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If you have been paying attention to the real estate market, you'll know that prices have been growing at astronomical rates. Driven by inflation, high savings amounts, and low interest, home prices across most of the country have experienced robust and consistent growth.
According to the S&P CoreLogic Case-Shriller National Home Price Index, which measures the average U.S. price in major metropolitan, home prices rose 18.8% in 2021, hitting a record high. As a result, motivated and cashed-up buyers submit offers on properties well and above asking prices, making it exceptionally hard for many to get into the market. In some regions, it's not unheard of for houses to sell for as much as 25% over the asking price.
With a red hot seller's market and record-high prices, many home buyers, owners, and unaware real estate professionals are wondering, are we headed for another major crash like 2008?
The answer is no, and there are many reasons why.
What happened that led up to the crash of 2008?
First, let's recap the market conditions and lending conditions that led to the crash in '08. Regulations in the U.S. were permitting some wild lending conditions. As a result, buyers could qualify on self-proclaimed income that didn't need to be carefully verified, and properties were qualifying based on drive-by valuations that didn't necessarily match their market value. Systematic problems and subprime lending criteria led to a market crash that can only be described as inevitable.
Subprime lending was widespread from the late 1990s through 2008.
Let's look at an example that could be one of hundreds of thousands of Americans.
John Doe goes to buy a house. He's self-employed, and last year he made about $80,000. This year John thinks he's on track to make the same. So, on his loan application, he puts down his income as $80,000. He's looking to get a loan with 100% financing because they are available, and why not? He believes that his cash is better invested elsewhere. So then, John buys his home for $300,000 that qualifies based on a drive-by appraisal and gets himself put into a fully financed, variable rate mortgage.
For a year, John diligently makes his payments before his income falters as the economy struggles, the real estate market starts taking a turn for the worse. Because of the market dip, he watches the value of his property plummet from $300,000 to $250,000. Then, his variable interest rate gets increased again and then again. Now he's struggling to make his monthly payments on a property he owes more to the bank than the property is worth, and it looks like the real estate market isn't going to improve anytime soon.
John, who didn’t have to invest a significant deposit and is now owing $50,000 more than the property is worth, starts to question if it's even worth holding onto the property. However, a short sale gives him a viable opt-out option from which he is confident he can financially recover. So, he gets in touch with his bank, and the property goes on the market.
Now, imagine John’s story or similar repeated millions of times. Homes are foreclosed on or short sold all over the country because buyers just don't have enough skin in the game, and interest rates have made their payments unmanageable. So when millions of homes go on the market nearly all at once, interest rates are high, and consumer confidence hits the floor, it's easy to see how prices could plummet at alarming rates.
Crazy sub-prime loans created the perfect storm for an insane crash. So, how is our market today any different? Despite initial assumptions, market and lending conditions are very different from those in the 2000s.
Why is today’s market different?
Firstly, lending conditions over the past decade and a half have tightened significantly. For example, buyers must meet stringent requirements, and unless you qualify for a USDA or VA loan, you must have a deposit. In addition, several major legislative responses were implemented to avoid another crash, including the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Emergency Economic Stabilization Act (EESA), which created the Troubled Asset Relief Program (TARP). Moreover, the Federal Reserve and loan originators have created their own set of tightened lending requirements.
Secondly, variable loans are tough to come by. Most buyers have been locked into a fixed rate, meaning that the interest rate hikes won't impact their monthly payments at the same severity as in 2008. So even if prices plummet, as long as their income remains steady enough to continue making their monthly payments, they will benefit by waiting for the market to turn around as it usually does.
Thirdly, yes, buyers are making offers well and truly above the asking price, and valuations aren't yet supporting these prices. However, today's difference is that these zealous buyers are filling the gap with cash. They aren't financing above a property's value but are coming to the table with even more cash to ensure they can purchase. Therefore, if the assets' value drops, they have more skin in the game and the motivation not to sell at a loss.
In real estate ownership, whether it be a primary residence or investing, you only really lose your initial investment if you choose to sell when the property is worth less than when purchased. If a property value dips for a couple of years, but the market turns around, resulting in a higher value than the purchase price, no money has been lost as long as the owner continues to make their mortgage payments. It's the sale of the asset that leads to money loss. Because buyers have had to deposit significantly more money, they are considerably more motivated to hold onto their purchases during market downturns.
The Wild West lending days are over. Even though homes are selling for seemly crazy high amounts, there is a lot of cash, not debt, being used. In fact, 20% of buyers today are all-cash buyers. Furthermore, according to the National Association of Realtors, the average deposit for buyers is currently 12%. That’s a big step away from a fully financed purchase.
There’s no crash in sight.
Despite rising interest rates, there is still an incredible amount of cash in the market and a severe housing shortage across most major metropolitan areas. With this imbalance in supply and demand coupled with homeowners being far more invested in their assets, it's unlikely that any market correction will create the same panic and largescale impact as the crash of 2008.
If you're looking to build a real estate career, have confidence that today's market is not an anomaly. If you're already an agent, educate buyers and homeowners about what makes today's market so different and why they should have confidence in their assets.
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