ratio has steadily climbed since bottoming at 1.9 agents per broker in 2012.
With the volume of sales and leasing and the pricing of property and rents fast declining going into 2023, expect the current flock of agents to be underemployed for the lack of need for their services and the resulting reduced incomes. Many have and will become discouraged, dropping out of the active licensee population as unemployed by a broker. First as non-productive agents which inefficient brokers will allow to hang their license with the broker. Then as unemployed-inactive agents who eventually let their license expire without renewing in 2024-2026.
Though many agents and brokers will appear active in DRE reports, a significant percentage of them will earn most or all their income outside of the brokerage business.
Challenges – and opportunities – for boomtime licensees
Most new sales agents enter the world of real estate sales, leasing, and mortgage services with little understanding about real estate matters, limited agency training, and no practical experience in brokering transactions.
To remedy this lack of comprehensive experience needed to advise clients on real estate transactions, agents need better education and training beyond what is covered in the mandatory pre-licensing courses. This increased need for pragmatic training includes:
- property investigations and disclosure training to develop an understanding about the costs of owning property to advise clients what consequences the transaction they are contemplating will bring to bear;
- training in financials, such as profit and loss statements and balance sheets;
- instructions on the economy of the real estate cycles; and
- a two-year apprenticeship as part of a team employed by the broker before they handle negotiations and documentation in a transaction unattended by a supervisor.
The DRE needs to consider implementing research for a study and report on the type and duration of apprenticeship training needed to permit a licensee to operate on their own, without a team member present, when dealing with clients. For the DRE, it is a matter of their consumer protection oversight, especially in homebuyer transactions funded by mortgage borrowing.
Hundreds of thousands of California families lost their homes over the past decades due simply to unsustainable mortgage debt incurred in a transaction negotiated by an agent. For mortgage lenders to get away with improper mortgage lending does not eliminate a buyer’s broker’s agency duty owned to their buyer to advise their buyer about fully foreseeable financial trouble.
It is likely that some 400,000 homes will be foreclosed on in the coming four to five years due solely to the negative equity which will develop for all mortgaged purchases made in the past four or five years.
An agent with proper training in personal finance and real estate cycles may advise their client of the consequences obtained by home debt arrangements being built into a transaction to fund the closing and put a stop to most improperly structured purchases.
When the deficiency in licensee training is not corrected, buyer lawsuits are the result.
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