Gary Shilling, the author of the Case-Shilling real estate index, accurately predicted the last real estate bust. He has come out with recent predictions that throw a cold towel on how this housing cycle ends. Are we at a peak in real estate? Where do we go from here in regards to prices? What should you do now if you are a buyer or a seller? Which areas will fare best during this market cycle?
What does Gary Shilling say about the housing market?
Here are the key points from his opinion piece in Bloomberg:
- Demand will weaken
- Homebuilder supply will increase at the higher price points leading to excess inventory
- Mortgage rates will continue to increase: we have already seen rates move close to 4% with the markets anticipating a substantially higher move up
- Housing prices will decline as supply outstrips supply: Schilling is predicting a minor correction on housing prices due to the three factors above
“As demand for single-family houses begins to weaken, supply is starting to leap. After the 2008 financial crisis wiped out many homebuilders, the survivors were extremely cautious. But with the passage of time, their confidence has leaped. From an index low of 9 in 2009, it climbed to 76 in December 2019 just before the pandemic, and in January of this year, rose further to 83, well above the pre-financial crisis top of 72 in June 2005. The number of new houses under construction exceeds completions by the largest margin since 1984. This will increase inventories of unsold new houses. They’ve already risen from 3.5 months’ supply in October 2020 to 6.0 months in December. Rising costs for everything from lumber to copper will make these houses more expensive and harder to sell. The National Association of Realtors’ index of pending house sales in December fell 7% from a year earlier.
I don’t look for a huge single-family housing price plunge as during the subprime mortgage collapse, but a decline of 15% to 20% seems likely. This would be a big shock to the many who have relied on housing as well as stock appreciation to support their spending.”
If we are at a peak as Shilling suggests, what should you do?
- Sellers: now is the time to get moving, if you are planning on selling now is the best time as there is little upside left.
- Buyers: Although rates are rising, there will be opportunities ahead as the market resets. Patience would be good at this stage in the market.
What happens when the markets fall?
Although, I don’t think this real estate cycle will end like 08, there will be pain aheas. As a lender in the last recession, I learned some important lessons about what happens when the markets tank and s*** hits the fan. We are a private real estate lender and portfolio and service all our own loans and therefore we were forced into a front row seat in the last crisis. Like many lenders we lost money on certain transactions. I wanted to try to avoid this same scenario whenever there was a market downturn.
Many years later I’ve gone back and analyzed which transactions we got hurt on and which ones we did okay on to ensure we don’t repeat the same mistakes. When I look at our portfolio in the great real estate correction, there were clear trends that emerged. Certain property areas got hit considerably harder than others. Why did some areas fare well relative to other areas?
What trends emerged after the 2008 real estate correction?
As I studied our losses in our lending portfolio there were three glaring trends that predicted losses. These trends are true for both commercial and residential areas.
- Consistency: the more consistent a neighborhood the better it fared during a downturn. I’m not saying all houses look alike, but the vast majority of houses were all well maintained and grouped at an average price point. Neighborhoods that had problems had outliers that were considerably lower than others. On the commercial side this was also a key indicator of success. Properties in uniform areas performed considerably better. For example, a building in an industrial park with many like properties did better than a property not in an actual industrial park but surrounded by different commercial property types.
- Closer to core fared better: Properties closer to the city core in good areas typically fared better and came back much quicker than other areas. There is a desire in many areas for city living as traffic has gotten worse and many companies have moved jobs back to the city cores. Denver and Atlanta are good examples. The closer in areas came back much stronger than the far outlying suburban areas due to demand and lack of new inventory.
- Euphoria (up and coming): Towards the end of the cycle it seems like every neighborhood is the next “it” neighborhood with speculation abound. These areas are much less solid than more established areas and therefore are at considerably greater risk during a downturn.
What is the mushroom theory for real estate?
A mushroom can predict the trends above. Look at the shape of a mushroom, its colors, and consumption.
- Shape: A mushroom is much stronger towards the middle as opposed to the outlying parts of the circle. The closer you are to the center, the better you will be in the next cycle. This relates directly to the “closer to the core” rule.
- Consistency: certain parts of the mushroom are much more consistent in shape/texture than others. As you get farther out on the top of the mushroom the colors change, pieces fall off the sides, etc… Stick to the consistent areas to excel in the next correction
- Eating too many mushrooms 😊: As we get towards the end of the cycle, there are always people that try and consume too much towards the end of the cycle and get into “marginal” areas. It is always the final mushroom that can make you sick. Make sure you manage your consumption towards the end of the cycle and not bet on marginal areas that could turn the other direction. Moderation is key to success this late in the game!
Although Shilling is an outlier in his predictions, I think they are right on the money. I’ve been seeing the same trends emerging in the market the last several months which leads me to believe that we are somewhere near a peak. With a peak in sight it is important to brace for possible downside risks of 15-20%. Although this sounds like a big number, nationally prices increased about 20% last year with some hot markets hitting 40% plus. This coming cycle will not be like the 2008 recession, but it will still be painful especially for those that have bought in the last year or two and did not put much down. Mark Twain famously said “History doesn’t repeat itself, but it rhymes”. I’ve been through a number of cycles and can hear the rhyming faintly in the distance …. !
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
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