3 Things to Watch with a Potential Housing Crash Coming

So today I’m going to talk about three things that you need to watch as we potentially have a housing crash. I’m going to make some predictions around inflation and interest rates and then, of course, at the end of the article, some things that you could do today to be prepared for this great opportunity.

1. Inflation

So the first of the three things is obviously inflation. And why I think this is a huge, huge thing is because where we are right now is 9.1% inflation as measured at the end of June. Now, what’s most important, however, is the own Federal Reserve and Powell are all saying that their target is 2%.

US monthly inflation vs Fed fund interest rates chart

And if you look at the history of inflation versus interest rates, you’re going to see that largely the Fed did a very good job of keeping inflation around 2%. This chart is a little bit dated. It actually stops in 2021. And of course, as you guys know, we’re sitting up here with inflation at 9.1% and it’s a lot higher. And of course, the federal funds rate has gone up and interest rates have gone up as well.

But the biggest issue here is not that we’re at 9.1. The biggest issue is actually that the Fed target is 2%. We’re over a 7% difference between what the Fed wants versus what the economy is doing today. That’s why I want to keep your eye on the 7% issue, not on the nine or the two. There are all kinds of articles and videos where Powell himself says that his biggest legacy is tied to whether he could break the fever of inflation.

US monthly inflation vs Fed fund interest rates chart 2

And I believe he’s going to continue to do that as he tries to target 2%. And as you can see from this chart from the 1970s, the Federal Reserve has the federal funds rate or interest rate as a mechanism or tool to speed up the economy or cool it down. And right now they’re cooling it down. As you can see, it’s done year over year.

And you can see as they raise the interest rates, inflation then goes down and up based on the cost of borrowing. This should not be news to anyone that the Fed is now using its very tool interest rates to calm inflation in the economy.

2. Interest rates

The second thing to watch, of course, is interest rates or the federal funds rate. And as the Federal Reserve raises interest rates or the bank’s borrowing rate, of course, they pass on those higher costs to the consumer, which slows down the economy. And that’s supposed to be how it works. Should be no surprise to you that the Federal Reserve hiked the interest rate again by over three-quarters of a point just in July.

What’s most important for you to realize is that this is the fourth time that the central bank has raised the rates this year. Historically, this is a very aggressive time for the Federal Reserve to raise rates four times this year. And, they still have three more meetings before the end of 2022.

federal funds effective rate chart

I put the federal funds rate from 2018 to 2022 here, so I can show you that this is the period that actually created a lot of the asset bubbles that we’re in right now.

federal funds effective rate chart 2

This is when the federal funds rate went down to nearly zero and created all this borrowing frenzy and the asset bubbles that we’re in today. The only thing that’s happening now is that the Federal Reserve is now raising the federal funds rate, which is, of course, slowing things down.

But nobody was complaining when it went to zero and it was speeding up and everyone is making a bunch of money. I love this next chart because this is basically just the Federal Reserve’s calendar of what they’re planning to do with the Federal Funds Rate and a bunch of other things.

2022 FOMC Meetings chart

But what I did is I put the inflation numbers over here to the left and you can see the beginning of the year, we’re at seven and a half percent and now we’re about 9.1. And they’ve had four increases through the year. As you can see, these inflation rates have gone up over this period of time while the Federal Reserve has been increasing the federal funds rate.

So this has not worked. But of course, the last federal funds rate increase that just happened in July has not yet been seen in the economy. And we don’t know if inflation is going to come off the 9.1 and go down or not. The big issue that I want you to pay attention to is not necessarily the next three meetings, but the difference between the 9.1% and the 2% target, which we just talked above. That’s the biggest issue.

Federal Funds Rate chart for 2022

You already saw that they were increasing rates throughout the whole year when inflation was in the seventh. So even if the 9.1 goes down to, let’s say, in the seventh or the eighth, the chances of them raising rates again in September are likely high. In fact, the Street is already preparing for at least a half a point increase in September as we talk today.

