In real estate, a pricing correction generally refers to when prices drop 10% below their peak market value. The median price of sold homes reached a market peak of $428,700 in the first quarter of 2022. For the current market to enter a correction, the national median home price would have to fall to $385,830 or lower.
With record high demand and record low supply coming out of the peak of the COVID-19 pandemic, the housing market has been a focal point of news headlines for the past two years. As remote work and migration towards low-cost cities increased, home values across the nation soared. This was especially true across the Sunbelt states and cities that experienced record-high in-migration including: Austin, Phoenix, Raleigh, Vegas, Charlotte, Dallas, Nashville, Atlanta and Tampa among others.
Now, as headlines highlight rising interest rates, soaring inflation, and a looming recession, we are slowly but surely starting to see slowing sales combined with increasing inventory on the market. What factors are contributing? What does this mean for real estate going forward? Let’s dive in.
While there are several factors that can contribute to a market correction, let’s explore the current conditions of the housing market and talk about what is happening and why. Home values have soared in recent years: In January 2022, average nationwide real estate appreciation reached 19.1%, the highest level in 45 years. Essentially, all of the pent-up demand concentrated in core cities like New York, San Francisco, and Los Angeles was starting to spread across the nation due to shifting trends that came out of the pandemic. This led to increasing home values as demand for homes increased and supply remained low as home-building slowed during the pandemic.
Great, so home prices were up at record highs. Homeowners were very happy, and homebuyers were just happy to be participating in the growth and moving into their new homes. Simultaneously, rent growth soared as for-rent properties achieved record-high year-over-year growth, upwards of 15% in some cities coming out of the peak of the pandemic. Additionally, the job market was on fire with unemployment hitting 3.5%, the lowest since 1969. Growth, growth, and more growth. Then came inflation.
Inflation hit 8.3% in August this year, and so the Fed decided to increase interest rates to slow down an overheated economy. What does this all mean for real estate? Well now that interest rates are up, the cost of capital to take out leverage is higher. When someone invests equity into a real estate opportunity, they participate in the upside as a return for their contribution. That upside fluctuates with the performance of the property both in cash flow and in appreciation, as we discussed in our “Cashflow vs Appreciation”. When someone gives a loan to purchase real estate, they are owed a pre-negotiated return on their investment regardless of the performance of the property. This return is tied to interest rates. As interest rates go up, the return to lenders goes up, which also means the cost of that loan goes up to equity investors in a real estate deal.
As we discussed in our “Why Invest in Real Estate” blog, a cap rate is a yield measured by your net operating income divided by your purchase price. Your numerator is determined by operations, your denominator is determined by capital markets. Well, now that growth is slowing down, your operations can only grow so much now that rent growth is cooling off. However, yields have to stay higher to keep up with the increasing cost of leverage. So, if your numerator is capped, what is left to change? Purchase prices. Hence, looming pricing correction.
You may be thinking, “does this mean real estate isn’t attractive to invest in anymore?” Quite the contrary! Real estate will be more attractive than ever. Although current owners will not be able to bank on returns primarily driven by increasing purchase prices, this will be a chance to optimize operations and buy into new investments at incredibly attractive prices. This will be especially advantageous to new investors in the current market. And that’s where mogul comes in!
mogul not only allows investors to deploy their hard-earned capital into attractive, high-yielding real estate investments with great cost bases, but will also allow current owners to liquidate all or some of their equity at a massive discount to traditional sales costs. Given where the market is positioned, mogul’s strategy will be the perfect angle for investors and owners alike, especially as the macro-economic appetite for real estate increases as confidence in the stock market declines.
Pricing corrections are a necessary part of every real estate cycle. They are not necessarily something to fear, rather something to embrace, internalize, and shift with as opportunity presents itself. If you are looking to invest in real estate, or have a property that you would like to onboard, register now on our platform and enjoy the benefits of cost-savings, liquidity, and incredible upside that come with our real estate offerings.