Commercial real estate is melting rapidly. Home values next.
— Elon Musk (@elonmusk) May 29, 2023
That’s what Tesla and SpaceX founder Elon Musk tweeted last week in response to a stream of tweets from venture capitalist David Sacks.
In this series, Sacks claimed that the Fed’s rate hikes and the increased borrowing costs they have caused are causing a host of problems in the financial world, including a impending crash in commercial real estate.
That last part could definitely be possible. In fact, JPMorgan estimates that nearly $450 billion in commercial real estate debt could default this year. Meanwhile, Morgan Stanley Wealth Management predicts a 40% drop in CRE prices, further increasing the risk of default.
Does this mean that a similar decline in home values is also to come? We’ll take a look.
Is there a link between commercial and residential real estate?
At first glance, CRE and residential real estate appear to be experiencing many of the same issues, including high borrowing costs and falling demand. But that’s about where the similarities end.
In CRE, loans are much shorter than the typical 30-year mortgage that most homeowners get. This means that most borrowers either have to pay off debt or refinance just a few years after buying a property.
This is a problem because interest rates are now much higher than they were a few years ago. Add to that the regional banks – which are having their own struggles to deal with at the moment – are often one of the biggest lenders in this space, and the risk to property owners only increases as these debts arrive. due.
Residential borrowers, on the other hand, can often hold onto their loans for decades without the need for refinancing. And given that about 85% of mortgage holders have an interest rate of 5% or less right now, it’s quite possible they’ll stick around for a few decades.
There is also the demand factor to consider. Since the pandemic, demand for commercial real estate has plummeted, largely due to remote working arrangements. Nearly 13% of offices were vacant in the second quarter of 2023, an all-time high, according to CoStar. In some metropolises like Houston, Texas, and San Rafael, California, the rate is nearly 20%.
This drop in demand simply does not exist in the residential sector. Housing is a necessity, and although higher mortgage rates have caused some of those on a tight budget to pull back, there is still built-in demand for homes, even with today’s affordability issues. .
One could even say that when CRE demand drops, residential demand increases. As Redfin CEO Glenn Kelman tweeted to Musk himself last week, “Loss of demand for commercial real estate is what is driving demand for residential real estate. People who work from home need more space at home.
We also have to think about the ultra-low supply in the residential market. Recent data from NAR shows only 2.9 months supply of homes for sale in the US (a balanced market is considered 6.5 months meaning supply and demand match). According to these numbers, it would take either a massive drop in buyer interest or a sudden glut of supply to cause any price drop.
Where are the house price forecasts at?
While many Musk followers agreed with his sentiments on Twitter, most housing experts aren’t predicting a big drop in house prices anytime soon.
The last House price index of the Federal Housing Finance Agency showed that house prices increased by 4.3% between March 2022 and March 2023, while the CoreLogic S&P Case-Shiller index recorded smaller gains, of only 0.7% per year.
Still, the long-term forecasts are positive. CoreLogic forecasts a price increase of 4.6% by April next year. Zillow expects a 3.9% increase in 2023.
It’s unclear how accurate these numbers are — and things can certainly change, especially with a possible recession and other potential Fed rate hikes on the horizon. For now, however, the data seems to be in favor of residential real estate (and owners).
Get the best financing
Quickly find and compare investor-friendly lenders that specialize in your unique investment strategy. It’s fast, free and easier than ever!
Note by BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.