Is a Denver Crash Coming?

Sales of homes worth more than $1 million or more fell 44.4 percent between August and September and sales of homes more than $500,000 dropped 33 percent during the same period. Overall, sales in September 2018 are down 21.4 percent year over year. Why the sudden cool down?

JUST A BLIP?

It's hard to write off the recent drop in sales as just a hiccup. The reduction is too big to just be a minor bump. There is something going on in the Front Range that is driving the drastic reduction in sales. Here are six theories:

1. INTEREST RATES RISING

As interest rates increase, mortgage payments also grow more expensive. For instance, if you could lock in a 3 percent rate a few years back on a $500,000 home, the payment on a 30-year mortgage would be $2,108. As rates rise to 5 percent (4.63 percent on a jumbo today), the payment would be $2,684 – a $7,000 difference annually. Mortgage rates typically follow the 10-year treasury, so rates are bound to increase even further. As rates rise and prices increase, fewer people can afford the monthly payments.

2. WAGES AREN'T KEEPING UP

With huge gains in appreciation and rates rising, real wages have barely budged. Denver and much of the Front Range has appreciated considerably over the last five years, at 10 percent or more annually, while wages have remained flat. Buyers cannot absorb the appreciation with their current wage growth (or lack thereof).

3. INVENTORY EXPANDING

As prices have increased, more people have decided to "cash out" thereby increasing inventory. According to the Denver Metro Association of Realtors inventory is up 16.10 percent this year. This increase in inventory is putting pressure on prices as buyers have more options available.

4. TAXES INCREASE SUBSTANTIALLY

Not only have borrowers payments increased due to rising rates and more expensive properties, but property taxes have increased substantially. Colorado revalues properties every odd year, so the impact of the recent appreciation is not flowing through tax bills. Many areas – especially in Denver county – have passed several initiatives (affordable housing, education, parks, etc.) that have further increased tax bills.

5. MARKET HAS GOTTEN EXPENSIVE: RENT VS. BUY

Front Range developers have been on a tear building luxury apartments. As the glut of high-end rentals has come online, rents have flattened, or in some cases, even fallen. As housing prices and mortgage rates increased, the rent vs. buy analysis has tilted toward renters. 

For the first time since 2010, it’s now easier to build wealth over an eight-year period by renting a home and investing in stocks and bonds, rather than by buying and accumulating equity, according to a national rent-versus-buy index of 23 cities produced by Florida Atlantic University and Florida International University faculty. That’s because home prices are high and rising mortgage rates are adding to the cost of homeownership.

That could be bad for sellers, especially in markets like Dallas, Texas and Denver, where renting is now so much more favorable than buying, according to Ken Johnson, a real estate economist at Florida Atlantic University, a co-creator of the Beracha, Hardin & Johnson Buy vs. Rent Index. (Bloomberg)

6. ALTERNATIVES ABOUND

Not only are more people now looking to rent, they are also looking at lower cost locations.  As Denver and the Front Range has gotten more expensive people are looking at alternative locations.

For example, Colorado Springs and Greeley have attracted people priced out of Denver.

ARE WE AT THE TAIL-END OF THE CYCLE?

Based on the recent drop in sales does this signify the end of the “boom times” and if it is, will we have a repeat of 2008? 

To address the first part of the question, I think we have reached a peak in the Denver market, especially the high end. Prices have gotten ahead of wages and rates have substantially increased; the eligible pool of buyers has decreased as a result. Furthermore, as more high-end luxury apartments have come online, prospective buyers can now rent for less than they could buy. All these factors will continue the downward pressure on prices above $500,000 in the near term. Although nobody can accurately predict a peak until after the fact, it sure looks like the market is close to a high for this economic cycle.

WILL WE FALL OFF A CLIFF?

Although there are a number of factors driving volumes lower, I don’t see a return to 2008 where prices tumbled. There is limited new supply in the metro area while Denver remains an attractive place for employers to hire from the well-educated young workforce. This should insulate Denver from a precipitous plunge like the last cycle.

I do see Denver leveling off for now. In the long-term prices will increase again due to attractiveness of the city. Denver real estate seems to follow a “step pattern” where you see fast appreciation, then a step where appreciation levels off until the next cycle. Denver is currently entering the bottom of a “step” in the pattern.

How long this step lasts remains a mystery.

WHAT TO DO?

Don’t panic.

There is no need to “dump” a property today to try to lock in appreciation but sellers’ expectations will need to reset to the new market. Properties will need to be priced realistically and sellers will have to be patient with their timing of a sale. The market in Denver along with the weather is cooling. Now is the time to grab a jacket and relax by the fire until the chill wears off.