How Do I Know if the Real Estate Market is Declining in my Area?

27 Jul How Do I Know if the Real Estate Market is Declining in my Area?

In 2022, there have been heightened fears of a recession. A recession is defined as a period of temporary economic decline in which trade and industrial activity are reduced, typically identified by at least two consecutive quarters of negative Gross Domestic Product (GDP). The real estate market in the U.S, including sales of residential and commercial properties, new home and building construction, remodeling, and mortgage financing, comprises about 16% of GDP.

The prices of new and existing homes, apartment buildings, and many types of commercial real estate rocketed upward since the outbreak of COVID-19 in early 2020. The S&P CoreLogic Case-Shiller National Home Price Index indicated that home prices went up 19.7% in May 2022 as compared to May 2021. Historically, home values appreciate 3-4% per year, so a 19.7% increase is dramatic and not sustainable in the long run. Home prices tend to go up over the long run, particularly in areas with population growth. The Case-Shiller data is oftentimes a lagging indicator, showing us what happened over the past year but not what is happening right now or in the near future.

Data released on July 27th, 2022 from the National Association of Realtors (NAR) shows that the number of pending sales dropped a whopping 20% in June 2022 as compared to June 2021. The number of pending sales in June 2022 were down 8.6% compared to May 2022. The number of pending sales is a leading indicator of what is about to happen in the real estate market. If mortgage interest rates jump up over a short period of time, that is a leading indicator of a market slowdown since many would-be buyers will either drop out of the market or pay less for a home.

The Case-Shiller and NAR data are nice for understanding national trends, yet it’s been said that all real estate is local. So how can you gauge what’s happening in your local market? As a real estate investor, how do you adjust your strategy?

Here are the metrics to track in your local market:

• Days on Market (DOM). If the DOM is increasing month over month and year over year, that indicates the market is slowing due to decreased buyer demand, lower supply, or both.
• Average Sale Price. If the average sale price is not increasing year over year, or declining, this indicates that demand has slowed while supply has increased.
• Inventory or Months Supply. If the inventory levels and/or the months supply levels have increased, that indicates that demand has decreased.
• Number of Price Reductions. If more and more sellers are cutting their asking price, then that indicates that there are fewer buyers and/or that the buyers out there believe prices must go down first.
• Number of Foreclosures. If the number of distressed sales (short sales, pre-foreclosures, and foreclosures) is increasing, that will put downward price pressure on all homes. Distressed sales tend to sell for less than non-distressed homes, and many buyers may search for a bargain.

These metrics can usually be obtained from your local Association of Realtors. Your Realtor can usually compile this data pretty quickly.

Perception matters. If a number of buyers think prices or rates will go down, they may wait. If a number of sellers become nervous, they may be much more willing to accept an offer below the asking price.

A savvy real estate investor can make money in any market. For a landlord, what typically matters most is the amount of free cash flow per month. For a flipper, the price, location, and renovation costs will help determine whether something is a deal. If you know your exit strategy, your renovation costs, your preferred neighborhood, and your financing costs, then finding deals becomes simpler. You have to identify opportunities and make offers knowing that many offers will be rejected or met with a counteroffer.

If you are a flipper, you need to be more careful in a declining market. The concept is to buy low and sell high. In a rising market or peak market, many amateur flippers buy high and hope to sell higher. And certainly don’t buy high and sell low. Landlords are playing the long game, counting on steady rents rising incrementally each year while the mortgage payment stays fixed and the balance goes down. Therefore, savvy landlords may be less affected by negative market shifts.

Be a local economist. Track basic data in your marketplace and chat with your team about what they’re seeing. Watch for leading indicators. If you can see market shifts in advance, you can position yourself to take advantage of them rather than react to them later.

Tai DeSa is a graduate of The Wharton School of the University of Pennsylvania.  He became a full-time real estate investor in 2004 after serving in the U.S. Navy.  Tai has made colossal mistakes in investing (and learned some things along the way).  He has helped hundreds of homeowners avoid foreclosure through successful short sales. Check out Tai’s books on Amazon.com. Tai may be available for coaching and speaking engagements on a variety of real estate topics.  Send an email to tai@investandtransform.com.