Is U.S. Real Estate Still A Safe Bet?

The cornerstone of the American dream is and has always been to own a home. Work, get married, have children, and take on a mortgage - that’s been the formula. 

And for decades, it’s worked just fine. 

However, this path only makes sense given a set of underlying assumptions:

• The debt you take on is affordable and consistent. 
• Your income increases more or less on par with inflation.
• Property values continually rise to build up your equity.

But what if those assumptions stop being true? 

The Writing On the Wall

One factor that could cause the U.S. real estate market to go haywire is interest rates. During 2022, record-breaking inflation forced the Federal Reserve to raise rates to the highest levels in decades. 

Yet nevertheless, inflation appears to be far from under control. Future expectations on the treasury debt, continuous threats of government shutdown, and the inevitable fallout of the 2020 money-printing binge are all still very much at play.

The Fed is now navigating a delicate balance between addressing inflationary pressures and managing systemic risks to the American economy.

High rates are the only thing keeping inflation in check - but with many companies (and homeowners) significantly overleveraged following over a decade of easy-money policy, sustaining high interest rates could prove just as devastating. 

Driven by the benchmark rates, 30-year mortgage rates are rising to the highest levels in two decades, reaching values close to 7.5%. This implies an increasing cost for those with variable-rate debt. Coincidentally, the percentage of families using this amortization method is at a 15-year high.

Mortgage Affordability

The main symptom of inflation is the increase in the nominal prices of all goods and services in the economy. However, some prices, such as wages, are in "rigid" markets, subject to contracts and preset adjustments.

Can you guess what happened to people's real incomes during the last few years of high inflation?

This effect erodes the purchasing power of families, as they must allocate a larger portion of their income to essential expenses such as food and energy. As a result, they have less money to pay for their mortgages and other loans.

Between 2007 and 2012, the decline in real incomes was offset by a reduction in interest rates, but we are in an entirely different game now as the Federal Reserve plans to keep interest rates high for some time. In fact, foreclosures have increased dramatically  over the last few years. 

Shades of 2008?

All of this is important because the number of foreclosures increases the available supply in a market with increasingly tight conditions for both home-seekers and developers.

Clear examples of this are the consistent decrease in housing starts since the beginning of the monetary tightening and the increase in credit card payment delinquency and debt.

First, real estate developers leverage themselves for the construction of homes or commercial properties, making them dependent on the interest rate cycle. An early indicator of the subprime crisis was a notable decline in housing permits and starts, signaling the conclusion of the easy money cycle.

On the other hand, there are signs of issues in the demand for properties - not only due to a drop in family wages and real incomes, but also because of record levels of credit card debt and a continual rise in delinquency.

And let's not forget that credit cards are the quickest way to get out of a jam, to fill in the "gaps."

Americans' credit card debt is on the rise, reaching $1.08 trillion, a 15% increase from the previous year. The average consumer balance has surged to $6,088, the highest in a decade, according to the Federal Reserve Bank of New York.

With record household debt, soaring interest rates, and unprecedented federal government deficits, the implications for the real estate market are troubling at best. And if disaster does strike, the implications could be severe.

The Fallout

A housing crash could have devastating repercussions on the American economy. Currently, a majority of families are grappling with the challenge of paying off their loans and credit card debts, and at the same must allocate a higher portion of their income towards basic expenses.

Many American families are barely holding onto their equity in the real estate they've acquired. But that could change:

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• The decline in real incomes is not being offset by a reduction in interest rates.
• Foreclosures and short-term loan delinquency are consistently rising.
• The bond market and the stock market are both flashing yellow.

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If property prices were to decline, it could potentially set off an unprecedented chain reaction scenario, with real incomes falling for a record number of years, and, similar to the 2008 financial crisis, families grappling with properties whose value is lower than their nominal debt.

The primary victims of this crash would be individuals looking forward to retirement, as they would witness their lifelong savings wiped out by a 33 trillion dollar credit bubble in the United States that, at some point, must deflate.

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Conclusion

By now things must be seeming pretty dark and gloomy. And there’s no denying it - we may be in for some very difficult times ahead.

But that doesn’t mean you can’t be prepared. And one of the best ways to be prepared is to be diversified. 

Foreign real estate assets have more of a ceiling for growth, and as the situation intensifies, this will become even more evident. 

If you’re interested in taking your portfolio global and gaining exposure to farmland real estate, get in touch with our staff. We can help you get started, or to increase your farmland holdings.