With the U.S Federal Reserve hell-bent on cooling an overheated U.S. economy, and choking off inflation, recession worries are reaching a fever pitch. The last recession of 2008-09 – “The Great Recession” – hit the housing market hard. For investors and homeowners who lived through that period, today’s recession talk is cause for anxiety.
But July of 2022 is a world away from July 2007. While a pullback/consolidation of housing prices is likely, even welcome, I don’t expect anything close to the 2008-09 correction.
It’s worth remembering that the average selling price of a house in 1963 was $18,000. Today it’s north of $400,000. Over this period, real estate appreciation has been remarkably consistent, though there have been a few bumps in the road. And 2008-09 period was a big pothole. Below is a historical chart of the median sales price of houses sold in the U.S. The 12% pullback during the Great Recession stands out as the largest pullback in recent history. And of course, we know that many markets (those that had skyrocketed most) fared much worse.
It’s obvious that the 2008-09 housing downturn was a historical anomaly. What made that correction so unusually bad? It all comes down to one word: Leverage.
As Warren Buffett has famously said, ‘If you’re smart, you don’t need leverage; and if you’re dumb, you shouldn’t be using it.” Back in the run-up to the financial crisis, a great many real estate investors and speculators – smart and dumb alike – were overleveraged.
Of course, intelligent leverage, or debt financing, is an important and even necessary part of most real estate deals. However, in the run-up to the Great Recession, financial leverage was historically extreme in real estate, and the financial sector in general.
Banks lent hundreds of billions of dollars to homebuyers who were gambling on higher housing prices. These subprime mortgages allowed buyers with minimal income, inadequate savings and less-than-perfect credit to borrow 95-100% of the value of a house.
Investment banks took this high-risk sub-prime debt, packaged it into securities, passed it off as investment grade, and sold the heck out of it. Due to regulatory changes enacted in 2004, the permissible leverage ratio for low-risk securities was about 60 to 1. When Bear Stearns went under in March of 2008, its leverage ratio was an astounding 33 to 1.
With the housing market leveraged to the hilt, falling home prices set off a “house of cards” scenario whereby lower prices drove increasing foreclosures which increased inventory and drove prices even lower.
But things are very different today. And we have regulations instituted as a result of the 2008 financial crisis to thank.
Fred Real Estate gone are the days when all you needed was to “fog a mirror” to get a loan. Significant down payments of 10 or 20% have been required for most homebuyers for over a decade. As a result, total mortgage debt in the United States is now less than 43% of current home values, the lowest on record. Just 2.5% of borrowers have less than 10% equity in their homes. This provides a huge cushion should home prices actually fall.
Which, by the way, for all the angst over a looming recession, hasn’t really happened yet.
Compared with 2008, today’s homeowners are in exemplary financial shape.
Lending standards are strict compared to 15 years ago. For the 53.5 million first lien home mortgages in America today, the average borrower FICO credit score is a record high 751. It was 699 in 2010, two years after the financial sector’s meltdown.
Another crucial difference between 2008 and today: Housing inventory. Back then there was a glut of houses. Today, inventories remain depressed. Here’s a chart comparing historical levels of housing inventory over the years (in thousands.)
The housing market is in the process of finding a balance between the sudden decline in affordability caused by the spike in mortgage rates and the continued demand from Americans anxious to own their own homes, but thwarted by limited availability.
Freddie Mac’s chief economist noted last week that “Fixed mortgage rates have increased by more than two full percentage points since the beginning of the year. However, in reality many potential homebuyers are still interested in purchasing a home, keeping the market competitive but leveling off the last two years of red-hot activity.”
Don’t be surprised if the correction in housing prices is surprisingly shallow and short-lived. This isn’t 2008 all over again.
Steve Sapourn is an active real estate investor, Aloha Capital’s co-founder, and portfolio manager. At Aloha, Steve has overseen more than 1300 real estate investor loans in 35 states. He has managed alternative investments in a variety of asset classes for over 25 years. He has deep experience in designing low-risk portfolios that reliably outperform benchmarks. Over his career, Steve has served as portfolio manager for a Fund of Funds, where he analyzed hundreds of alternative investment strategies. In addition, he has developed and implemented quantitative trading strategies in the futures, stock, and volatility markets. Steve’s long and diverse career benefits Aloha’s investors.