Commercial real estate is melting fast. Home values next.
— Elon Musk (@elonmusk) May 29, 2023
Last week, Tesla and SpaceX founder Elon Musk tweeted in response to a stream of tweets from venture capitalist David Sachs.
In that series, Sachs claimed that Fed rate hikes and increased borrowing costs were causing many problems in the financial world, including an imminent crash in commercial real estate.
That latter part certainly could be possible. In fact, JPMorgan estimates that some $450 billion in commercial real estate loans could go into default this year. Meanwhile, Morgan Stanley Wealth Management predicts a 40% peak-to-trough decline in CRE prices, further increasing the risk of default.
Does this mean a similar drop in home values is coming? let’s take a look.
Is There a Relationship Between Commercial and Residential Real Estate?
On the face of it, CRE and residential real estate are facing many of the same issues – high borrowing costs and demand chief among them. But that’s where the similarities end.
In CRE, the loans are much smaller than the typical 30-year mortgage that most homeowners get. This means that most borrowers will have to either pay off the loan or refinance within a few years of purchasing the property.
This is a problem, because interest rates are much higher now than they were a few years ago. Throw in that regional banks—which have their own struggles to deal with right now—are often among the larger lenders in this space, and the risk for property owners only increases as those loans get paid down.
On the other hand, residential borrowers can often hold onto their loans for decades without the need to refinance. And with nearly 85% of mortgage holders having interest rates of 5% or less now, it’s a real possibility 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 thanks to remote working arrangements. According to CoStar, approximately 13% of office vacancies were due in the second quarter of 2023, the highest ever. In some metros such as Houston, Texas and San Rafael, California, the rate is around 20%.
The decline in demand is not in the residential sector. Housing is a necessity, and while high mortgage rates have resulted in a shortfall among those with tighter budgets, there is always an underlying demand for homes – even with today’s affordability problems.
You could also argue that when CRE demand falls, housing demand rises. As Redfin CEO Glenn Kelman tweeted last week at Musk himself, “Decreasing demand for commercial real estate is driving up demand for residential real estate. People who work from home need more space at home.” Is.”
There is also the ultra-low supply of the residential market to think about. The most recent data from NAR shows a supply of homes for sale in the US at just 2.9 months (a balanced market is considered 6.5 months, meaning supply and demand are matched). By these numbers, it could either lead to a massive drop in buyer interest or any kind of price-wise drop due to a sudden glut of supply.
Where do home price forecasts stand
While many of Musk’s followers on Twitter agreed with his sentiments, the vast majority of housing experts are not predicting a big drop in home prices anytime soon.
Last Federal Housing Finance Agency House Price Index Home prices are expected to increase by 4.3% between March 2022 and March 2023, while the CoreLogic S&P Case-Shiller Index recorded smaller gains – only 0.7% annually.
Nevertheless, the longer-term forecasts are positive. CoreLogic forecasts a 4.6% jump in prices by April of next year. Zillow expects 3.9% growth in 2023.
There’s no telling how accurate these are — and things can certainly change, especially with a potential recession and more potential Fed rate hikes on the horizon. For now, though, the data appears to be in favor of residential real estate (and in favor of homeowners).
get the best money
Quickly find and compare investor-friendly lenders who specialize in your unique investment strategy. It’s faster, free and easier than ever!
Note by BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BigPockets.
