Anyone have an idea where the market is headed?

[Bruce Woodruff]

I'm just curious what y'all think about the general market? Good time to buy or sell? Buyer's market/Seller's market/neither?

I had a discussion today with a Realtor who expects a rough time ahead....what with the election year coming up and the current state of the Economy/Feds/Rates/Etc. I don't necessarily agree, but I'm thinking status quo is maintained. I am selling a big property and buying a couple of LTRs so I would prefer that. 

But what the heck do I know?

[Scott Trench]

The first high level point, for me, is that I think that the housing market is about to see a huge regional variance. Over the next few years, some markets will see appreciation and rent growth, and others will see severe corrections. If I had to guess, on a national basis, I'd expect to see deep correction/crash declines in multifamily real estate (5+ units) and more muted declines or close to flat prices in single family housing in 2024 and beyond, with 2-4 unit properties somewhere in between. 

The second high level point is that I personally do not believe interest rates are coming down. I think we are nearing the top in terms of raises from the Fed, but I expect the federal funds rate to remain north of 5% for the next several years, and personally believe that the yield curve will uninvert, seeing mortgage rates and interest rates on commercial real estate investments continue to increase from here. I understand the counterpoints here, but feel that the bet on rates coming down is a bet on the Fed suddenly and dramatically reversing course - something I think unlikely until Jay Powell's term expires and a new chairman is installed. 

Diving a bit deeper:

5+ unit multifamily: I'm deeply, deeply bearish. Cap rates are already rising nationwide, and we have 700K+ units currently under construction (multifamily alone) nationwide. Mostly concentrated in the South and West. I think it's really hard to believe in interest rates saving the space from general cap rate expansion, and the glut of supply coming online in the next 16 months is going to continue to crank the vise on operators already struggling by and large to achieve their NOI targets. I think this is going to get worse before it gets better, and 2024 is going to be a part of the "getting worse" phase. I'll be really surprised if any major market in this country sees Cap Rates decline or even stay totally flat in the next 2-3 years. Thus, I believe that only the true value-add plays are viable at this time, and investors need to have a really long time horizon. 

Fundamentally, investors have to believe in interest rates coming down, or believe rents will rise rapidly in the commercial space to justify buying property at cap rates below interest rates. I don't believe either, and I bet the market will be painfully forced to agree in a process that will get more excruciating with each passing month for the next 18. 

Now, sometime in 2025 and beyond, the bottom hits, and a new dawn will emerge for the multifamily space. All that new construction will cease coming online, and there will be very few new projects hitting the market, and a lot of painful exits may mean less competition for entrants. 

In the residential space, I'm cautiously optimistic that a "Crash" (nationwide) will be avoided. however, note that supply is even bigger here with some 900,000 single family units under construction (also concentrated in the south and west). Some markets, like Florida and big chunks of Texas, unfortunately, are unlikely to be spared. These markets, and their neighbors, have a ton working against them. Huge supply growth, huge anticipation of inbound migration that I think, frankly, is overly optimistic), and rising costs, due in part to climate change, do not bode well for these areas. I'd lump cities like Phoenix, Denver, Boise, and Nashville into this category as well, but I'd bet that they will feel a "secondary pain" to many Texas and Florida markets. 

Markets that have already taken hits in 2022 and didn't see a big run up in the aftermath of COVID, like California, might actually not see the same pain. I'm not bullish on California, I'm just less bearish on big parts of the state, including Southern California, than the South and other parts of the West. 

Markets that didn't change or have been steady for years are likely to be the best friend for investors over the next few years. Upstate New York, big chunks of the midwest, and less urban parts of the West and NorthEast are likely to do great. Chunks of the South as well, but in places that didn't see the big booms of the last few years.

I think that vacation rental operators will feel a ton of pain, relatively speaking, over the next 2-3 years. Prices in these markets can swing by 50-100% in a matter of a few short years, and the party's over in terms of "moderately wealthy" Americans being able to afford vacation homes for the forseeable future. I'll be surprised, frankly, if we do not see a couple of notable vacation rental markets decline precipitously from a pricing standpoint in the next few years. Further, even though demand for buying these properties puts downward pressure on rates, even the well-off investors and homeowners are likely to try to find extra ways of generating cash, and a personal home or vacation home in a vacation rental market, even at lower Average Daily Rates, generates cash for the owner. Expect to see even more competition in markets that allow short term rentals over the next few years, even as the profitability in the sector per unit declines. I think this is going to be really hard. 

I think that by end 2026, investors will be feeling very differently about real estate depending on their strategy and market, but very few will have created massive amounts of wealth through market forces. 

Investors with a long-term, traditional outlook on investing will see their properties slowly amortize and rents go up over the next 5-10 years, and are still likely to do better than alternatives like the stock market or a conservative bond portfolio. I personally have this viewpoint, and even though I am in Denver with my portfolio (a market I expect to underperform the nation over the next few years), I am holding and will continue to buy (1-2 in the next 2 years).

But, investors chasing great returns in a 2-3 year timeframe may be disappointed in some of the recently hot markets, and those depending on big rent growth and appreciation in any form may be devastated. 

As usual, the well-capitalized, long-term investors will soak up inventory, buy when their financial positions are ready, and do so on solid properties that they can and intend to hold for decades. A few will place bets and try to time it, and inevitably, there will be some really smart but unlucky losers, and the same in reverse on the upswing. 

Lastly, some real estate entrepreneurs (I use this term to describe wholesalers, flippers, large-scale operators, turnkey providers, etc.) will likely be "business as usual". The spread on deals, flips, etc. is likely to normalize quickly, and these activities will likely be as profitable as ever for the select few who perform them professionally, quickly, and at reasonable scale.