One of the most frequent questions I get asked by home sellers is “When should we downsize our home?” These days most sellers are thinking of personal considerations. They are pretty much taking a bull market of increasing values for granted. They aren’t even thinking about the “housing bubble timeline”.
It’s been 10 years since the housing crisis of 2008 and memories have faded fast. But the main reason I’m bringing this up now is that judging this market is getting tricky. From 2011 -2018, it was easy. No rocket science required. The housing market had been pulverized by the crash of 2008. Prices had no other place to go but up.
In 2018, there were signs that while some markets were just starting on a tear a few others seemed to be topping out. Most of the latter were in markets that had already had major run-ups from early in the recovery. We are seeing the same pattern in 2019. The result is a mixed picture.
In my market (Westchester, NY) the lower to moderate end of the market is full speed ahead. However, the upper end is seeing a slowdown in value increases. This means that prices are still moving up but at a slower rate. The exception is in high-tax towns and villages. This is probably due to the capping of state and local tax (SALT) deductions. This should surprise no one. New York is known for its high state and property taxes. Capping the ability to deduct these taxes from federal taxes is a big deal in towns where property taxes can run well over $50k/year. The fact that the slack in those areas has been picked up in surrounding towns is a very bullish sign.
Local markets vs global trends…
I qualify all of the above by stating that all housing markets are local. What is true in one market may not be true in other markets. However, a general read across several regions in the US and beyond indicates that there are significant pockets with similar scenarios. In these markets, the big yearly gains in home values that the high-end homeowners have gotten used to are ebbing. So this has some of the earmarks of a systemic trend, not a local variance.
So, what exactly is the “housing bubble timeline”?
The phrase is my own concoction and I use the word “bubble” advisedly. Housing market bubbles form when markets get ahead of themselves. The result is an overpriced market that is running hotter than inflation and salary increases over several years time. This impacts affordability and is not sustainable over the long haul. For the most part, these bubbles are nothing like the massive bubble that took down the housing market in 2008. That wasn’t any normal bubble. It was more like a giant hot-air balloon on steroids. I’m talking about the typical run-up in prices that is a normal part of the housing market cycle. The housing market has a well-known cycle that runs on a relatively long timeline. Understanding that cycle can prove very useful.
You can’t time the housing market…but…
No, you can’t time the housing market. Not 100% certainty. By this, I mean that no one rings a bell or sends us an email when the market has hit the bottom or the top. We will only know when we’ve hit the absolute top or bottom of a market after it has happened. Trying to time any kind of market in such an absolute way is like trying to read tea leaves. It can’t be done.
But that doesn’t mean that you ignore the direction of the market and known historical trends. If you know that you need to make a move in the next few years, it is wise to understand the market cycle. There is a saying that those who don’t learn from history are destined to repeat it. Of course, history doesn’t repeat itself in the exact same way and we can’t be ruled by the past. But we can gain insight from it and adjust our plans accordingly.
Housing tends to run in long cycles of boom and bust. Recently Teo Nicolais of the Harvard Extension School reviewed the long-standing model of the real estate cycle. The real estate cycle differs from other market cycles in that it tends to run in regularly spaced intervals of approximately 18 years. We must remember that the housing market doesn’t occur in a vacuum. Outside influences such as employment may make that time shorter or longer. The telltale signs that show us when the market may be shifting are what is most important for our purposes.
The 4 phases of the real estate cycle…
The real estate cycle was first described by Henry George in 1876 and later refined by Glenn R. Mueller. It occurs in four phases. It is best described in this link to the review by Teo Nicolais, but I will review it briefly here.
Phase 1 – Recovery
This is the period of time immediately following a market recession. When the economy goes into a recession layoffs increase and so does unemployment. Most people reading this blog have been through at least one recession as adults. If you have, I don’t need to tell you what it feels like. Those who are lucky enough to have a job, are looking over their shoulders worried that They may be the next person to get a pink slip. For the unemployed, finding another job is difficult if not impossible.
It’s pretty obvious that under these conditions, few people are jumping up and down to take on the financial burden of a home. As for the rental market, underemployed people are doubling up and making the best of a difficult situation. This, in turn, creates lower prices including the price of land and other materials.
At some point, the government usually steps up to create better market conditions including lower interest rates. This is often the push the markets need for things to get moving again. Lower interest rates encourage investment. Jobs are created.
When people feel like they finally have financial legs to stand on, they move on with their lives. Contrary to popular stereotypes, millennials stop couch surfing or living in their parent’s basements when they have the means.
Vacancy rates for rentals start to decline and people become interested in purchasing a home again. Since there is generally no new construction being built during the recession/recovery phases, housing inventory tightens. When that happens, real estate prices start to rise again.
Phase 2 – Expansion
The combination of lower interest rates, lower vacancies, and higher prices encourage real estate developers to start building again. But real estate is not like any other “product”. You can’t manufacture homes en masse like so many iPhones. Land has to be bought and sold, site plans have to be considered by local municipalities. Permits need to be issued and financing approved. This is why there is a major time lag between when development activity begins and new homes/apartments appear on the market. Given the complex nature of the market, that time lag is measured in years. 5-7 years to be exact. Meanwhile, prices rise along with rental rates.
