News of a potential housing market correction often causes many Americans to worry about the global economy, but that concern may be unfounded. Correction is not necessarily a bad thing. It may help improve housing demand and inventory when real estate values increase faster and higher than normal.
Housing market corrections affect people differently, and there are pros and cons to consider depending on whether you buy or sell. For a real estate investor, a market correction could be a great opportunity to buy property at a discount and grow your investment portfolio.
What is a housing market correction?
A housing market correction occurs when the real estate market contracts and real estate values drop. Housing market corrections may be regional or national and occur when prices exceed what the market can bear.
Rather than being a cause for concern, a correction may benefit the economy as a whole as the real estate market returns to sustainable levels. The overall real estate market value typically drops 10% or less in a correction.
A housing market correction is very different from a housing bubble and market crash. A housing bubble occurs when there is a rapid increase in housing prices due to limited supply and high demand.
In a housing bubble, home values are pushed far above what the market can afford when bidding wars break out. Speculators hoping for quick profits also contribute to rapid price increases. Then the bubble bursts, and prices collapse when demand falls or supply increases (or both).
Unlike a housing bubble where prices fall quickly and significantly, home prices fall much less frequently and are slow to correct. Lower prices allow buyers to get better deals and have more homes to choose from. On the other hand, sellers may get less and their homes may take longer to sell.
What causes a housing correction?
Several factors may contribute to the housing market correction. However, not all factors need to be present for a correction to occur. Property values can only decrease by one.
First, the availability and affordability of mortgage credit may shrink the housing market. Mortgages can be difficult to obtain due to economic uncertainty. For example, news of the closure of a local factory that employed many people may cause local lenders to be more cautious in approving home loans.
Lenders may also tighten their lending standards during recessions or when analysts predict a near recession. And then fewer people will be eligible for mortgages, which will lead to lower demand for housing.
Job loss is another important factor. During an economic downturn, many companies are downsizing their workforce to save money, streamline operations, and stay competitive. This results in fewer people qualifying for mortgages.
Finally, higher interest rates directly affect the cost of borrowing. Depending on the amount borrowed and the term of the loan, an interest rate increase of 1-2 points can add tens of thousands of dollars to the total cost of borrowing over the life of the loan. Increased monthly payments make home ownership more expensive or force buyers to settle for less expensive homes.
How do housing corrections affect buyers?
If you are considering investing in a property during a housing correction, there are some important pros and cons to consider. Make sure you consider these and other factors carefully before making an investment decision.
Pro: More affordable properties
As an investor, the primary advantage of a housing correction is that you can take advantage of lower home prices. This could allow you to acquire a large amount of new assets or buy more real estate.
Pro: You may have more buying options
If fewer people are buying homes due to economic uncertainty or higher interest rates, there may be more inventory on the market to choose from. This may allow you to purchase a property that better suits your preferences and needs. It could also mean less potential for a bidding war between buyers.
Pro: You may have more demand for your rental property
When fewer people buy homes, demand shifts from buying to renting. As a real estate investor, demand for your rental properties may increase during a housing correction. This may allow you to charge a premium or be more selective with your renter’s applications.
The negatives: You may have fewer purchasing options
This does not contradict the previous point. When real estate prices fall, some sellers may take their homes off the market to wait for better market conditions, resulting in low inventory in some places. Whether there is more or less stock in the patch will vary depending on the location.
Cons: Stricter lending requirements
If market uncertainty is a contributing factor to the correction, lenders may tighten their lending standards and make it more difficult to obtain a loan. However, that doesn’t mean you can’t get the financing you need to grow your portfolio.
If getting a loan through a traditional lender is not possible, you may be able to get the financing you need through a hard money loan or a private lender. Although these lending options usually charge higher interest rates, you may be able to refinance after the correction is over and the economy has stabilized.
Cons: Higher interest rates
Since increasing mortgage rates are a common cause of corrections, you may have to pay more interest over the life of the loan. This may represent a significant increase in the cost of borrowing.
