Denver just passed an “affordable housing program” with new requirements for low-income housing. Multifamily will…
Sales of homes worth 1 million or more fell 44.4% between August and September and sales of homes over $500,000 dropped 33 percent during the same period. Overall sales in September of 2018 are down 21.4% from September 2017 (Denver Metro Association of Realtors). What is happening? Is the sky falling? Is a “crash coming”? Why the sudden cool down? Is this a blip or a trend? What are 6 possible explanations of the drop
Just a blip?
I think it is hard to write off the recent drop in sales as just a blip. The reduction is too large to just be a minor bump. There is clearly something more going on in the front range that is driving the drastic reduction in sales above 500k and more profoundly above 1m. Below are six prospective causes of decline that I put in rank order.
What caused the decline:
- Interest rates rising: As interest rates rise, mortgage payments also become more expensive. For example, if you could lock in a 3% rate a few years back on a 500k home, the payment on a 30-year mortgage would be $2,108. As rates rise to 5% (4.63% on a jumbo today), the payment would be $2,684, a $7,000-dollar difference per year. Furthermore, the 10-year treasury today hit the highest level in seven years. Mortgage rates typically follow the 10-year treasury, so rates are bound to increase even further. As rates rise and prices increase less people can afford the monthly payments.
- Wages not keeping up with huge gains in appreciation: Along with rates rising, real wages have barely budged. Denver and much of the front range has appreciated for the past 5 years at 10% or more annually while at the same time wages have stayed about constant. Buyers cannot absorb the appreciation with their current wage growth (or lack thereof).
- Inventory expanding: As prices increased more people have decided to “cash out” thereby increasing inventory. According to the Denver Metro Association of Realtors inventory is up 16.10% this year. This increase in inventory is putting pressure on prices as buyers have more available options.
- Taxes increased substantially: Not only have borrowers payments increased due to rising rates and more expensive properties, but property taxes have increased substantially. Colorado revalues properties every odd year, so the impact of the recent appreciation is now flowing through tax bills. Along with appreciation many areas (especially Denver county) have passed several initiatives (affordable housing, education, parks, etc…) that have further increased tax bills.
- Market has gotten expensive, rent vs buy: Developers in the front range have been on a tear building luxury apartment units. As the glut of high-end apartments have come online, rents have flattened or even fallen. As housing prices and mortgage rates increased, the rent vs. buy analysis has tilted towards renters.
For the first time since 2010, it’s now easier to build wealth over an eight-year period by renting a home and investing in stocks and bonds, rather than by buying and accumulating equity, according to a national rent-versus-buy index of 23 cities produced by Florida Atlantic University and Florida International University faculty. That’s because home prices are high and rising mortgage rates are adding to the cost of homeownership.
That could be bad for sellers, especially in markets like Dallas and Denver, where renting is now so much more favorable than buying, according to Ken Johnson, a real estate economist at Florida Atlantic University, a co-creator of the Beracha, Hardin & Johnson Buy vs. Rent Index. (Bloomberg)
- Alternatives abound: Not only are more people now looking to rent vs buy, more people are also looking at lower cost locations. As Denver and the front range has gotten more expensive people are looking at alternative locations. For example, Colorado Springs and Greeley have been recipients of people priced out of Denver. Other cities that are less expensive (like Nashville, TN or Charlotte, NC) are also becoming alternatives for residents.
Are we at the tail end of a cycle?
Based on the recent drop in sales does this signify the end of the “boom times” and secondly if it is the end will we have a repeat of 08? First to address the first part of the question, are the good times in real estate over? I think we have reached a peak in the Denver market especially at the high end. Prices have gotten ahead of wages and rates have substantially increased; the eligible pool of buyers has decreased as a result. Furthermore, as more high end luxury apartments have come online, prospective buyers can now rent for less than they could buy. All these factors will continue the downward pressure on prices above $500k in the near term. Although nobody can accurately predict a peak until after the fact, it sure looks like the market is close to a high for this economic cycle.
Will we fall off a cliff?
Although there are a number of factors driving volumes lower, I don’t see a return to 2008 where prices tumbled. There is limited new supply in the metro area while Denver remains an attractive place for employers to hire (well-educated young work force). This should insulate Denver from a precipitous plunge like the last cycle. I see Denver “leveling off” for now. Ultimately in the long-term prices will increase again due to attractiveness of the city. Denver real estate seems to follow a “step pattern” where you see fast appreciation, then a step where appreciation levels off until the next cycle. Denver is currently entering the bottom of a “step” in the pattern. How long this step lasts is a mystery.
What should you do?
I wouldn’t panic at this point in the cycle. There is no need to “dump” a property today to try to lock in appreciation but sellers’ expectations will need to reset to the new market. Properties will need to be priced realistically and sellers will have to be patient with their timing of a sale. The market in Denver along with the weather is cooling. Now is the time to grab a jacket and relax by the fire until the chill wears off.
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
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