Home Prices Could Stagnate for Years

0:00J Scott:Home prices always go up, but what if they don't? Housing appreciation is the bedrock of real estate investing and in a lot of ways of the entire U.S. economy. But prices aren't really going up right now and they may actually fall for a while. And although no one wants to talk about it, we have to talk about it. This is how to invest profitably while home prices decline.

0:28J Scott:Hey everyone, I'm Dave Meyer. I'm a housing market analyst and I've been investing in real estate for more than 15 years. And on the BiggerPockets Real Estate Podcast, we help you achieve financial freedom through rental properties. Today on the show, we're talking about a big change in the housing market. Home price appreciation has really slowed a lot in recent years, and prices, at least to me, are likely to begin to decline in a lot of markets by the end of the year. Now, to be clear, I am not saying we are headed for a real estate crash. There is no evidence that something like that is imminent.

1:02J Scott:And I'm not saying prices will never go up again. In the long run, they very, very likely will. But prices falling at all is not a dynamic we've seen in a long time. So I want to talk about how investors can take advantage of the very real opportunities this kind of market provides and protects themselves against risk, even if they can't just pencil in growth every single year without analyzing deals. Here to do that with me is my longtime friend, the co-author of my book, Real Estate by the Numbers, and friend of the show and BiggerPockets in general, Jay Scott. Jay, welcome back to the show.

1:40J Scott:Thanks for having me once again. Glad to be here. I am glad to have you. I was thinking about this topic and instantly you came to mind as the person to have this conversation with. I have been saying going on three or four years now that my belief is that real estate prices have substantially plateaued and will stay somewhere in the vicinity of where they are for maybe the next three, four, five, six years. And the reason for that is because historically what we see is that real estate tracks inflation. If you go from 1900 to about 2014 and you kind of graph out the inflation trend line and the real estate home values trend line, they basically go from the same starting point to the same ending point.

2:29Now, they diverged for a little bit there in 2008, but they kind of reconverged around 2013 or 14. Good reason to believe, based on that, that long-term housing should grow at about the rate of inflation. Now, we've seen over the last few years, since 2014, and especially since 2020, that those two trend lines have significantly diverged again. So housing has gone much higher than the inflation trend line. So one possibility is that we see housing prices come crashing back down and those two trend lines kind of intersect again. But my thesis is that given where we are in terms of the inflationary cycle, given where we are in terms of supply and demand characteristics in the market, that what's more likely is that inflation is going to continue to go up over the next several years, but real estate is going to stay flat.

3:21And those two trend lines will meet up again at some point in the future.

3:24J Scott:I've sort of reached a similar conclusion looking at a different metric, because I think the inflation argument makes a lot of sense, what you just said. There's also sort of the affordability piece of it, too, which we are at near 40-year historic lows for affordability. and a lot of people point out, say like, oh, the market needs to crash in order to get back closer at least to historic affordability. Not necessarily. I think most of the economists I talk to either on this show or on the market, what they point to is like what can happen instead of a market crash is that prices stay flat and hopefully wages start to increase.

4:06J Scott:Maybe rates come down a little bit and then you sort of get this gradual restoration of affordability. It doesn't have to be this big event. If prices just stay even, that can still happen over time. So it's like two different methodologies, but sort of reaching a similar conclusion. Yeah. And here's the other way I like to think about it. And we can take a 10 ,000 foot view of it. But at the end of the day, if we want to see higher prices, if we think they're going to be higher prices, we need to argue why we think supply is either going to go down more or demand is going to increase more. And I think it's unlikely that we see either of those in the near future.

4:43Supply is already at, or it was as of a few months ago, it's starting to go up in a lot of markets. But as of a few months ago, supply was basically at a historic low. And demand right now is tremendously high. We're undersupplied on housing. A lot of people want to buy houses, whether it's residential homeowners, whether it's investors, there's a ton of demand. And I've heard numbers, something like$200 to$300 billion of cash sitting on the sidelines looking for a home in real estate. And so I think it's unlikely that over the next couple of years we're going to see lower supply and higher demand.