This is obviously a nice time to buy a home. People know this instinctively. The market is stable, prices are going up but still have a long way to run. The very buyers who wouldn’t take the crazy gooey sweet offers that sellers were begging them to accept during the recession are suddenly willing to buy. They wind up paying more for the same home. But for many buyers, the higher price is worth the peace of mind. Buying into a bear market may be very profitable, but it can be scary.
Phase 3 – Hypersupply
As new developments appear on the market, the inventory is quickly absorbed. At least at first. But as more and more housing units appear on the market, the tightness of the market starts to loosen. The extreme thirst for new homes starts to be satisfied. This finally results in an increase in vacancy rates. That’s usually the first sign that the cycle of expansion is ending. Prices are still rising, but the rate of price growth starts to slow down. At this point, the pipeline of new housing is full. Development that started earlier in the cycle is still just coming onto the market. This sets the stage is being set for another turn in the housing cycle.
Phase 4 – Recession
Eventually, occupancy rates will fall below their long-term averages. This seems to be a critical inflection point at which new development tends to stop. However, new housing will continue to come out of the pipeline for some time to come. This sets the scene a housing recession.
A general recession worsens the overall situation because high unemployment means that fewer people have the means to either buy or rent. At this point, the cycle has come full-circle back to where we started.
Prices are too high and the market is swollen with inventory. When this happens buyers have more choices and they get very picky. Offers from sellers that would have had them on their knees crying in happiness a few months back are turned down. And with so many choices, many home buyers choose not to choose.
This results in even higher vacancy rates. As a result, rents start to decline as do sales prices. Higher vacancies and lower rents eat into profits quickly and often this leads to a cycle of foreclosures. This signals that we have entered a housing recession.
Key take-home lessons from recent downturns:
- The housing market is cyclic
- These cycles tend to be of long duration
- The higher end of the market is often the first to decline and the first to recover
- Moderate and lower range markets recover late in a bull market cycle
- A bear market is the best time to buy and the worst time to sell
For those who prefer video – two excellent summaries…
For those who prefer video tutorials – here is an excellent summary of the housing market cycle and shows clearly how the housing bubble timeline forms. I went on a video binge before selecting this video. Some caveats are that the video is roughly 18 months old and refers to a specific market. It’s also taken more from the investor’s perspective. And remember that all markets are local.
This second video is a sharp contrast to the first one, but valuable in its own way. It’s an interview with Robert Shiller. To people involved in housing, he needs no introduction. He is a Noble Laureate and best-selling author. The famous Case-Shiller index is based on the methodology created by Shiller, Karl Case, and Allen Weiss. This is somewhat wonkish and academic, but it also helps explain the long cycles of the housing market and what outside factors influence it.
What does this mean for the downsizing homeowner?
Well, downsizers need to look at where they are in this cycle. This can be complicated because every real estate market is unique. In the United States, some markets are already in the hyper-supply phase. I would put New York City in that category. The same could be said for places like London in the UK where prices seem to be drifting lower. In this case, Brexit fears are a big part of the picture. Vancouver, B.C., which has been on fire, is now seeing a housing market slow down. Australia appears to be poised for a major housing crash. Note that these are all located in major urban hubs. The very areas that have seen an explosion in prices and growth over the past 10 years since the 2008 crash.
It is also interesting to note that markets near these major urban cores seem to still be in their expansion phases. Many of these areas are, however, are going to start to top out. Appreciation will slow down and eventually turn in the opposite direction. Other areas in more remote locations, may actually still be in the recovery phase. But if you live in or near a major city, chances are the bull market cycle is starting to get a bit long in the tooth.
A house is both a home and an asset…
In this day and age, many retirees (and even younger people) see their house as both a home and tangible equity. Homes are hard to part with. We grow emotionally attached to them. These two facets to owning a home can be at odds with each other. Many would-be sellers whistle past the graveyard on housing markets that are topping out because they aren’t yet emotionally “ready” to part with the family home.
Missing the market can be a costly mistake…
The trouble is that given the length of housing market cycles, missing the market can mean a very long wait through a bear market for values to recover. That’s years of outlay that will eat into your nest-egg. The alternative of selling into a bear market for 25% less or more is generally unpalatable to anyone who can hang on. For those that can’t wait, missing the market can be devastating both financially and emotionally.
For those who are not at the top-end of the market, the wait can be even longer. After the 2008 crash, the tony areas sprang back fairly quickly. Living and working in a suburb of New York City, I can vouch for the frustration that many homeowners felt while the highest end of the market started sprinting ahead while their perfectly nice homes sat mired in recession for years on end. Homes across the street from each other could see for vastly different prices based on a change of zip code. Eventually, the differences in pricing between adjacent towns were too great to ignore and the areas left behind started seeing healthy gains. But it took the better part of a decade for it to happen.
