What Can We Expect in 2023?

At the beginning of the year I like to share what may be in store for the year ahead in terms of the local real estate market. While I like to think I have a pretty good read on things, the past couple years have been proof that making bold predictions are more or less bold guesses and are worth little more than the paper they are written on. Since I am not a trained economist, I have instead synthesized predictions from true economists and share my interpretation of their forecasts and how likely these predictions will prove true in the South Bay real estate market. My goal is to help you identify trends and opportunities before a new cyclical market trend is firmly underway. It’s being ahead of the curve that wealth is either created or preserved. For those that are looking to real estate to diversify their investment portfolios, I hope to assist you in spotting opportunities so you can maximize your upside while helping minimize downside risks. So without further ado, I present the 2023 Real Estate Forecast for the South Bay and Palos Verdes….(no drumroll needed).

The Economy
There’s no question we are wrestling with inflation and the effects of over stimulating the economy via low interest rates and pumping cash into the economy. The Federal Reserve has announced it wants to intentionally slow down the economy to put a lid on inflation, so by design, 2023 is not supposed to be a banner year for the economy. We should not be surprised by this; the Fed telegraphed their intentions in the Fall of 2021 and we’ve had plenty of time to prepare. While sorting out the problems is way over my expertise, you may find it surprising that NOT everyone agrees that the economy is headed for a recession. Chris Thornberg at Beacon Economics puts it best.

“The 70+ economists who contribute to the Wall Street Journal’s quarterly ‘Economic Forecasting Survey’ (Beacon Economics participates in this survey) think there is a 63% chance of a downturn in the year ahead….For the record, none of this should really worry you. These consensus forecasts generally have a lousy track record: they failed to predict any of the last four recessions, while predicting a number of others that never arrived. As for consumer confidence, that is a coincident indicator, not a leading one. Given that unemployment in the United States is still well below 4% (historically low) and consumer spending remains one of today’s primary drivers of economic growth, we can assume that the consumer sentiment indicator reflects the pessimism of news headlines and not what’s happening around the kitchen table.

Given this shaky body of evidence, it’s fairly easy to dismiss the calls of recession…. While 2023 is unlikely to be a good year for growth, without excess stock within these cyclical components, it is difficult to imagine any large, protracted declines in overall economic activity. This, in turn, suggests that the chance of a recession in 2023 is highly exaggerated and implies that the Fed might just get the so-called ‘soft landing’ they are hoping for.”

My takeaway from what Mr. Thornberg spells out in his recent newsletter is that while 2023 is likely to have some rough patches ahead, the market fundamentals indicate that as the economy recalibrates, we will likely see things turn around in 2024 or with any luck, perhaps sooner. The risks to a soft landing are many, including inflation remaining stubbornly high, geopolitical conflicts, and continued supply chain hiccups due to Covid outbreaks. But overall, the fundamentals of the labor market and personal savings and equity should help make households more resilient to a full blown calamity.

Real Estate in 2023

-Higher mortgage rates means more buyers on the sidelines
-Properties are taking longer than the past 2 years to sell, but still selling relatively quickly if priced right
-Real estate prices won’t crash – the single family market is grossly undersupplied in the South Bay
-Mortgage rates should stabilize by mid-year, but don’t expect rates to return to the 3% range anytime soon
-Fewer homes for sale due to sellers not willing to give up their current low mortgage rate
-Areas of Opportunity: Single family homes and town homes as rental properties, multi-unit properties for cash buyers
-Rents leveling off but not dropping since higher rates mean first time buyers may be renting longer

What can we expect for real estate in 2023? I want to start by saying be careful what you read about real estate in the national headlines. While it is a well known fact that bad news sells, the real estate market is hyperlocal, especially now more than ever. For example, one headline recently read “US home price gains fall sharply in November as rising mortgage rates cool housing market.” Additionally, Forbes recently published an article where they surveyed 27 real estate economists about the market. Of the 27, 24 predict a downturn in real estate. Most of these 24 identify increasing supply and high interest rates as the driver. Now this may be the case when you look at real estate markets across the country, but when you take a closer look at the South Bay and PV markets, the story is quite different.