5:17So I don't think prices are going to go up significantly. So then the question is, are we going to see prices go down? And for that to happen, we'd have to see the opposite. We'd either have to see much higher supply or higher supply and lower demand. And I think it's possible that we're going to see that. So let's talk about each of those sides. So on the supply side, what would it take to see higher supply? The obvious answer is a recession. So if people are forced to sell for some reason, if people are losing their jobs, if they're having their hours cut, if they're having their wages cut, if they can't pay their mortgage, if they have to move to another town to get a better job or a different job, we're going to see supply go up.

5:59people are going to be forced to sell their houses. Then we have to ask the question, how about on the demand side? For prices to come down, not only is supply going to have to go up, but for prices to come down, we're going to want to see some less demand as well, because there's so much demand out there right now that if supply went up a little bit, if 5 % or 10 % more people wanted to sell their house, there's enough demand out there that it would probably be absorbed, and prices probably wouldn't drop. So I think to see a significant drop in prices, the big thing we would have to see is a big drop in demand.

6:30And I think there's only two things that lead to a big drop in demand. One, a recession so bad that investors and homeowners are terrified to buy again. So for anybody that was investing in 2008, we remember this. We saw prices drop by 10, 20, 30, in some places, 40 or 50%. And a lot of us who weren't investing, if you weren't investing in 2008, you're probably thinking, wow, prices dropped 50%. How could I not have been buying everything out there. And the answer is, it was a scary time. You woke up every day thinking, how much worse is this going to get? Is this ever going to recover? This could be a 10 or 20 year recession.

7:08That's what it felt like back then. And so nobody, even though we had the opportunity to buy at amazing prices, it was hard to pull the trigger because it was so scary. So that's one thing that could happen that could reduce demand. The second thing that could happen that could reduce demand was another thing that happened in 2008 due to the recession, and that's bank stop lending. When banks stop lending, even if people want to buy houses, they're not going to be able to. So my thesis is that it's unlikely prices are going to go up because it's unlikely that supply is going to drop more, demand is going to go up more.

7:37And it's unlikely we're going to see significant drop in prices simply because for that to happen, we would have to have a major, major recession where people were too scared to buy and banks were too scared to lend. And I think that's unlikely as well. So again, if you look at it in that context, I think it's also a good argument for why I believe prices are likely to be relatively stagnant over the next few years.

7:59J Scott:I do tend to agree with you, Jay. Thank you for the explanation. And for similar reasons, I would imagine that people are wondering, what about if rates come down? Could that dramatically increase demand without a corresponding increase in supply? Because that's kind of the key, right? It could increase demand, but if supply goes up at the same rate, then prices don't really grow that much. There's another intermediate discussion we need to have. You mentioned rates. And so a big question is, do we think rates are coming down? And what would it take for rates to come down? And I think this is the discussion I have with a lot of real estate investors that they really don't like to hear.

8:37But the reality is, I think it's highly unlikely that we're going to see significantly lower interest rates unless we see a significantly softer economy. Unless we see a recession, we're not going to see lower rates. Well, I don't think it's a given for a lot of people because there's a lot of talk now that the Federal Reserve is going to be pressured to lower rates or that the president's going to fire the Jerome Powell or Jerome Powell's term is going to end the beginning of next year. And he's going to be replaced with somebody who is a little bit more dovish on rates and is willing to cut rates.

9:13But my personal opinion is, and there's a lot of data that supports this, if the Fed cuts their key interest rate called the federal funds rate without a corresponding softening in the economy, it's not going to bring down mortgage rates. It's very possible that we can see the Fed drop rates. In fact, we saw that three times last year. Cut rates and mortgage rates went up. Yeah, and mortgage rates went up. And so I don't think it's the Fed dropping rates that's going to lead to mortgage rates coming down. It would have to be a softening in the economy. And if you have a softening in the economy, well, that leads to the other questions of how many people are dealing with job losses.

