THE STRESS TEST FOR HOUSING IS HERE

And at the end of March 2022, things got real.

Welcome to the land of 5% mortgage rates, formerly known as the land of 3% mortgages.  Fresh off the fastest short term rise in rates in nearly three decades, housing is now officially totally unaffordable.

We've chronicled extensively the "everything bubble" created by the Fed since March of 2020, when the discount rate was cut to 0% and banks were allowed to essentially line up for free money.

Now two years later, the money supply has been inflated by more than 40%, inflation is raging out of control and the median home price in many markets is up 30% - 40% from pre-pandemic levels.  (Unless you're talking about Bozeman or Austin, in which case prices have increased that much in the past year)

For 18 months, most semi-decent homes in the Denver metro area have been attracting five to 15 offers, and my favorite moment of 2021 was writing a contract on a home in Littleton that ended up attracting 53 offers (no, we did not win).

In 2019, the last time mortgage rates touched 5%, the Denver market went dormant.  At that time, on the heels of a decade of strong price appreciation with some neighborhoods doubling in value from Great Recession lows, buyers decided they had had enough.  The median home price was $497,000 and with a 5% mortgage, PITI payments on a single family detached home were around $2,500.  

Too much, the market said.

So inventory piled up to 11,000 homes, the absorption rate peaked at 2.16 months of inventory and there were 1.58 active listings to each home under contract.  I had totally legitimate listings that sat for weeks on end.  It felt like the end of an era.  

Then the pandemic happened.

The Fed zeroed out the discount rate and mortgages fell to 2.5%.  Affordability came back in a way we hadn't seen in a decade.  Working from home made home more important than ever, and instead of focusing on kids and vacations and activities and cars, the full attention of the American public seemed to lock in on... houses.

Inventory plunged, prices soared, the stock market roared and the Fed, in charge of managing it all, kept its foot on the gas pedal.  

The discount rate remained at 0% from nearly two years.  

The treasury printed money, the government flung it from the heavens, spending bills were passed and passed again.  Demand rocketed, supply chains collapsed and then Russia decided to kick off what could become World War 3.

As we began March 2022, there were fewer than 2,000 active listings in the metro area, the absorption rate was a ridiculous 0.43 months of inventory and there were 0.31 active listings to each home under contract.  The median home price in Denver is now $665,000, nearly 34% higher than it was when the pandemic began.

The last listing I sold in February attracted 37 showings, seven offers and sold $105,000 over list.  That buyer closed with a 3.25% mortgage.  It would be 5% today, and at 5%, those results would not have looked the same.  

With $30 trillion in federal debt, another $10 trillion of assets on the books at the Fed and inflation topping 8%, the era of cheap mortgages is over, at least for now.

If the Fed isn't going to buy any more discounted mortgages, who will?  Who else would be dumb enough to take 3% returns when the real inflation rate is nearly triple that.  

The Fed giveth, and now the Fed taketh away.

That $2,500 PITI payment on a median-priced home in 2019 that buyers decided was too much?  Today, the payment on that same home is more than $3,400.  

If you're already in the homeownership ecosystem, you've got massive equity (for now), and at least that gives you a chance.  But for the young and the poor and those lifelong renters, it's total devastation.  

Massive government overreach broke the economic system, and now I fear it will take massive government overreach - likely in the form of much higher taxes on personal income, capital gains and real estate transactions - to try and address it.  

The Fed decided the best way to save the economy in 2020 was to fire up the printing presses, jack up asset values and encourage people to pull massive amounts of money out of their personal ATM's (i.e. "homes") to try and keep the economy afloat.  

It was a defensible strategy, initially.  But for 24 months, come on. 

The Fed kept rates low so the federal government could continue borrowing without limit or reason.  Stimulus checks did a great job... stimulating inflation.  The American Rescue Plan "rescued" every government program, interest group and bureaucracy in the country.  

State pension plans were bailed out, state Legislatures are swimming in unspent cash and student loan payments have been paused for two years.  Another $17 billion in student loans has already been forgiven, with more to come.  Mortgages were moved into forbearance, eviction moratoriums kept renters in place and the printing presses just kept running.  

While the Fed kept stockpiling those 3% mortgages. 

I have said we have compressed 8 to 10 years of traditional home price appreciation into 24 months.  Now that rates are recalibrating toward reality, it's entirely reasonable to expect home prices to flatten and underperform, perhaps for years.  

Another recession is unavoidable, which will likely result in the printing presses being turned on again in a few months.  

The net effect of higher rates is going to be fewer buyers.  But it's also going to mean fewer sellers, since virtually everyone refinanced into a 3% mortgage and the pain of letting go of that loan for a 5% mortgage on a replacement property is just too severe.  

Fewer buyers, fewer sellers.  And that means fewer agents and brokers.  By orders of magnitude.    

I've said for a while that the next market shift would be an extinction level event for half of the agents and brokerages in our industry.  

Brace for impact, because that day has arrived.  

