December 26, 2023 – Happy Holiday Week

Economic Commentary

And so ends another year. While challenging from a real estate perspective, the year has been quite extraordinary. Conventional wisdom would have put our economy into recession after the Federal Reserve proceeded to raise interest rates eleven times from March of 2022 to July of 2023. Yet the economy continued creating a plethora of jobs and kept expanding. It just was not supposed to happen this way. Yet, there are no textbooks to explain what happens to an economy when you close it down due to a pandemic.

The real estate boom, strong stock market and inflation were all a by-product of the pandemic-induced economy. And we suspect that at least part of the resiliency of the economy in the face of much higher rates was also due to the pandemic-induced booms, as consumers had gained plenty of equity to help them stave off bad times. From here, it is expected that consumer spending will finally wane, and we will see a slower economy and perhaps even a mild recession in 2024. Of course, that is just speculation.

If interest rates continue to ease in 2024, as they have in the last quarter of 2023, there is always the possibility of the economy picking up in the new year. In our first edition of 2024, we will present some of the major forecasts for the year, with our usual warning. Caution: there is no way to predict the future. We would love to see lower rates and a more robust real estate market in 2024, but we will have to wait and see. Meanwhile, have a great holiday week and don’t forget to rest up for another interesting year ahead.

Weekly Interest Rate Overview

Mortgage rates moved solidly below the seven percent mark in the past week amid signs that the real estate market is awakening from its slumber. For the week ending December 21, 30-year fixed rates fell to 6.67% from 6.95% the week before. In addition, 15-year loans decreased sharply to 5.95%. A year ago, 30-year fixed rates averaged 6.37%, less than 0.5% lower than today. Attributed to Sam Khater, Chief Economist, Freddie Mac, “The 30-year fixed-rate mortgage remained below seven percent for the second week in a row, a welcome downward trend after 17 consecutive weeks above seven percent. Lower rates are bringing potential homebuyers who were previously waiting on the sidelines back into the market and builders already are starting to feel the positive effects. A rise in homebuilder confidence, followed by new home construction reaching its highest level since May, signals a response to meet heightened demand as current inventory remains low.” Note: Rates indicated do not include fees and points and are provided for evidence of trends only. They should not be used for comparison purposes.

Real Estate News

According to new predictions from Zillow, affordability will continue to remain a challenge for the foreseeable future, but they now predict that conditions will improve at some point in 2024, giving buyers more breathing room in their search for housing. Those that can’t buy are turning to rentals, leading to increased demand in that market, especially for apartments and single-family rentals with easy access to dense employment areas such as city centers. Zillow also predicts artificial intelligence (AI) in real estate will continue to advance and be quickly adopted by the industry, improving the home-buying and selling process for all involved properties. Looking ahead to 2024, Zillow predicts home buyers will have a bit more breathing room—but only a bit. Buying a home will remain expensive, keeping pressure on the rental market to cater to families that will be renting for longer than previous generations. Many who buy will turn to homes that need some work, according to Zillow’s predictions, and do-it-yourself upgrades and repairs will keep new homeowners busy. “I expect the beginning of a long healing process to kick off in the housing market next year,” said Skylar Olsen, Zillow’s Chief Economist. “We know there are a huge number of households in prime home-buying ages waiting for the winds to turn in their favor.” “While still presenting challenges, the market will be better for buyers, with more homes to choose from and improved affordability,” Olsen continued. Source: Zillow

According to data from RentCafe parent company Yardi Matrix, a total of 10,090 apartments were converted in 2022, down from 11,422 one year prior. That’s down from the two years prior, when the practice was ascendant; 12,487 converted apartments were delivered in 2019 and 13,530 in 2020. But with commercial real estate undergoing a weak period and the office sector lagging, conversions are on an upswing in a big way. A whopping 122,000 units are currently undergoing conversion into rental apartments, with 45,000 of those coming via the repurposing of office space. Interestingly, while much has been made of the potential (as well as the challenges) of converting offices into residential spaces, office conversions have actually hit their lowest point in a decade. Such transformations hit their all-time high in 2020, when 6,874 apartment units were converted from square footage previously zoned for office space. In 2023, just 3,390 apartments were converted from former office buildings. “Office-to-multifamily conversions target smaller, older properties, yielding limited sector effects,” said Doug Ressler, senior analyst and manager of business intelligence. “Based on the latest research by CBRE, the conversion of office spaces into multifamily units will primarily be restricted to smaller, older office properties due to factors such as construction costs and regulations related to residential construction.” Despite the drop, former offices still made up roughly 33.6% of all adaptive reuse projects, the largest share among property types. On a hard charge to the top, however, are former hotel spaces, which made up 29.3% of 2022’s converted apartments. That share represents a five-year high for the asset class and was up 43% from the previous year. Per Yardi, the share of hotel conversions is growing for a variety of reasons. For one thing, hotel-to-apartment conversions are understandably easier than office or industrial conversions, with the unit footprint and electrical, kitchen and plumbing layouts more conducive to the switch. Additionally, RentCafe called the decline of some hotel markets as “a significant catalyst behind the current wave of hotel makeovers.” Source: Scotsman Guide

With apologies to Charles Dickens, the housing market has become a tale of two sectors. The existing home market has been stymied – largely by mortgage rates that have climbed, but also by a rock-bottom lack of inventory. The low interest rates people took advantage of during the pandemic have become a “disincentive” for those who would otherwise sell now, said Ali Wolf, chief economist at Zonda, an advisory firm. “They’re not eager to sell.” At the same time, the new home market is thriving, mostly because builders can satisfy demand, even at higher loan costs. According to Wolf, whose firm specializes in analyzing the new construction market, builders are gobbling up a third of all sales. That’s double their traditional share of 10 percent to 15 percent. “People are still out there shopping the market,” Wolf said during a recent webinar, “and builders are finding a way to satisfy them.” While some builders are seeing a slowdown, most report their sales are still on track, she said. The majority of builders are not worried because they believe any falloff is seasonal. While some builders have raised their prices – some, just because they can; others, to slow things down a bit so their construction crews can keep pace – most are instead offering some kind of sales incentive. The most popular incentive? A mortgage rate buydown. More than two-thirds of the builders queried by Zonda offer to buy-down their buyer’s rate, either for the short term (one to three years) or permanently. Source: Lew Sichelman, Banker and Tradesman