9:51How bad is that softening in that recession? And is it going to trigger other concerns that are going to impact supply and demand outside of just rates?

9:59J Scott:Yeah, well, I'm on the downer, the buzzkill train with you. I put on the market, I put out a forecast for mortgage rates for the rest of the year. And I said, I don't think they're going much lower than they are today at 6.5%. And maybe they will. But I believe that sort of regardless of what the Fed does, I don't think the bond market's going to move. I think that I've said this before, and you can listen to the other podcast if you want to get into this. But just so everyone knows, mortgage rates are not controlled by the Fed. The Fed controls the federal fund rate, which impacts short-term lending and borrowing costs.

10:37J Scott:That is one element that impacts the bond market and mortgage costs. but is not the only one. And I personally just think there's so much uncertainty in the global economy that's going on that bond investors are going to need to see a lot more data, a lot more clarity around not just what the federal funds rate is, but inflation, GDP growth, geopolitical tensions. All this stuff needs to be, we need to get some line of sight on where it's going before the bond market's going to move a lot in either direction, in my opinion. And so that's where I think mortgage rates are going the same. But that's where I stand.

11:12J Scott:So I think Jay and I, maybe we're buzzkills. But I think the whole point here is that, at least to me, I think there are ways, even with rates as high as they are, even if you're going to have sideways prices, that you could still invest in real estate. So I do want to talk to you about how you might go about that. We've got to take a quick break, though. We'll be right back. If I had to hire someone to join the BiggerPockets team, I wouldn't just be looking for someone who checks a few boxes on a resume. I'd want someone who understands real estate, can move fast, communicates well, and can jump into a fast-paced environment without missing a beat.

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15:10J Scott:Welcome back to the BiggerPockets podcast. I'm here with Jay Scott talking about how to invest in a world where, you know, home prices might be flat for a while, rates might stay where they are. Jay, does that mean that real estate is dead or are there ways that you can still earn a profit? I don't think that means real estate is dead. In fact, what I've been saying for as long as I've been doing these podcasts with you, Dave, and before you, David Green and Brandon Turner and Josh Dorkin, I've been saying this for literally over a decade now, that we shouldn't be banking on appreciation. Even if we think we're going to see significant appreciation over the next several years, we shouldn't be putting our faith in that.

15:52We shouldn't be running numbers based on that. We shouldn't be making purchase decisions based on that. A very smart person that I saw speak at a conference a couple weeks ago said it best. He said, don't pay$3 for an asset that's worth$1 in the hopes that it goes to$5.

16:12J Scott:Yes, yeah. That's not a good investing strategy. speculation. A good investing strategy is buying a property that's worth a dollar for 50 cents, and maybe you get lucky and it goes to$5. But you're buying it for the inherent value on the day you purchase it, not the potential value a year, two years, five, 10 years down the road. Because you are so consistent about this, this is exactly why I wanted to have you on to talk about this. You have been preaching this strategy for as long as I've been listening to you for a long time. I have. And let me tell you something. It means that buying real estate today is harder and in some ways less profitable than it has been in the past, or at least less profitable short term than it has been in the past.

16:58But when you look at real estate, the benefits that real estate provides outside of appreciation, again, maybe we'll get lucky and maybe prices will go up. And we don't even have to get lucky. If you're going to hold a property for 10 years or 15 years, it's going to go up in value. There's been no 10-year period in history where real estate hasn't gone up in value. So we will get the appreciation. It just may not be next week or next month or next year. But there are other benefits to real estate that we should be focused on in a market where prices are flat or even where prices might be coming down that still can be beneficial to buy real estate in a market where your concern prices are coming down because we don't know.

17:38I mean, I remember back in 2020, people thinking that it was the end of the world and real estate was going to crash. And everybody was sitting saying, okay, as soon as we see a 10 % drop or a 20 % drop or a 30 % drop, I'm buying. And here we are four years later and prices have gone up 50%.

