The United States is officially in recession. What is a recession? A recession is a contraction of the business cycle or a general economic decline due to a significant drop in spending and other business activities. Most pundits and politicians will blame the Covid-19 crisis for the recession, but even before Covid-19, the proverbial handwriting was on the wall.
The United States had more than 120 months of economic growth, which was the longest expansion in modern history. Other indicators, such as the negative yield spread on Treasuries (long-term bonds with lower interest rates than short-term T notes), pointed to an imminent turnaround in the business cycle and an impending recession. The only real question was: when and how bad?
Then came Covid-19… If the cycle was to change anyway, Covid-19 acted as a huge and unexpected accelerator to make the recession much more immediate and severe.
Inevitably, during recessions, all classes of real estate, including residential homes and condominiums, will be negatively affected, as lower consumer spending and higher unemployment rates affect real estate prices and times to market.
Here are six costly mistakes sellers of homes and other real estate make during recessions and how to avoid them:
Mistake #1: This will pass and the real estate market will be hot again soon
The first thing to remember is that real estate cycles are much longer than general business cycles. Even if the general economy recovers, which it always does eventually, a typical real estate cycle takes 10-15 years. The cycle has four key stages: upper, declining, lower, and ascending.
Consider the last real estate cycle, which lasted approximately 14 years:
- 2006 – Prices reach the top
- 2006 to 2012 – Price decrease
- 2012 – Prices bottomed out (minimum)
- 2012 to 2019 – Price increase*
- 2020 – Prices reach the top
- 2020 to? – Price decrease
*NOTE: In 2016, the National Residential Real Estate Price Index reached its peak levels prior to the 2006 recession. The real estate market took 10 years to recover.
The way to avoid this mistake is to recognize that real estate cycles take years to run and plan accordingly. Also, no one knows for sure when prices will top or bottom until after the fact.
Mistake #2: Low interest rates will cause the economy and the housing market to recover
Between 2006 and 2011, interest rates (Fed Funds) were continuously cut by the Federal Reserve Board from a low 5% to almost 0%. However, that did not stop the real estate recession and the depreciation of property values.
To be sure, low interest rates made the economic downturn and housing recession less severe and saved some properties from foreclosure, but it still took a painful six years for the housing market to bottom out and then four more years for prices to return to their pre-recession levels.
Some markets had never fully recovered. For example, residential home prices in parts of California, Arizona, and Nevada are still below 2006 highs.
To avoid this mistake, one must realize that while low interest rates help stimulate the economy and the housing market, they do not cure them.
Mistake #3: I don’t need to sell right now, so I don’t care
If you don’t need to sell until the end of the cycle, which typically lasts more than ten years, then you won’t be as affected, especially if you have a strong capital position, limited mortgage debt, and solid liquid assets.
However, it is good to keep in mind that “life happens” and that professional or personal circumstances may change and we may have to sell the property before the recession takes its course.
Additionally, if a property has a mortgage on it and its value declines to the point of being “upside down,” meaning the mortgage loan balance exceeds the value of the property, then your options to sell, refinance, or even obtain an equity line of credit, will be significantly limited.
This does not mean that everyone should rush to sell their real estate if there is no need to, just keep in mind that circumstances can and often do change and ownership options will be affected so plan ahead. As a wise proverb says: “Dig your well before your thirst.”
Mistake #4: I’m selling, but I won’t sell below my “bottom line” price
This is a common and potentially very costly mistake. Generally speaking, every seller wants to sell at the highest price and every buyer wants to pay the lowest price. Thats nothing new. When selling real estate, most sellers want to hit a certain price and/or have a “bottom line.”
However, it is important to understand that the market does not care what the seller or their agent thinks the value of the property should be. Market value is a price that a willing and able buyer will pay when a property is offered on an open market for a reasonable period of time.
Overvaluing a property based on the Seller’s subjective value or what is sometimes called an “aspirational price,” especially in a declining market, is a sure first step to losing money. When a property remains on the market for an extended period of time, maintenance costs will continue to accumulate and the value of the property will depreciate in accordance with market conditions.
Additionally, properties with long time-to-market tend to become “stale” and attract fewer buyers. The solution is to honestly assess your sales goals, including your desired time frame, evaluate your property’s attributes and physical condition, analyze comparable sales and market conditions, and then decide on market-based pricing and marketing strategies.
Mistake #5: I will list my property for sale only with the Agent who promises the highest price
Real estate is a competitive business and real estate agents compete to list properties for sale that generate their sales commission income. It is not unusual for a Seller to interview multiple agents before signing an exclusive listing agreement and go with the agent who agrees to list the property at the highest price, often regardless of whether that price is based on the market.
Similar to Mistake #4, this mistake can be very detrimental to sellers as overpriced properties stay on the market for extended periods of time, costing sellers expenses like mortgage payments, property taxes, insurance, utilities, and maintenance.
Also, there is the “opportunity cost” as the equity is “frozen” and cannot be used anywhere else until the property is sold. However, the most expensive cost is the loss of property value as the real estate market deteriorates.
During the last recession, we have seen several cases where overpriced properties sat on the market for years and ended up selling for 25-40% below their initial fair market value.
The solution is to make sure your pricing strategy is based on the market, not empty promises or wishful thinking.
Mistake #6: I will list my property only with the Agent who charges the lowest commission
Real estate commission rates are negotiable and are not set by law. A commission typically represents the highest transaction expense in the sale of real estate and is typically split between the brokers and agents working on the transaction.
Some real estate agents offer discounted commissions to induce sellers to list their properties with them. But does paying a discounted commission ensure savings for the Seller? Not necessarily.
For example, if the final sale price is 5-10% below the property’s highest market value, which is not that unusual due to poor marketing, poor pricing strategy, and/or poor negotiation skills, it will easily wipe out any commission savings and, in fact, cost the seller tens of thousands of dollars in lost revenue.
The solution is to hire an agent who is a “trusted advisor”, not just a “seller”. A trusted advisor will take the time and effort to do the following: 1) Conduct a Needs Analysis – listen and understand your property’s needs and concerns; 2) Prepare a Property Analysis: Thoroughly evaluate your property and market conditions; 3) Execute Sales and Marketing Plan: prepare and implement a personalized sales and marketing plan for your property; and 4) Obtain optimal results: be your trusted advocate throughout the process and achieve the best possible result.
Finding such a real estate professional may not always be easy, but it is certainly worth the effort and will pay off in the end.
In conclusion, this article has outlined six costly mistakes real estate sellers make during recessions and how to avoid them. The first mistake is not understanding that real estate cycles are long and take years. The second mistake is the misconception that low interest rates alone will create a recovery. Another mistake is not realizing that circumstances can change and not planning ahead. Mistakes four, five, and six relevant to understanding market value, proper pricing, and selecting the right real estate professional.
By understanding and avoiding these mistakes, real estate sellers have a much better chance of minimizing the negative impact of a recession while selling their properties.