What's next? Top economists tackle the biggest questions in real estate

Is the housing market in a correction or an economic downturn? Has the Fed already raised interest rates too high? Is inflation coming down any time soon? How will Hurricane Ian impact the economy? What can we expect in 2023?

Leslie Appleton-Young and John Tuccillo, two of real estate’s top economists, draw on their decades of experience to answer the most pressing questions facing our industry today.

While many people believe we are in uncharted waters, the events we’re currently experiencing are following the same patterns as each of the previous downturns that I have experienced. 

During the first part of the cycle, prices continue to rise for another six to 12 months as inventory begins to build and the factors triggering the beginning of the cycle (in this case, the high rate of inflation coupled with a doubling of mortgage interest rates) cause sales to slow down. This ultimately leads to price declines and a buyer’s market, which many economists are predicting we will be experiencing by the end of 2023. 

The big question is where are we in this cycle now and if there is a downturn, how deep will it be? 

Correction or downturn? 

According to Appleton-Young, the Fed’s goal is to slow down the market. For the last six to seven months, sales have been dropping, new listings are below where they were a year ago, and sales are down a few percentage points month-over-month.

The direction is clear. The market is slowing down because mortgage rates went from less than three percent to over six percent. Add that to general inflation that’s impacting people’s budgets and the wealth effect (decline) in the stock market, and that’s a good indicator of what’s going to happen to housing.

 

The question is this a crash? Is this a downturn? Is this a correction? From my perspective we’re in a correction, (but whether it becomes a downturn) really depends on how long it takes for the numbers to conform to the Fed’s objective of reducing inflation and getting it on the short track headed back towards two percent. 

She went on to add that although job growth is slowing down, it’s still above expectations. 

As long as the job market remains robust, people are paying their mortgages that are at three percent. In fact, 90 percent of the mortgages are below four percent at this point. 

What’s happening with inflation? 

According to Tuccillo, 

If you look at sales, the markets are in a downturn, but if you look at prices, the markets are in a correction, and this is where the Fed wants to hit the housing market. The problem is that the Fed almost always misses the mark.

 

There are things happening that are not showing up in the numbers yet, but the policy makers are reacting to what they see. The result is we have an overcorrection coming, probably a bit of a recession, and probably a continued housing market downturn, at least in sales. 

 

Because inflation lags so long (behind), the Fed has probably already stopped inflation. It just hasn’t found out about it yet. It’s going to find out in about six months, but by that time you’ll have two or three more rate increases. The Feds have already blown it by overcorrecting, and sadly, much to our pain, we’re going to find out 6-8 months from now. 

Tuccillo did have some good news. The Inflation Expectations Surveys including the ones from the New York Fed and the University of Michigan all suggest that: 

By the end of 2023 inflation will be around 3 percent. 

Inflation may already be declining

A developer I’m working with told me his cost of lumber is currently 80 percent less than it was in 2021 and many of his other building costs have also declined. Furthermore, many developers and builders have slowed down or exited the market for the time being, resulting in a decrease in demand as well. 

Tuccillo shared some additional facts that show inflation may already be declining. 

What recently caught my eye that was during the pandemic and into 2021, the cost of a shipping container to go to China from the West Coast was $20,000. Now it’s slightly north of $2,500. 

Tuccillo also argued that due to the actions currently be taken by Saudi Arabia and Russia, 

We will see gas prices go up in the near future again, but they’ll come down again, because China is going into a recession and they’re a huge consumer of petroleum products. Their demand will fall off and their prices will fall off too. 

Tuccillo also noted, 

We are also seeing a weakening in rent increases. Rents are figured into the CPI, but home prices are not. Because rents are weakening, we will see a softening of that price inflation and that will feed through the CPI. All these straws in the wind suggest that we will see inflation come down over the next 6-12 months. 

What impact do you expect Hurricane Ian to have on the economy?

Appleton-Young and Tuccillo both agreed that the GDP nationally will decrease. As people begin to build, the GDP will recover, but it’s going to take an awfully long time. 

Appleton-Young warned about the ability of the insurance companies to cover the costs. The amount of damage is really daunting. Bloomberg estimates that the costs to US Insurers will be $63 billion.

This doesn’t even begin to address the half the homeowners who did not have flood insurance. An even greater concern, however, is that only ten percent had adequate insurance for wind damage. 

Tuccilo added, 

From an insurance point of view, these are such overwhelming catastrophes that they’re very hard for them to cope with. Yes, the essence of insurance is pooled risk. When a disaster like this happens, that goes out the window. You can’t pool the risk, so they are really behind the eight-ball trying to catch up on this. 

 

I know they get a lot of criticism, but just the capacity to process a disaster like Florida, or the San Fernando Valley earthquake, or the forest fires, their capacity to process this is very limited, as compared to the scope of the disaster. The process of clearing out the damage, getting the permits, ordering what you need to start building is obviously not an overnight process. We’ve seen this with Katrina, and we’ve seen it elsewhere in the country. 

Will these factors lead to a decline in the number of Realtors in 2023? 

Appleton-Young who conducted membership forecasts during her 33-year tenure with the California Association of Realtors says:

When you look at earlier downturns, membership numbers lag behind the market by two years. So, when the market peaks, two years later membership peaks. When it bottoms, two years later membership bottoms, but in the last 10 years, that relationship has disconnected. Even as we have seen a slowing in sales, it really hasn’t impacted membership. In fact, membership has kept growing. I think that’s due to a couple of things. I think it’s the low barriers to entry to become a Realtor. I also think it’s that hope springs eternal. 

Tuccillo added his research shows that 50 percent of all Realtors did not participate in a single side. 

When markets are down, it doesn’t matter since they’re not making any money anyway. Instead, they pay their fees, they have a place to hang out, they can go to meetings, and get free lunches at broker opens. There’s nothing keeping people in the business on the basis of competence. Sales are not the key. The key is barriers to entry. 

Appleton-Young described the “reverse impact” she has observed in previous downturns.

When we see the labor market crack and start to see the unemployment rate head up, what do people do when their salary is gone? 

 

“Well, let me become an independent contractor in real estate. At least a few people in my family can help me out.” 

 

So, it almost works in reverse as to what you may be thinking. 

What can we anticipate for first quarter 2023 and beyond? 

Appleton-Young believes that this housing market depends on how long the rates stay high. If anyone tells you they know what’s going to happen, they don’t know. 

It really depends on what the Fed decides to do. I’m in John’s camp in that I think they’re going to double down, and we’ll see rates going go even higher. That’s going keep the market softening. 

Tuccillo elaborated: 

I think the Feds have at least another full point in them, and maybe a point and half, which is tragic. That will really bring the economy to a stall. I don’t see a deep recession or a long one, but then again, we haven’t grown that much over the last decade. I think we’ll see a mild recession for a few quarters and unemployment will rise. And don’t forget, we’re in an environment where the rest of the world is worse off than we are. Combining the Fed’s interest rate increase with the psychology of inflation, and what’s happening in the rest of the world, I see a very, very sluggish to negative economy in 2023. 

Appleton-Young added that:

The unemployment rate just dropped from 3.7 to 3.5. That’s where it was in February 2020 before the pandemic and that was at a historic 50-year low. I’m going to be watching the labor market really, really closely to see how it survives the pellets that the Fed is throwing at it and then looking at the inventory.

 

If people start to get into trouble, you’re not going to see it in the foreclosure numbers. You’re going to see in the listing numbers because people have the equity to ride out until they sell. I agree with John. I think it’s just a question of what is the severity going to be. We just have to see what the Fed does.