(Photo-illustration by Paul Dilakian/The Real Deal)

For months, Compass agent Diana Sutherlin has been running like a bartender at last call. Catering to a diverse clientele looking for a new residence on New Jersey’s Gold Coast — condos and waterfront homes in Hoboken, Jersey City and Weehawken — Sutherlin’s life has been dominated by cash offers and bidding wars as determined buyers, including those relocating from New York City, race to close a deal before interest rates and prices rise further.

Now, Sutherlin says, the market is slowing. She’s advising clients to buy for the long haul. 

“It can’t continue at this rate,” she said. “The demand from desperate buyers — that’s a renewable resource today. People are paying more than they might have paid before. But I tell people to buy a place a little larger than they need, so they can stay there longer, build up equity, and ride this market out.”

At the high end, housing continues to reach previously unthinkable prices as buyers fight for limited inventory. It’s a national phenomenon, not just in pricy coastal enclaves; year-over-year home values increased in 99 percent of metro areas across the United States, according to recent research from the Terwilliger Center for Housing Policy. 

Between the stratospheric price gains and rising mortgage rates, buyers eyeing a larger home or a fancier address would be paying an increasing amount for the same place. This is the emerging trade-up gap. That renewable resource of desperate buyers with the will and the means to compete for a dwindling number of homes is shrinking; homeowners with low rates locked in are more reluctant to sell, knowing they’ll pay more to borrow for their next purchase; first-time buyers are increasingly getting priced out of the market. 

As the supply of move-up buyers dwindles, the market’s machinery will slow, possibly drastically.

“Is the party over? Depends on who the party guest is,” said Brad Hunter, founder of Hunter Housing Economics. “Those who already own a home feel pretty good. The trouble comes with a 30-year-old couple with a kid on the way that wants a suburban home with a yard. It’s not just the monthly payment, or the trouble coming up with a down payment.”

Trickle-up economics

At the low end, 9 million potential buyers have already been priced out by rising mortgage costs, while higher rents are stymying first-time buyers’ ability to save for a down payment to get them onto the housing ladder. As the market cools from last year’s red-hot pace, the loss of those entry-level buyers means move-up buyers have no one to sell to as the effect ripples to the top.

Roughly 80 percent of mortgages right now are locked in at 5 percent or lower, said Rick Palacios, Jr., director of research at John Burns Real Estate Consulting. If that rate rises significantly, it will likely limit buying potential and suppress inventory on the resale side. Plus, he said, there’s significant capital being deployed in the build-to-rent market, and giant rental landlords waiting to scoop up any additional inventory. 

“I think you can say the gears are slowing, but not totally stopping,” Palacios said. “Housing is the Fed’s sacrificial lamb. When your backdrop is chaos, and that’s what we’re in now, the only thing the Fed can control is rates. It’s immediate; when the Fed moved rates to 5 percent, the housing market immediately slowed down.” 

“If the market slows, which it definitely is from our vantage point, every company that touches the housing food chain will feel the impact.”  

Taken aback

Realogy, now renamed Anywhere, has almost 200,000 agents and a constellation of real estate brands including Century 21, Coldwell Banker and Sotheby’s International Realty. CFO Charlotte Simonelli said earlier this year that the company’s “continued momentum reflects the strength of our core business,” highlighting $1.6 billion in first-quarter revenue and a 10 percent year-over-year increase in closed transactions. eXp, a rapidly growing brokerage aiming to have more than 100,000 agents by the end of the year, saw global sales blossom, with $1 billion in revenue and 55 percent more agents. Even so, with 88 percent of the company’s agents in the U.S., the firm’s executives see the domestic market slowing.

Redfin, one of the nation’s top brokerages, performed better than expected, adding market share and increasing online search volume, and Compass saw revenue jump 25 percent year-over-year, reducing losses and attracting more agents, and becoming the top brokerage by sales volume.

Most of that record-setting quarterly performance happened before rates started to rise, inflation got worse, and a sentiment shift truly took hold.  

By late May, amid growing concerns about falling home sales, Redfin’s stock had fallen 73 percent over the last 6 months, and Compass was down about 40 percent.

Now, agents across the country are seeing signs of a slowdown, especially outside of the Sun Belt; a second-quarter RealTrends survey found 42 percent of brokers expecting sales to be down over the next three months. The Real Estate Board of New York’s most recent Broker Confidence Index score, in a third-straight quarter of declining optimism, found residential agent sentiment sinking, even compared with office brokers hawking desolate central business districts.

Ryan Schneider, Anywhere’s CEO, told CNBC in early May that rising rates are a “headwind” for the industry, but people are still buying; during a May 12 interview for the firm’s Investor Day event, he went into more detail, noting that any slowdown will affect the firm “across the board,” and that the sector most impacted is sub-$500,000 homes, with first-time buyers struggling and listings declining.

“If Millennials don’t have the down payment savings — and our survey data shows most of them don’t, the median amount saved is zero — with rents increasing it gets harder and harder to save that money,” said Chris Salviati, an economist at Apartment List. The rent increase nationally has been 17 percent, and in some markets, has topped out around 30 percent. 

Carrie McCormick, whose firm specializes in luxury Chicago real estate, said the shift happened seemingly overnight. Buyer fatigue was obvious: homes going under contract haven’t had as many multiple offers, the offers aren’t nearly as aggressive, and the lines and excitement at open houses weren’t there anymore. 

