You Can’t Buy What’s Not for Sale
Will Investors Find Inventory in 2021?
by Rick Sharga
One of the biggest challenges facing real estate investors is the lack of available inventory. According to the National Association of Realtors® (NAR), the number of homes for sale at the end of October 2020 was 1.42 million units, down 2.7% from September and down almost 20% from October 2019. The NAR report notes that unsold inventory is at an all-time low of 2.5 months’ supply, down from 3.9 months a year ago, and almost 70% below the 6 months of inventory available for sale in a normal, healthy housing market.
Investors also find themselves in intense competition with homebuyers, who have returned to the market with a vengeance after staying on the sidelines due to the shelter-in-place orders issued after the COVID-19 pandemic was declared in March. Homebuyer demand is being driven in part by demographics, as Millennials reach prime homebuying age, and in part, ironically, by the pandemic itself. Searching for more space to accommodate the need for home offices and healthier environments for growing families, renters are abandoning high-cost, high-density urban markets to become homeowners in the suburbs.
All of this demand increases competition for the limited number of properties for sale, driving prices to all-time highs – a daunting challenge for investors, whose profits depend on their ability to buy cost-effectively. The NAR report notes that the median price of a home rose to $313,000 in October, up 15.5% from the prior year. The California Association of Realtors® (CAR) reported sales results that were equally challenging for investors. Median home prices in November “dipped below $700,000 for the first time in four months.” But at $699,000, prices were still more than 18% higher than in November 2019. CAR also reported that inventory, at less than one month’s supply, was the lowest it’s been in over 16 years, and properties listed for sale were typically purchased within 9 days.
For homebuyers, the record high home prices have been offset by historically low mortgage rates—Freddie Mac reported rates as low as 2.67% on a 30-year fixed rate mortgage and 2.21% on a 15-year fixed rate loan. These rates, however, have also increased demand, which ultimately will raise prices beyond affordability for many owner-occupants, and dramatically reduce margins for investor buyers.
Low inventory, high demand from consumer homebuyers and escalating prices combine to make a fairly toxic environment for real estate investors. Will 2021 be any better?
Is Help on the Way from Homebuilders?
Homebuilders are benefitting from the surge in demand from buyers, with new home sales well above 2020 forecasts. New home construction has lagged behind historic levels ever since the Great Recession, with many economists suggesting that there was a housing deficit of between 300,000-400,000 per year for the last few years. In recent months, however, single family housing starts and building permits have both been heading in the right direction. According to Census Bureau data, there were almost 1.2 million single family housing starts in November—a 27% increase from the prior year, and the highest number of single family starts since 2007.
Housing permits were up 8.5% year-over-year, with 1.1 million of those permits issued for single family homes.
Most new home inventory will go to owner-occupants rather than investors; but adding a million or more new homes to the housing stock in 2021 will free up existing homes from “move up” buyers, which should make at least some properties available for investor purchases.
Will Sheltering-in-Place Result in a Surge of Homes for Sale?
Why is the inventory of existing homes for sale at record lows? Many industry analysts believe that COVID-19 has been a major reason. Research suggests that many homeowners are reluctant to put their properties on the market during the pandemic, as they’re uncomfortable with strangers traipsing through their homes. Similarly, homeowners who might be inclined to sell their homes aren’t excited about the prospect of visiting other properties, owned by people they don’t know. And finally, many people are concerned about the stability of their jobs due to the pandemic-induced recession and have decided to stay put rather than buy a new home and take on a larger financial commitment.
It’s reasonable to assume that at least some of the homeowners who have been sheltering-in-place will decide to sell their homes in 2021, once it seems like the pandemic is under control. While the inventory of homes for sale has hovered around 4 months’ supply since 2016, even a return to that level would bring many thousands of properties onto the market, providing much-needed relief to the severe supply/demand imbalance that exists today.
Will Distressed Properties Flood the Market?
There will definitely be an increase in mortgage defaults—to suggest otherwise in an economy that shed 20 million jobs would be ridiculous. But investors shouldn’t count on another foreclosure tsunami in 2021, or an over-abundance of deeply discounted properties to choose from.
First, the CARES Act virtually eliminates foreclosure activity (specifically on the 65% of mortgages that are backed by the government) through the end of 2020, with a high probability of this moratorium being extended for at least a few months. Separately, the mortgage forbearance program included in the Act has probably spared several million financially-impacted borrowers from facing default by allowing them to defer mortgage payments for
up to 360 days.
What happens when these programs unwind? Well, according to the Mortgage Bankers Association, more than 87% of the borrowers who exited from the forbearance program between July and early December did so successfully – having their loan reinstated or having a repayment plan in place. If those numbers hold through March 2021, when the majority of borrowers in the program are scheduled to have exited, it means that approximately 325,000 borrowers will leave forbearance at risk of default—a large number, but nothing like the millions of loans that were foreclosed on during the Great Recession.
There were about 250,000 loans in foreclosure prior to the pandemic, before the various moratoria were put in place. It’s likely that most of these foreclosures will restart at some point during the new year. It’s also likely that there will be borrowers in addition to the 325,000 exiting the forbearance program whose income will have been affected, and who will default on their loans. So, it would not be outrageous to estimate that between 500,000 and 750,000 homes will be in some stage of foreclosure in 2021.
The good news for investors is that inventory levels should improve in 2021, and demand for fix-and-flip properties and single-family rental units will remain strong. The challenge will be finding the hidden gems in the market and buying them at a price that can deliver the ROI that investors need.