So what does all this mean? What this means is that this is what the Federal Reserve is watching, and they’re using interest rates as a tool to drive it down further. And if they increase the interest rates, then borrowing is going to go down and real estate prices are also going to go down. The whole point of increasing interest rates is to slow things down.

So now let’s take a look at the federal funds rate. Now, essentially, the federal funds rate is the average interest rate that banks pay for overnight borrowing in a federal funds market. And you’ll be able to read the rest of this. But essentially it’s the amount that the bank is charged for borrowing. But what it does do and affects the value of the US dollar and other household and business assets, and it’s often thought of as the most important interest rate in the world.

As this rate goes up, so do rates on credit cards and mortgages and auto loans, etc.. This is a very important thing to watch because if inflation continues to rise, the federal funds rate will also continue to rise and borrowing will continue to go down, as will consumption and real estate listings will go up and real estate prices will go down. And everything is predicated on these things as these rates go up. The affordability factor is also down.

Federal funds Effective Rate chart 3

People’s ability to buy a house or buy a car or buy a TV go down. However, as I want you to see back from the sixties, the federal funds effective rate has been all over the map and these gray areas are recessions. As you can see, this is what it’s done from 2018. It is still low by comparison. It’s still very, very low by comparison. But everyone’s freaking out. But this was bound to happen as the Federal Reserve tries to combat inflation.

3. Real Estate Prices

So what’s happening to real estate? The first thing is, is capitalization rates are going up. That’s not good. That means that if capitalization rates go from 4 to 5, for example, that’s a 20% discount on the value with the exact same net operating income. The next thing is that these borrowing rates continue to go up and what will happen as they continue to go up? Consumption will go down.

People will continue to buy less homes, less investment, less cars, less TVs. That’s what happens with rates go up on credit cards and all those other things. Construction costs are also up, which is not necessarily good. And yes, this is more of a supply chain issue. But as construction costs go up and borrowing rates go up, then of course, supply will continue to go down.

We all know that inflation has gone up, too. So continue to watch this as the Federal Reserve uses the borrowing costs to try to drive it down. The last one is what we call days on market. This is a very important one because we’re starting to see this creep up and this is what I call the lag factor.

Real Estate Price LAG factor chart

So what we have here is, as all of these things are happening and the Federal Reserve starts to increase these rates, things start to slow down.

We are starting to see real estate longer on the market, 30, 60, 9000 plus days now, which is normal when before, of course, people were bidding and overpaying for things when money was cheaper. Continue to watch this days on market here because real estate professionals are targeting days on market and using creative financing techniques to be able to buy these properties at deep discounts from sellers right now.

Action steps you can take

So what are some action steps that you guys can do right now in preparation for all this stuff? The first one is, Please, please, please buy for cash flow versus capital gains.

If you’re trying to time the market like a lot of flippers or let’s say you’re trying to build something and you’re trying to figure out what interest rates are going to be at the end of the project or even what the project itself is going to cost, because supply chain issues and labor issues are up be very, very careful here before cash flow. There’s still plenty of good deals out there that do cash flow.

The second one, of course, is fixed debt. Even though it’s going up, I’m telling you, I believe it’s going to be as high as 8% by the end of the year, based on the inflation factor of being 7% difference from 2% to 9.1. I do believe we’re going to see some interest rate hikes in either two or three in the next Federal Reserve meeting.

The third, of course, and the last we’ve been talking about the whole time is cash. Make sure that you have plenty of cash. You have cash reserve. If your Airbnb didn’t work out, you have cash reserve. If your tenant loses their job, you have cash reserve. If your mortgage payment goes up, all of this is going to be very, very important on how protected you are.

So if you have a lot of investors, make sure that you’re putting some cash reserves together and for sure, make sure that you’re not distributing all the money out and spending all the money and that you have plenty of reserves and it’s still your money. So if we get through this period of time, that is still yours and you can use it the way you want.

DISCLAIMERS: Any information or advice available on this channel is intended for educational and general guidance only.

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