THE EVENTURAL DEMISE OF BUYER BROKERS, ZILLOW AND THE MULTIPLE LISTING SERVICE ITSELF

The world is shifting under the feet of the real estate industry and it's my contention that very soon, traditional real estate consumers will have a hard time recognizing anything about an industry that seemed to not evolve much at all for decades on end.

 

With barely 1,100 active listings on the market in the Denver metro area as of the writing of this article, the number of active listings in Denver is down 83% from two years ago.  Current inventory is 73% below the pre-pandemic all-time low of 4,203 active listings, set in December of 2017.

Nationally, the statistics are not quite as bleak, but they're close.  According to Federal Reserve research data, in December of 2019 there were 1.125 million active listings on the market in the United States.  At the end of 2021, that number was 483,000, a decline of 57%.  

What does it all mean?

Very soon, the end of buyer agents, data aggregators and perhaps the MLS system altogether.  

Let me explain.

In most markets, it is customary for a real estate brokerage to charge a "gross commission", usually between 5.5% and 6.0%, to market and sell a home.  Historically, about half of this amount has been offered to buyer agents as "co-op", or cooperating compensation, while the listing brokerage retains the other portion.

In the environment that has been created in the past two years, with record low inventory caused by record low rates and little hope for a return to anything resembling the "pre-pandemic" market (since almost all homeowners have refinanced into 3% mortgages, which they will likely never give up), the inventory is not coming back.

And that means we are now in a perpetual low inventory environment, which supports prices but also exposes the fact that there are far, far too many real estate brokers in pursuit of what will be a very limited pool of sales for many years to come.

How bad is it?  

There were approximately 6.2 million completed home sales in the US in 2021.  Assuming 80% of those ended up in the MLS, that's about five million transactions.  With 1.6 million licensed NAR member nationally, that's about three sales per agent per year.  

Clearly, we have too many agents by orders of magnitude.

This is not news.  Having too many agents in the ecosystem has been a fact of life forever.  The difference is that Fed's economic response to the pandemic (cut rates to zero, set off a frenzy in the housing market like we have never seen before) took something that was hidden and put it out in the open.  

Professor Darwin now has his opening.  We will never again have enough sales to justify the existence of 1.6 million agents.  

The point of this post, and the reason I'm writing about this, is because in a world where buyers are a dime a dozen and buyers' agents are up against near-hopeless odds for success, the value of a buyer's agent becomes... almost zero.

Truth is, in this environment, listing agents hold all of the cards.  

Yet, under the antiquated MLS rules, sellers are being asked to pay between 5.5% and 6.0% to list their homes, with the very low-value buyer's agent taking half or more of that commission.

That is where the change is coming.

In most of Europe, there is no MLS.  Sellers hire brokerages to sell their homes, and the brokerage is expected to find the buyer.

With no separate buyer's agent to pay, commissions are lower. 

And so you can clearly see here, in our current low-inventory environment which will likely become endemic because of the Fed's extended low-rate policies, sellers should question why there are paying buyer agents anything at all.

Realogy, the holding company which owns Century 21, Coldwell Banker, LIV Sotheby's and other prominent real estate brands, recently filed a court brief challenging NAR's so-called Clear Cooperation Policy, which requires compensation for buyer agents on homes listed for sale in the MLS.  

Sooner than you think, just as with the European brokerage models, homes likely won't even be listed in a regional MLS system.  Instead, sellers will choose a major brokerage - like Compass or RE/MAX - to sell their home.  Those sellers will likely pay smaller commissions - say between 4% and 5% - and they won't care where the buyer comes from.  

Those major brokerages will control all marketing, exposure, contract solicitation and negotiations in house, usually at a much lower fee than what sellers are paying today to outside third party brokerages through MLS compensation rules.

And so soon - and I'm talking months, not years - you will see the rise of models where Zillow and MLS systems become irrelevant as consumers focus on in-house listings of the largest brokerages, going direct to the seller's agent or an in-house buyer's agent being fed leads by the company at a reduced commission rate.

It will be more efficient for the seller, more profitable for the brokerage, and it will spell the end of half or more of the real estate brokerages in America.  

I'm not saying I'm in favor of it, or opposed to it.  

But if you're 27 years old and trying to decide if a career in real estate is right for you, chances are it's not.  Because very soon, listing agents (who are generally more experienced with deeper databases of past clients) and large brokerages will run everything, and sellers won't be paying the freight for rookie agents just starting out with random buyers they met at an open house, at church or in a checkout line at King Soopers.  

The real estate world is about to get very small, very fast.  It won't be the welcoming haven it has been for newcomers or those going through a mid-life career crisis.  It will be a cutthroat, closed industry with smaller commissions, fewer participants and a very different fee structure than the one we know today.

If inventory levels are never going back to pre-pandemic levels, thanks to everyone refinancing into 3% mortgages, then it's time to discuss what that means for the real estate industry.  Cross-brokerage cooperation, buyer agency and MLS systems were built for the old world, where selling listings was hard and you needed the help of outside brokers.  

In the new world, the survival of brokerages will depend on doing it all in-house, exclusively, with thinner margins and no outside help.  Which means 50% or more of agents are in their final act, whether they know it or not.