What can we learn from the past? Volcker Hike in 81 & Real Estate Got Done, but it was no fun. What does 2023 and beyond hold?
“History Doesn't Repeat Itself, but It Often Rhymes" - Mark Twain
The housing market is currently facing significant challenges, with rising mortgage rates, unaffordable homes, and a scarcity of properties for sale preventing many individuals from realizing their aspirations of homeownership.
There are some eerie similarities between the current economic cycles and the housing market of 1980's, particularly in terms of how it impacted different generations. In that year, the oldest members of the baby boomer generation were around 35 years old, representing a significant demographic engaged in active home buying. Additionally, 1981 marked the birth year of the first millennials, who now comprise the next-largest generation and have been actively searching for homes in recent times.
Both these generational cohorts faced the harsh consequences of rapidly escalating mortgage rates, triggered by a series of rate hikes implemented by the Federal Reserve to combat ongoing inflation. The average interest rate on a 30-year fixed-rate mortgage peaked at an unprecedented 18.63% in October 1981, having surged by nearly 5 percentage points within a span of just 12 months (Fed Funds Rate and Mortgage Rates are Not the Same). The Rates bounced up and down throughout the 1970s and1980s with significant progress being made after 1989.
20 year volatility chart (February 01, 1972 - February 01, 1992)
These historical parallels highlight the common challenges faced by both the baby boomers and millennials, as they grapple with the impact of soaring mortgage rates. The steep surges in mortgage rates during both eras resulted in a significant retreat of prospective homebuyers from the market. Historical data from the National Association of Realtors reveals a substantial decline in existing home sales, with a year-over-year drop of 22.3% in 1980 followed by another 18.6% decrease in 1981. Similarly, in the most recent period, the pace of existing home sales experienced a significant decline of 28.4% in the 12 months leading up to October of 2022, according to the NAR.
Another common factor observed in both periods was the phenomenon of "rate lock-in". Homeowners, eager to preserve their low-rate mortgages, refrained from listing their properties for sale. In March 1981, a real estate executive acknowledged that home sales were being hindered due to homeowners' reluctance to part with their low-interest mortgages. Similarly, in September 2022, NAR chief economist Lawrence Yun highlighted that some homeowners were unwilling to trade up or down after securing historically low mortgage rates in recent years.
There is another similarity, although not exactly the same. There was the savings & loan crisis of the 80s, and now we have the Regional Banking Crisis. The Regional banking crisis is another history repeat rhyme. It also entails the the looming "Commercial Real Estate Crisis" that seems to be on the radar. Over 2.9Trillion worth of commercial real estate is coming due (maturity) and will need to be refinanced in the next 3 years. Regional banks hold almost all the notes on the commercial paper, and with deposits down month over month and several regional banks collapsing and being absorbed by larger banks, this could be one big can of worms. Commercial Real Estate Offices are foreclosing, office buildings sit empty and if you google commercial real estate news, you see headline after headline on the storm coming. There are several factors at play in the economy right now and this is why it is imperative to have options or solutions and creative ones at that.
While there is a glimmer of hope in the fact that the United States has encountered a similar situation in history and eventually witnessed improvement, it is crucial to acknowledge the sobering reality. It is crucial to note a significant distinction between the 1980s and the present era, which relates to the availability of assumable mortgages. Unlike the early 1980s, the factors which existed and sustained the housing market during that period are largely absent today. During the early 1980s, assumable mortgages were abundant, allowing buyers to assume not only ownership of the house but also the seller's existing home loan. This feature presented an opportunity for affordability, particularly when mortgage rates were soaring. However, Congress discontinued assumable loans in 1982, and currently, only a subset of mortgages insured or guaranteed by government entities such as the FHA, VA, and USDA remains assumable, accounting for approximately 18% of mortgage origination volume in the second quarter of 2022.
The prevalence of assumable loans in the 1980s facilitated what was known as "creative financing". This approach filled the gap between the purchase price and the assumed mortgage balance, often involving loans from sellers to buyers, such as promissory notes or second mortgages. Nevertheless, the practice of creative financing diminished over time due to lenders' reluctance to transfer existing loans and the associated risks for buyers and sellers.
As we navigate the challenges of the present, new solutions are required to sustain home sales. Perhaps innovative approaches, such as "creative financing" comes back into play, that is already being seen in the market now. Although assumable loans aren't a huge factor in our market, even if assumable loans were plentiful, and they are not, they can still prove difficult to get approved.
However, lenders will need to come out with new loan programs either a 40 or 50 year mortgage (speculative), or even modifications to loan programs like Shared Equity Programs. Or things such as seller financing, more affordable options like 3D-printed houses, wider adoption of container homes or tiny homes, shared ownership among groups of friends, all of these things could play a role. However, it is important to remember that predictions in such matters are merely speculative. There is no crystal ball, only shifting horizons and which one seems most likely the closer we get.
There could be many new innovative ways to jump start the housing market, below are ten proven tried and true techniques to get your creative financing wheels turning!
Interest-only loans — If you are an investor looking to purchase, rehab, and sell a property quickly, an interest-only loan may make sense. This financing allows you to make small payments at the beginning of the loan, leaving more money for renovations. When you sell the property for a profit, you can pay off the loan in full, having paid only a small amount of interest.
Seller carry-back — Also known as owner-financing, the seller of the property agrees to finance the property outright. They transfer the title to you in exchange for a promissory note and deed of trust for the full purchase price of the property.
Seller second mortgages — If the buyer can obtain a loan, but not for the full price of the property, sometimes a seller second mortgage is what is needed to make the transaction possible. In this case, the bank mortgage pays the seller for the bulk of the amount owed (for example 80 percent), and the seller deeds the property to the purchaser in exchange for a promissory note for the amount of the balance remaining (in this example 20 percent).
Contract for deed — Similar to seller carry-back, a contract for deed is another method of owner- financing. The difference under a contract for deed is that the seller retains title to the property until the mortgage has been paid in full.
Private mortgages — Private mortgages work like mortgages from a bank, but since the lender is an independent entity, they can follow different guidelines for lending. Interest rates are often higher, but this creative mortgage technique allows more borrowers to qualify for a loan.
Assume payments — If you can find a seller who needs to sell a property quickly and has financing in place, you can assume the seller's payments, often with little or no down payment.
Lease options — A lease option allows the buyer to rent the property for a given amount of time, with a portion of their rent credited toward the purchase price of the home. At the end of the lease, the buyer has the option to purchase the property at the amount agreed upon when the lease was created.
Retirement accounts — Most retirement accounts will allow you to borrow from yourself and repay the funds over time at a low interest rate. What a great creative financing resource!
Loans from family and friends — Friends and family may be willing to invest in your business in the form of personal loans. Talk to the people around you, share your enthusiasm and your needs, and perhaps "Aunt Jan's" loan will be the next option in your creative financing approach.
It's really important to state that each of these comes with risk. Each very different and for all parties involved. Do your research on the risks and problems with each of these creative financing solutions.
History has demonstrated not only can the real estate market recover but mortgage rates can recover. Lets keep in mind those times of turbulence were rocky to say the least, but if we look for opportunity, we may find it. This historical perspective can pose a potential reassurance that despite the difficulties, challenges and fluctuations experienced, the housing market can and will ultimately recover, trying to guess what comes next is impossible, but we know we need to pivot to sustain housing. What it will look like once the smoke has cleared, thats anyones guess. Political regulations, new mortgage programs, new laws, and AI may very well change the landscape of the industry once again.