Rather than showing you a slew of graphs, charts, and stats for our Q4 market update for 2022, we’re trying something different. We decided to do a real-life exercise to try to explain what’s going on in the real world.
For context, we went back and looked for properties that sold between May and July 2021 in Alameda, on the main island. We looked at the median sales price of $1.2M to $1.25M. That price range is generally regarded as the upper limit of the entry-level category. So we calculated what that property was on average. Then, we compared that same property in November 2022. Let’s take a look at what we found.
Case 1: Average Home sold in May–July 2021
To start with, there were 10 properties that sold from May to July 2021. On average, as you can see from the table above, they had 2.6 bedrooms and 1.5 bathrooms (2.6-BD/2-BA), and an average area of 1,305 square feet. In addition, these homes sold for an average cost of $1.223 million. That is 29% over their average list price of $951,200.
We have talked about teaser pricing in other blogs before. Here in the Bay Area, we had a lot of instances where buyers went significantly over the listing prices. So, it is no surprise to see that figure.
Case 1: Average Home sold in November 2022
On the other hand, only four homes sold or closed in November 2022. These homes had an average of two bedrooms and 1.4 bathrooms (2-BD/1.4-BA). Also, they were a little bit smaller, with an average area of 1,255 square feet. Furthermore, they sold for an average price of $1,137,000. That is 7.03% lower than the average sales price of the properties sold between May and July of 2021. So, we didn’t see the huge drop that you might have been hearing about from the media. And interestingly, on average, these homes from November 2022 sold just 6% over their average listing price of $1,072,500.
In this case, we did not see that big teaser pricing model as much. So why is this the case? What is leading to this? Well, simply put, it’s a supply and demand issue.
Case 2: May–July 2021 vs. Case 2: November 2022
Then, using those averages, we now compare the cost of ownership of both of those homes.
For the sake of this comparison, let’s assume a 20% down payment, a 30-year fixed rate, and a 3% interest rate. For the average home from May to July 2021, the principal and interest payment (P&I) is $4,125. The tax, based on Alameda taxes, is around $1,184, and insurance is $200. So, this gives us a total monthly payment of $5,509. That’s the monthly cost of ownership for the average 2.5-BD/1.5-BA, 1,300-square-foot home in Alameda.
Now, let’s take a look at the average home in November 2022. Currently, interest rates are at around 7.5%, plus or minus. So for this case, let’s consider an interest rate of 7.5% instead of 3%. However, the down payment is still at 20%, and it’s still a 30-year fixed-rate mortgage. In this case, the P&I payment alone for the home went up to $6,360. That’s equivalent to an additional 54.18% of the P&I of the average home from May to July 2021. However, the tax, which is about $1,101, went down a little bit because it is based on the final sales price. For the insurance payment, we assume $200 as well. In total, the monthly cost of ownership for that same house is $7,661. That is equivalent to about a 39% increase compared to the average monthly cost 14–16 months earlier. Thus, the same property, even though it costs less to purchase, costs a lot more to own.
Case 3: Assuming a 20% Discount
We have actually anticipated this based on the recent increase in interest rates. After we saw the significant jump in the numbers in the monthly costs, we went through some thinking.
We asked, “What would it take to make the payment more palatable?” What would it take, in terms of a reduction in home value, to make the monthly payment more palatable to buyers?
One way to achieve a smaller payment is a big reduction in price. For example, let’s say we took a 20% price reduction off of the sales price in May–July 2021. This means that the same home now has a final sales price of $978,400. So, what we found is that this brings the principal and interest payments down. If we use the same interest rate of 7.5% as in November 2022, the P&I payment becomes $5,473 per month. Furthermore, because there’s a decrease in the sales price, the tax also goes down to $948. And, assuming the same insurance of $200, this brings the total monthly payment to $6,620.
Unfortunately, that is still 20.16% larger than the monthly cost of the average house sold in May–July 2021. So, even assuming a 20% price reduction, it still costs 20% more every month to own and operate that property. On the bright side, you’re a lot closer to the monthly cost in mid-2021 than you are right now.
Takeaways
In a nutshell, this is what we’re seeing across the Bay Area. One thing you really have to remember is that these are all based on averages. There are going to be properties that perform above and, of course, below the average. If you are in a situation where there’s a property that you think you can get that 20%, 25%, or 30% discount from where it was selling, you might be able to start to break even, even if you have that higher interest rate.
But ultimately, what we’re seeing on the ground does not follow that story. Buyers are not getting that deep, deep discount simply because there’s a lack of inventory. If inventory comes up or interest rates go down significantly over the next couple of quarters, all of this can change. But right now, we’re in gridlock. The price that buyers are willing to pay is significantly below where some of these properties are actually selling.
What’s more, it’s becoming harder and harder to bridge the gap. Of course, sellers are going to look at historical sales data. They want the price that their neighbor got 6–12 months ago. On the other hand, buyers are going to look at that PITI (principal, interest, taxes, and insurance); that 20%–40% increase of what they would have had to pay for the same property every month; and try to rationalize how $7,661 makes sense for this 2-BD/1.5-BA and 1,255 square foot home.
So, that’s where the gap or the divide is. That’s where we’re seeing this gridlock and tension occur. Ultimately, that’s what is causing our market to slow down significantly. Transactions take a lot longer to put together. Ultimately, we’re just having to get more creative.
Tip for Buyers: "Make sure you have a fabulous lender on your team."
Speaking of being creative, here’s one of the things that we really talk about with our buyers. We try to remind them to make sure they have a fabulous lender on their team. This is really one of the most important things. That’s because a great lender will be able to take all of the financials and look at every little piece of them. They’ll be able to get creative with all the different avenues a buyer might be able to utilize to play with this payment number every month.
For example, one thing we’ve talked about is the 3-2-1 buydown and similar types of programs. These programs could potentially help you step into a higher mortgage payment year by year. Ideally, we want to put some of that load, if we can negotiate it, on a seller who can help you make those payments over the first couple of years. So that’s just one of the options out there. There are several out there. But as we’ve noted, we see a lot of buyers crunching the numbers just like we just did. Buyers are seeing what the payments are and deciding to park themselves on the sidelines as a result.
Tip for Buyers: "Explore the lease option."
Another creative avenue that we just negotiated for someone and might work in some scenarios is a lease option. In this case, the buyers we negotiated on behalf of are going to move into the property as a tenant. They’re going to have the option to purchase the property at a given price within the next six months. In this case, it’ll work because they’re going to file their taxes in January. Filing the taxes will give them a lot more lending options, and they’re going to get better rates and terms. So, they’ll be able to pay the price that we locked in after they do the taxes. So, in this particular situation, it worked out. There are numerous other scenarios that you can employ.
Tip for Buyers: "Look at other opportunities that other people are not willing to look at."
Ultimately, start looking at some of these creative options if you can’t get that price low enough to where you’re comfortable. People are so fixated on the 30-year fixed number and interest rate that it is putting them on the sidelines. But just be aware that there are actually other opportunities that you can consider and explore to avoid being sidelined.
If you’re thinking about buying a house, crunching the numbers on a mortgage calculator online, and not sure how to put this all together, feel free to reach out to us and have a conversation. At the very least, we can talk through some of your options and what might work in that case.
Tip for buyers: "Loan limits are going up."
Lastly, for the people considering a purchase in 2023, take note that the loan limits are going up. We actually did a video on that topic, so we won’t dive into it here. But just know that that is going to give you more options on the lending side. This is especially true in the model and in the scenario that we just presented.
WE hope our Bay Area Housing Market Q4 Market Update 2022 has helped you.
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