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Despite rising interest rates, affordability crises, and a 60% chance of recession, there’s one thing that’s still defying all odds – housing prices are climbing higher with no sign of slowing down. RedFin reported that the total value of homes jumped by 5%, the biggest gain in nearly a year, and the housing market is more than $2 Trillion expensive as of now.
While buyers are wondering how much higher prices can go and which areas are going to be the most expensive, Warren Buffett just cashed out on all his housing market investments. Does he know something that we don’t? With 2024 shaping up to be an important year for real estate, let’s look at:
- The outlook for this year
- Why Warren Buffett sold his housing market investments
- What are the factors that will affect prices
- What you can do to come out ahead as a buyer
The perfect storm in real estate
Over the last two years, the value of the housing market has increased by a whopping 13.3%. Why? There are three factors putting pressure on real estate right now.
One: Scarcity of listings
Homeowners were able to lock in houses at record-low mortgage rates, and it’s going to take a much better deal for them to let go of what they have. 99% of homeowners have locked in rates better than what’s offered on the market. 85% have a rate below 5% and 63% have a rate between 2.5% to 4%.
If a homeowner currently has a 3% mortgage, prices would have to drop by 36% (from $400,000 to $255,000) for the same house to have a mortgage payment identical to what they’re paying. So unless they’re forced to sell, they aren’t going to let go of their mortgage. On the other hand, if rates fall to 5.5%, that would be the magic number that would push more buyers to start looking for homes.
Two: Home values have no place to go but up
Last year, home values hit a low after a complete standstill in 2022 over interest rate fears. That’s partly the reason why we’re seeing such a dramatic increase in prices now. When rates were high, sellers had no choice but to stay locked into their homes, very few homes were being listed, and from there, the market had no place to go but up. Suburbs saw the biggest comeback, while high-priced cities are falling out of favor. The shift in favor of remote work could be a reason for this.
Three: More homes are being built
Home builders are finally beginning to fill the void with new constructions making up a third of the total market inventory. Compare this to 2000 to 2019, when this figure was just 13%. This incentive has led to a 21.7% increase in new buildings compared to a year ago.
Given all these factors leading to rising prices, why has Warren Buffett cashed out at what looks like a perfect time to be in real estate?
Buffett’s investments
Warren Buffett is often quoted as saying “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.” But what he did with his real estate stocks seems to go against this. You see, in August of 2023, Buffett announced that he had made a substantial investment in three major US homebuilders: DR Horton, Lennar, and NVR. All three specialize in building single-family homes across the US and contribute to nearly 170,000 new constructions a year.
At the time he bought these stocks, they were worth about $800 million – and homebuilder stocks had done incredibly well outperforming the S&P 500 by a wide margin, with DR Horton leading the list. After his purchase, the stocks did even better:
- DR Horton increased by 35%.
- Lennar was up by 30%.
- NVR was up 20%.
In a period of 7 months, Warren Buffett was able to cash out $250 million in profit. How? The profit margins built into their sales let mass builders offer better terms to buyers – like buying down mortgage rates, money back at close, additional upgrades, and price reductions if closed by a certain date. Interest rate buydowns have been extremely successful for DR Horton. They offer mortgages at a point below market (e.g 6.5% instead of 7.5%), which lets you afford better homes, which also means a better profit for them.
The housing shortage also meant that there was a lot of demand that flocked to homebuilders, which gave them even more control over the terms they offered. If all this is true, why has Buffett chosen to sell now? Some say that the market rallied faster than he expected, and he’s just locking in profits, while some others think that this is a red flag indicating that he’s bearish on the housing market.
Personally, I think that it’s not as big an alarm as it seems – Warren Buffett has warned investors that it’s unrealistic to expect the skyrocketing performances from Berkshire Hathaway that it was known for in the past due to a lack of investing opportunities, especially outside the US. Also, Berkshire is sitting on about $168 Billion in cash. Their investment in the three real estate companies is the equivalent of someone investing $700 from their $100,000 savings account and it’s just a drop in the bucket that might not reflect much about Buffett’s overall strategy.
Despite all that, there just might be a case for a real estate Bear Market.
What could cause housing to crash?
Here’s where there are some excellent analyses by experts – Ben Carlson wrote an article on his blog, titled “The bear case for housing prices” which he starts by pointing out that so far, nothing has substantially impacted housing values to the downside – not high interest rates, rising prices, or the economy. People are adapting by staying in their homes for longer, and are loathe to sell their homes when capital gains taxes could take up a big portion of their proceeds.