Negatives: Possible decrease in home value
If you buy a home during a market correction, the value of the home may drop after you buy it, reducing your equity in the home. It can also lead to a situation where you’re underwater in the house, which means you owe more on a mortgage than the house is currently worth.
How do housing corrections affect sellers?
With prices falling, a housing correction may not be the best time to sell. There are some important considerations for investors; However, that might make selling during this time a smart move.
Pros: Selling an underperforming asset
Although a housing correction occurs when national prices fall, selling may make sense if you have an underperforming asset or a property that is difficult to maintain. Removing it from your portfolio may allow you to reinvest in an asset with greater long-term potential.
Pro: Reduce or eliminate debt
If you are experiencing cash flow or liquidity problems, selling a home or other investment property in a housing correction may allow you to reduce or get rid of debt. Whether this is a viable strategy depends on how much equity you have in the property and how much revenue you generate.
The negatives: Your home may sell for less
Since home prices fell during the correction, you may get fewer offers than before the market downturn. However, this may not always be the case. The location of the house may be an important factor. If the home you want to sell is located in a popular tourist destination with strong demand for short-term rentals, your home may be sold for a premium.
The negatives: It may take longer to sell your home
When interest rates rise, and there are signs of economic uncertainty, fewer people may be interested in buying homes. This may result in more properties for people to choose from, which may mean that you get fewer offers and your home stays on the market longer.
Cons: Buyers may be more demanding
When prices fall, and competition decreases, buyers may demand more concessions from the seller to smooth the deal. For example, they may require the seller to pay part or all of the closing costs. They may also request upgrades to the home or to the vendor to include furniture and accessories.
How long do housing corrections take?
It is often difficult to predict how long it will take for the housing market to correct. It may continue until the factors that caused it stabilize. If the housing market correction is caused by an increase in mortgage rates, for example, the correction may continue until the Federal Reserve stops increasing rates, inflation subsides, and consumer confidence increases.
Since the duration of housing market corrections is uncertain, waiting for the market to stabilize to make investment decisions may not always be beneficial. Depending on your goals, long-term goals may outweigh the downsides of buying or selling when home prices drop.
What does the market look like after a housing correction?
A housing market correction usually ends when home prices start to rise again. The main indicators of stable prices include an increase in both the supply of real estate for sale and an increase in market demand.
Although some people have to move in unfavorable market conditions due to job transfers and other reasons, many buyers will wait to shop for larger homes or search for better neighborhoods until they believe their investment will increase in value over time. No one wants to be underwater when they have a mortgage.
How does the housing correction affect real estate investors?
Although the housing correction may provide an opportunity to acquire new properties at a reduced price, some may need a new investment approach to achieve their goals. This may mean investing in different types of real estate or using different investment strategies to diversify your portfolio and reduce risk.
Investing in different types of real estate may allow you to enter new markets, increase revenues and stabilize cash flow. If you’re currently investing in warehousing facilities, for example, buying single-family homes for short-term market rent in popular tourist destinations may allow you to take advantage of local rent shortages.
If you’re primarily focused on single-family homes as long-term rentals, you can get additional homes for rent in the mid-term market. This could allow you to take advantage of the need for corporate housing for travel nurses and other professionals in developing markets.
Focusing on a new investment strategy can also be beneficial when real estate markets are shrinking. If you are currently using a short-term flip strategy, such as fixing and reversing, you will get a progressively lower percentage when you sell with market contracts. This could be a great opportunity to try out a medium or long term strategy to take advantage of the eventual market recovery.
A housing market correction could be a great time for real estate investors to acquire real estate. With the difficulty of predicting the length of a correction, the timing of purchasing investments to reduce risk can be challenging.
If you sell a home during a housing market correction, you might sell it for less than you would when prices go up. The sale may also take longer, and buyers may demand more of the seller’s privileges. Selling a home or other property in correction can still be beneficial if you need to reduce or eliminate debt or remove an underperforming asset from your investment portfolio.
Join the community
Our huge community of over 2 million members makes BiggerPockets the largest online community for real estate investors ever. Learn about investment strategies, analyze real estate, and connect with the community that will help you achieve your goals. join for free. what are you waiting for?
Note by BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.