Sooooo, if you are thinking of downsizing, you should ask yourself the following questions:
- Where in the market cycle does your area look to be?
- How did homes in your immediate location fare during the last downturn? Did they bounce back or did pricing only just recently recovered?
- If your market appears to be topping out, can you comfortably wait up to a decade to sell if you need to?
Buyer’s attitudes towards buying a home shifts dramatically in a bear market. Nothing is ever big enough, perfect enough, or cheap enough. Serious buyers are as rare as hen’s teeth. Many buyers refuse to pull the trigger no matter how nice the homes they see are. Those that do buy, have dozens of homes to choose from. The trouble here is that buyers don’t feel “safe” in this market. Bear markets are scary. The smart money may be buying, but few people have the stomach to do so. If you are trying to build up your nest egg from the sale of your home, the last thing you want to do is compete for very frightened, fickle and rare buyers.
If you don’t think you can sit out another 18-year cycle and gains in your market are slowing down, it would be wise to work with the cycle and not count on the bull market lasting several more years. Once a market turns, you can’t go back in time and recapture the value that you have lost.
Different types of housing can have different recovery patterns…
This is going to vary from location to location. In the market where I work, there is a tendency for condos and townhouses to bounce back before most of the single-family home market. I observed this in two housing market cycles. The first when I was buying a home and the second as an agent. In both of these cycles, the price of condos and townhouses sprinted ahead of single-family homes. When I was purchasing my home (later 90s) I wound up in a house because, at the time, it made more financial sense. I had planned to buy a condo, but they were obviously overpriced compared to single-family homes.
At the beginning of the recovery from 2008, the condo/townhouse market did the same thing I observed in the 90s. Condo prices rose before housing prices saw similar gains. This has big implications for people who are trying to downsize into a condo lifestyle from a large single family home. Right now, single-family homes have risen at a rapid clip. Should there be a “correction” these home-sellers are going to have a long wait for prices to recover if the market follows the same pattern as it has in the past. Worse still, the condo they want to buy is going to recover, before their home will. If what you are selling is undervalued compared to what you want to buy, you are not playing with a winning hand.
Some bellwether signs that the global housing market is softening…
As previously stated, all markets are local. But in this case, some global trends seem remarkably consistent. They should not be ignored.
The trend towards urbanization has created pockets of housing market bubbles…
Since that time, the trend has been towards urbanization. Major cities worldwide have seen strong price appreciation and rapid development. The latter usually being in the form of high-rise apartments or condos. This is truly a global trend the scope of which included the major cities of almost all developed nations.
The runup in this cycle started in urban centers…
The recovery in housing has been uneven. Some areas (urban centers) have exploded in growth and price increases. Once an area starts experiencing almost exponential growth, it tends to have a ripple effect on nearby cities and towns. They too start to see sharp price increases and developer interest. This is the natural result of rising prices pushing people further and further from the cultural and employment hubs in search of affordability. The housing cycle in these suburban hot spots are therefore a few steps behind the urban areas where the recovery started.
It is important to note that if these urban epicenters are hitting a brick was called “affordability” at pretty much the same time. The surrounding suburban areas may still appreciate rapidly during this period. But people living in these outlying areas should be aware that the party will start to wind down for them as well. Probably sooner than later. Their market cycle is just a bit behind that of their urban neighbors.
The party does indeed seem to be winding down globally in the big urban centers. New York City, Boston, Washington, D.C., Los Angeles, San Franciso have all recently started trending downward, particularly at the high-end. Likewise, in Canada, popular destinations such as Toronto and Vancouver are also seeing a similar pattern. In the UK, London also appears to be slowing down and there is nothing short of a housing crash going on in Australia. The big picture is that of a global housing bull market that is finally starting to plateau precisely in the locations where it started. This is something to watch for because it is a global trend that will cut across all markets if it continues. It is a possible indication that the global bull market for housing is ebbing.
When will the next housing bubble burst?
The short answer is that we don’t know precisely when, but we can use historical trends to determine where in the cycle we are. If home price increases have slowed down or stopped, it is a sign that the market is turning towards a buyer’s market. We don’t know exactly when this shift will take place, but we can be pretty sure that the change is on the horizon.
Because housing cycles are long, we tend to think that the status quo will go on indefinitely. We forget about a crash that took place over a decade ago and watch happily as our homes rise in value. But when things get a little bit too good, you need to realize that this is something that won’t go on forever.
When you should downsize your home depends on your individual situation. The “why” often helps determine the “when”. For example, if you are very secure financially, then downsizing will probably have more to do with age and infirmity than with finances. If that is the case, the market cycles are really not of that great importance. But if your financial situation is a big piece of the puzzle, you will really need to consider the natural market cycle. No, you can’t predict how the market will be, but you can learn from past cycles and plan accordingly.
© RGHicks 2019 – https://www.downsizingup.com – All rights reserved.