Further, if there’s a recession, people are already locked into low-rate mortgages, so they’d be unlikely to sell. 40% of homeowners don’t even have a mortgage, and it’s unlikely that they’ll panic sell (unless there’s a black swan event).
But what could cause housing prices to fall? I think one of the best analyses was by Mark Woodworth who noted that housing prices would fall if there’s a) a reduction in demand or b) an increase in inventory (Duh). But what made his analysis different is that he assigned numbers to his predictions –
- Demand would need to fall 50% for housing prices to be in line with historical averages. Transaction volume hasn’t fallen below 2 million since the early 1980s, so this is unlikely to happen.
- Supply would have to double for the same effect to be achieved – but it’s going to take a while for us to reach those levels.
One way this could happen is this: A large portion of homes were bought by individual investors, and as market prices increase relative to rent, it could prove to be a profitable exit point to sell. This could also extend to those who bought AirBNBs figuring they’d buy a property because the market would go up, and anyone else who hoped to speculate on housing values for a quick profit. With more rental units being built, returns could go down, and all the speculators could list for sale around the same time – but that’s just a theory.
As to what could happen this year…
The outlook for 2024
According to Morgan Stanley, the Bull Case is that housing prices rise another 5% this year, in the case that the US economy avoids a recession and the housing market picks up as incomes rise. They predict that consumers will jump in when mortgage rates start to fall. This is the best case – in a more realistic scenario, they predict that prices will fall by 3% at the end of 2024. In the worst case, unlikely scenario, they think housing could fall by 8% if everything goes wrong – with mortgage rates remaining elevated as the economy slips into a recession, and demand for housing reduces.
But this last scenario is extremely unlikely – home prices hit a record high in December during a time when seasonally adjusted prices tend to be at their lowest. Other economists think that home prices will increase 2.3% in 2024, rising a bit slower than average hourly earnings. So what’s going to happen when interest rates eventually do drop?
Realtor.com pointed out a while back that mortgage rates will continue to decline gradually over the next few years, and they expect the mortgage rate to fall to 6% by the end of 2024. Lower rates would allow buyers to qualify for larger loans, making housing more affordable if the market doesn’t continue going higher. For example, a buyer could afford 17% more home if rates move from 7% to 5.5% – but if increasing demand put pressure on prices to rise at the same time, the effect would be dampened.
The “scary” truth is that for every 1% drop in mortgage rates, 5 million more households would qualify for a mortgage, leading to multiple offers, reduced inspection, and a lot more time and patience to land a deal. As a buyer, would you rather have higher interest rates or higher prices and more competition? The housing market is in a “heads I win, tails you lose” situation for anyone looking to buy a house – you need to be incredibly careful about what you purchase.
The reasonable solution
The housing market has a long way to go before things return to “normal” – it would take five years to meet demand for single-family housing even if the rate of construction tripled. The only reasonable solution according to me is Multi-family housing like condos and apartments. These properties accounted for 32.1 percent of housing starts from 2012 to 2021, because single family homes are getting too expensive to build and purchase – and multi-family could be a way for builders to developer more, at cost, and pass on the lower-priced units to future buyers.
As someone who’s worked full time in real estate since 2008, outside of a black swan event, I don’t think there’s much that can cause the market to fall radically. So here are some suggestions from me if you’re looking to buy a house in the next few years:
- Shop around your mortgage rate: Even though rates have gone up significantly, that doesn’t mean you can’t get a better deal with a different lender. Take your pre-approval letter, hand it to a different bank, and ask them to beat that offer. Then repeat with another bank… and so on till you come back to the bank you started with. Buyers who do this save an average of $84,000 on their loan!
- Don’t get attached to any property: Eventually, there’s a chance that something just as nice will come up. If the numbers don’t make sense, don’t be afraid to walk away.
- Lock in a fixed-rate loan: There’s a lot of excitement around locking in a variable rate 5-year interest only term, because it’s cheap, and “rates will eventually come back down” – but unless you’re expecting to flip the property, there’s a lot less risk in locking your interest rate, long term. That way, no matter what happens, your payment stays the exact same. Plus, you can always refinance in the future.
- Buy long-term: Only buy a home that you intend on keeping for at least 7-10 years. That way, you’ll be able to ride out any fluctuations in the market long enough for it to (hopefully) recover. Also, with rents as “inexpensive” as they are right now, relative to buying, it’ll take about 10 years to break even – so if you buy, make sure it’s with the intention of holding.
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That's it for this week. I hope you enjoyed this article. Let me know your thoughts by responding to this email - I read every single comment :)
Stay safe, stay invested and I will see you next week – Graham Stephan.
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