17:56J Scott:Yeah, you missed the biggest bull run in real estate probably in history. Exactly. So even if we're quote unquote certain that prices are coming down, we don't know that for sure. Okay, so what are these other reasons to buy real estate besides appreciation? Number one is cash flow. And that's the thing that we're not going to see nearly as much of today as we would have seen three or four years ago when interest rates were really low, or 15 years ago when values were really low. To get good cash flow, you either need low values or relatively high rents to value, or you need low interest rates.

18:31We're not going to get that today. So we may not be buying for cash flow, but the key is you want to buy properties that generate at least enough cash flow that it's going to pay all of your expenses and your mortgage every month. You don't want to be losing money each month because that's not sustainable. It might be sustainable for a couple weeks or a couple months, maybe even a year or two, but most of us can't sustain losing money every month for the next 10 years. So buy properties that they don't necessarily have to have a lot of cash flow, but enough that they're maintaining themselves.

19:00They pay for all their expenses and their mortgage every month. So that's number one is cash flow. Number two is principal pay down. So one of the best benefits of real estate is the ability to get large loans against your asset. You can buy a house. You can get a loan for 60, 65, 70, 75 % of the value. And your tenant is now paying that loan for you. And so over time, over 5, 10, 15, 30 years, your tenant is paying off that loan. So that$300 ,000 property that you bought for$50 ,000 because you got a$250 ,000 loan, well, your tenant is now paid off and that$250 ,000 loan is now your equity. So loan pay down is a huge one.

19:44And then finally is the tax benefits. And we don't talk about this enough, but there are tremendous tax benefits in real estate even with single family houses. So we talk about or I've talked about a lot in the past that over the course of my career, the rental houses I've held have generated about a 15 percent return year over year. And that's inclusive of the cash flow. It's inclusive of cash benefits. That's inclusive of the principal pay down. But a significant portion of that is the tax benefits. A significant portion of what I'm earning is the tax benefits. And the nice thing about tax benefits is it basically keeps money in your pocket so that you can invest in other things.

20:26You're not giving that money to the government as soon and sometimes not at all, and that allows you to invest and compound your money more quickly. So tax benefits are a huge benefit. So again, even if you're not getting the appreciation or you don't expect to get the appreciation, there's still a lot of great benefits to investing. And there's no reason to stop investing at any time if you can get one, two, or three of those other benefits.

20:49J Scott:The way I think about it is those three provide a really nice floor for your investment because they're very low risk. If you are analyzing your deals correctly and you're producing positive cash flow, you shouldn't have risk in that because you're accounting for all of your expenses. And I know some people go on social media and they're like, cash flow is not, you know, you might have cash flow until your hot water heater breaks. Well, if you're not accounting for the hot water heater breaking, you didn't have cash flow in the first place. You had bad math. You were just not thinking about this the right way.

21:24J Scott:But if you have real cash flow, amortization and tax benefits, those things, they don't care about market cycles. Like, sure, there are times when rents go down, but those are very few and far between. There are times when vacancies go up a little bit. That can happen. But it is, you know, those are minor things. They're relatively low risk. And then, as Jay said, that's what allows you to earn a return while you're holding on to the property for 10 years, like you said. And then properties will at least keep pace with inflation over the long run. And then sometimes you might get these beneficial times where they do.

22:02J Scott:We might not. We don't know. But then you put you in a position. So you're already earning a decent return, a strong return. And then you have the opportunity to maybe earn some amazing return if it so happens in your area or macroeconomic conditions allow it. And let's talk about something else. I mean, when is it a good time to borrow money? Obviously, you want to borrow money against good assets anytime, cash-flowing assets anytime. But the best time to borrow money is in an inflationary environment. If we have a decent amount of inflation, borrowing money today is going to be paid off in dollars that are worth less in the future.