“I have clients who say they don’t want to look around anymore, their buying power is way down,” said Colin Stok, a Denver agent. His boss Kelly Moye, who has seen showings for houses on the market shrink after Easter weekend, said she expects a very different second half of the year, telling writers of a local real estate report that, “they say you only know when the downturn comes right after it happened.”

The slowdown means brokerages will be faced with falling sales at a time when their workforces have been inflated. The National Association of Realtors hit a record of nearly 1.6 million members in 2021, up from 1.4 million at the end of 2019.  McCormick believes this will lead to a weeding out of brokers later this year because “a lot of people jumped in thinking the market was always hot and easy.” 

Stok said he’s planning to ride it out. “I’m leaning more on the leasing side of the real estate now,’’ he said. “Lots of people just aren’t wanting to buy.” 

The brokerage industry has adopted a wait-and-see attitude, says Adam Ducker, CEO of consultancy RCLCO. “It’s almost surprising that it’s not worse,” he said. “The sentiment is, ‘let’s be careful, let’s keep our fingers on the pulse. If we need to pivot our strategy, don’t do it now, it’s too uncertain.’” 

The wild pricing gains that fueled so much broker revenue came after decades of underbuilding and the largest generation in history, the millennials, entering prime homebuying ages without the resources to compete. 

The nation is short 5.8 million homes, said Realtor.com Chief Economist Danielle Hale; that’s more than five years of building at a fast pace, without the natural attrition of units over time. Experts surveyed by Zillow agreed that even with a slight boost in inventory in March, it would take until fall 2024 for depleted inventory to hit pre-pandemic levels. 

Sitting on capital

That shortage has been pushing prices higher as buyers with the cash or access to cheap mortgages compete for a dwindling inventory, especially at the high end. Home sales have decreased every month this year, according to the Census Bureau.

One factor keeping housing inventory low, and prices high, is the single-family rental industry that was born out of the 2008 housing crash. Across the country, when homes become available, investors buy them and turn them into rentals. Even builders are getting in on the act, producing homes built to rent.

“Groups of investors small and large are sitting on mountains of capital to build their rental portfolios,” Palacios said ($40 billion, according to some estimates). “These groups didn’t exist in the last downturn, which helps put a floor on the market.”

Higher borrowing costs don’t just drive up prices for potential buyers; they also make homeowners with locked-in low interest rates much less inclined to move, said Hunter, the housing economist. He predicts that after a short-term increase in sales to beat the mortgage rate increase will come a downward shift in sales volume. Even with that predicted decline, he sees home values going up, albeit at a less “unsustainable” pace: 8.5 percent in 2022, and just 4.35 percent in 2023. 

A different calculus

Buyer sentiment suggests bad vibes. A recent Fannie Mae survey found “only 24 percent of consumers believe it’s a good time to buy a home, with similar levels of pessimism expressed by nearly all of the demographic groups surveyed.” It’s pretty much the definition of a market failure if three of four buyers of any product feel bad about their choice, yet it’s still the only product they can buy. 

Therein lies the trickle-up problem. For a home that sold at the national average price in March 2022 of $523,900, with 10 percent down, a mortgage rate shift of 3 to 5 percent means an extra $500 due every month. 

Next, as the market cools, for-sale homes get pulled, since they aren’t getting the prices buyers want (likely a big problem in the immediate future, with home values at or near historic highs).

Jodi Hall, president of the Nationwide Mortgage Bankers, told her members in early May that she’s expecting a recession in the latter half of the year, and declining home values. That expectation may keep recent homebuyers from selling, since a sinking market might price their homes below recent record-high valuations, and they certainly don’t want to make less than the neighbor who sold six months ago. 

Then comes the next knock-on effect, which starts touching mid-level homes and even cooling off luxury sales.  

With prices still rising double digit percentages, the lock-in effect for existing owners becomes more pronounced; it’s harder to trade up in a nearby neighborhood, especially if a home with a bloated price tag is accompanied with a sky-high mortgage rate. Why not just stay put, or add on? 

Remodeling data from Harvard’s Joint Center for Housing Studies suggests that’s happening.

American spending on upgrading homes has exploded during the pandemic, said Abbe Will, a research associate at Harvard, and is forecast to jump almost 20 percent quarter-over-quarter in the third quarter of this year. 

When people assume they’ll be in their current homes for a while, and see prices and equity rise, that “gives them a lot of confidence to invest in a major way,” said Will. Moving for the last several years has been more and more out of want and need, so those on the market are making a move out of necessity. “It’s a different calculus,” Will said. 

Realtor.com hasn’t revised its forecast just yet, but Hale says we will likely see slower sales volume later this year. If sales stay within the 5.5 to 5.8 million range, that will bode well for the health of the housing market. High prices have offset the impact lower supply has had. But dip to 5 million or lower, and firms that work on volume business will have to look closely at their sales models. There are a lot of markets at or very close to the horizon of what people can afford without having wealth to draw on, she said. 

“The percentage of Americans participating in the housing market is shrinking,” said RCLCO’s Ducker. “Now we’re just dealing with the upper third [of Americans], whereas back 10 years, much of the middle third were trying to get into the housing market, and wagering their discretionary income to do so.” 

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