Three Myths About the Luxury Residential Market
Cracks in the Foundation
The Batterymarch Insider
(Note: This article first appeared in Banker & Tradesman - June 25, 2023.)
If I told you a year ago that the Federal Reserve was going to raise interest rates by over 500 basis points, that mortgage rates would top 7%, that the supply of inventory would jump 25%, and that sales volume would plunge by 20%, you’d probably bet big money that real estate prices would be lower – meaningfully lower.
This exact scenario unfolded in Boston’s Back Bay. If you had bet that prices would be lower, you’d be out of luck. Year-to-date, the average asking price for a Back Bay condominium is up 22% vs the same time period a year ago, and the average selling price per square foot is up 1.6% – a modest gain, but still in positive territory.
Firm pricing can’t be explained away by supply and demand dynamics. Rising inventory and declining sales suggest weaker prices. So, what’s going on?
We suspect that the answer lies in marketing myths that are intended to stoke a sense of urgency with buyers and perpetuate the pandemic era FOMO.
Myth One: Interest Rates Are on the Verge of Collapsing
The real estate sales banter a year ago was that the Federal Reserve would be slashing rates after just one or two hikes. The pitch was to buy the property now and re-finance the mortgage in a few months at a sharply lower interest rate, i.e., buyers assume the interest rate risk.
A year later, mortgage rates are near a cycle high. We can’t say how many people fell into this sales trap, but “fighting the Fed” generally never ends well.
We don’t have problem taking interest rate risk if you’re buying properties at a discount – you get paid to take risk. But perversely, buyers are paying premiums to take interest rate risk.
Where do rates go from here? We’ve been around long enough to know how humbling it is to forecast interest rates, but our baseline thinking continues to be that rates will stay elevated.
In a Bloomberg interview published June 5, Jim Grant, the publisher of “Grant’s Interest Rate Observer” said that he thinks that the 0% interest rate, all you can eat credit buffet is over. He went on to speculate “that we are embarked on a long cycle of rising rates.”
Myth Two – the “3% Mortgage”
We’ve heard it ad nauseam - inventory will remain constrained because homeowners don’t want to give up their 3% coupon mortgages. While there is some wisdom to this, we have a different take.
The average American moves roughly every seven years. Artificially low interest rates pulled a huge amount of demand forward, driving up prices. As much as these homeowners may have a love affair with their mortgage rates, statistically you wouldn’t expect them to move for several more years. While this is disrupting supply trends, it’s also keeping a lid on demand. Should market prices broadly decline, that missing demand could spell sharply lower prices.
With higher interest rates and inflated property values, many homeowners can’t afford to buy the property they currently own. Yes, thanks to the magic of free money, they can afford to stay in their properties, but we see this as an unhealthy phenomenon.
Myth Three – There’s a Shortage of Housing
There is no shortage of luxury housing. To the contrary, there’s a glut of condominiums currently begging for buyers in downtown Boston, and developers are struggling to move new inventory. Most unsold new condominium units don’t show up in MLS inventory data.
We suspect that developers are haunted by the thought of The W Boston Hotel and Residences. The W was one of the first lifestyle developments in Boston. It opened in 2009 with a ton of fanfare, but when the condominium sales failed to materialize, the developer was forced to file for bankruptcy a year later. It wouldn’t surprise us if one or more developments goes belly up this cycle.
Cracks in the Luxury Foundation
We are seeing cracks in the foundation at the high end of the market. Just look at the sale of unit 5502 at 1 Dalton Street. The seller bought the place in January of 2020 for $16.65 million. Less than two years later, it was put up for sale for $19.75 million. The property just sold for $13.8 million.
Forget the fact that the sale came in 33% below the ridiculous original asking price. The real story is that net after fees, the seller took a $3.456 million (21%) loss to unload the unit. This is not an isolated situation – this is the reality of the Boston luxury condominium market.
On a side note, we were somewhat amused that the seller’s agent grandstanded the sale on social media stating, “There is no greater measure of success than client satisfaction.” Makes you wonder what an un-satisfactory transaction would look like.
Market sentiment can change abruptly. There are clear signs of stress in the luxury market. We suspect that as market participants begin to accept that the free money days are behind us, the weakness will work its way down market.
About Andrew Haigney – A 25-year Wall Street veteran, Andrew held senior positions at leading global investment banking institutions where he routinely valued and negotiated complex securities transactions on behalf of institutional clients. Andrew has been an outspoken advocate of a universal fiduciary standard. In founding Batterymarch Group, Andrew brings that same discipline and passion to real estate brokerage.