For those of us who own real estate, we saw a massive increase in equity growth over the last 2 ½ years (36.8% for those who are keeping score). Unless you are in a must sell or distressed situation, you can expect to hold on to most of your gains in equity despite the higher rates. There is some consensus that the Fed is likely nearing the end of rate increases and should be moving more to a wait and see approach for the second half of 2023. According to First American Economist, Mark Flemming, “the housing market will continue to rebalance as prices adjust to the reality of higher mortgage rates…. The main trend to watch is whether mortgage rates will go any higher and, if so, by how much. Once mortgage rates peak, home sales volume and price declines will stabilize.” In fact, First American calculated that a 1% drop in interest rate is the equivalent of an 11% drop in price. Once rates drop, we should see these rate dependent buyers enter the market again.

We must remember that our real estate market is largely a luxury market. So while price appreciation has slowed significantly compared to the first half of 2022, prices have plateaued rather than “fallen sharply.” This is because sellers are not being forced to sell, and most buyers buy based on life changes and personal needs, and and less based on what rates are doing. Fannie Mae’s Chief Economist, Doug Duncan, puts it best: “Existing homeowners may continue to wait to list their properties, since many have already locked in lower mortgage rates, creating minimal incentive to sell and buy again until rates are more favorable.” This limiting factor on supply should help keep upward pressure on prices and reduce the likelihood of a major correction in our market.

How will the current rate environment impact our local real estate market? As it stands today, available inventory is at decades long lows in most markets. This is the result of 2 factors – the rate lock-in effect, and lack of options for would-be sellers. When compared to the Great Recession, new listing activity is only about 50% of where it was in early 2008 (approximately 8700 new listings in 2008 compared to 4600 in 2022). An undersupply of inventory will maintain upward pressure on prices until buyers have more homes to choose from. Should rates drop, it could be off to the races again as more buyers can afford to enter the market again.

In the meantime, higher rates means buyers can afford less and that should keep prices in check. But good properties will continue to sell quickly, and some with multiple offers. Until inventory levels grow substantially, I anticipate it will remain a seller’s market for the foreseeable future.

Opportunities in 2023
Challenges breed opportunity and right now the smaller number of buyers looking for a home is where the opportunity lies. Less competition means better terms. A year ago buyers were waiving all their contingencies and offering seller’s incentives like free rentbacks. Today, buyers have the ability to write terms that may even include seller credits, longer escrows, and sales contingent on selling the buyer’s existing property.
Another thing to consider especially for those with a strong cash position is investment real estate. With high inflation and a volatile stock market, investment diversification into income producing real estate may be just the answer for your wealth building strategy. “Debt prices equity,” and with rates on investment properties where they are today, many multifamily sellers are forced to lower their prices due to the higher carrying costs for new owners. We’ve seen some stellar deals in the 4th Quarter of 2022, and I expect the investment market to be more of a buyer’s market until rates adjust significantly downward. If you can buy with cash, I expect great opportunities for you coming in the year ahead. Even if you need a mortgage to make the purchase, if you can break even or come close, the long term appreciation cycle could be very rewarding for the patient investor.

I see opportunities for value-add single family homes in the low $1M range, many of the current buyers are facing the highest interest rates so there are fewer buyers competing for these homes. These properties typically rent quickly and have lower turnover. In addition, they aren’t subject to the same rent control measures as multi-unit properties.

The Bottom Line
The real estate market is fundamentally sound. The market is under supplied and once mortgage rates stabilize, buyers sitting on the sidelines will return to the market. More buyers means higher prices, and the growth cycle will begin again. If you’re not sure what to make of the current real estate market, I am here for you. Real estate is both local and personal, and what may be best for your neighbor is not always what’s best for you. The key is having clarity on your position and having a plan that helps you sleep at night.

Thanks for reading and let me know if I can help.

All the best, Kyle

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