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How Does the Housing Market Work?

The housing market contains all the properties going up for sale or rent at any given time. The market fluctuates with social, economic, and geographic factors at local, regional and national levels. As an investor, the housing market provides plenty of opportunities for growth and profits – but it’s not risk-free. 

What is the housing market?

The housing market, or real estate market, contains all the properties being bought and sold at any given point. Market participants include home buyers and sellers, landlords and renters, investors and the brokers who facilitate sales. 

You can consider the housing market at a national level to examine broader trends. You can also analyze local or regional housing market trends, such as California state or the city of San Francisco. 

How does the housing market work?

The housing market operates on principles of supply and demand. When supply is high and demand is low, prices fall, as sellers have to compete for buyers. But when supply falls or demand rises, prices go up as buyers have to compete for housing. 

Factors that impact the housing market

The housing market is unique in that it doesn’t behave like a normal “good.” 

For one, it’s far more durable – unlike food or cars, houses are designed to last decades or even centuries. 

Additionally, real estate can’t readily be shipped from high-supply to low-supply areas, limiting ways to mitigate supply issues. 

The housing market is also influenced by factors like:

  • Demographics. Age, gender, race, income levels, population growth and migration patterns can all impact the housing market. Consider baby boomers – as they migrate during retirement, we’re likely to see new housing shortage and surplus patterns.
  • Economics and financials. High or low unemployment and GDP growth, housing inflation and tax-related legislation can all influence housing prices. Fluctuating interest rates also impact prices as higher rates increase the cost of borrowing a mortgage and constrain homebuyers financially. 
  • Geography. When an area has limited space for development, construction activity can’t explode, keeping prices elevated compared to demand. 
  • Weather. When people have to contend with unfavorable weather patterns, property demand may remain lower. 
  • Seasonality. In general, the housing market slows down in winter and picks up in the summer. That makes it difficult to compare real estate data over time. As such, most housing reports use “seasonally adjusted” numbers. 

What does a “good” housing market look like?

In a “good” housing market, home sales and prices tend to move together. Home sellers may receive at or near asking price for their homes when they sell, while buyers can more easily afford their mortgages. 

Additionally, good markets have tight enough inventories to support moderate price growth. While buyers compete somewhat for housing, they’re not priced out of homeownership or flooding the market. 

By contrast, bad markets tend to see too many houses for sale with not enough buyers. Homes may sit on the market for months or years, prompting homeowners to slash prices or skimp on maintenance. 

But as the pandemic showed, a “bad” market can also overshoot price growth by too much, drastically impacting the average person’s ability to afford a home. When home prices grow so high that the average homebuyer is priced out, home sales are limited to a smaller buyer pool, leading to lower rates of homeownership. 

Will the housing market crash?

Given the whiplash between 2021’s soaring prices and 2022’s sudden reversal, you might be wondering: will the housing market crash?

The answer is that a housing market crash is unlikely, though not impossible. 

Throughout 2021, as pandemic-stricken households reevaluated their priorities, families began to move en masse. Combined with record-low mortgage rates, home values soared as demand surged. In some areas, homes sold for more than $100,000 over asking price in cash sales. 

Between the supply squeeze and pandemic-fueled pricing frenzy, home prices soared arguably higher than they should have. Meanwhile, new builds couldn’t keep pace, with supply chain snarls driving up the price of construction.  

But in 2022, reality smacked the housing market – gently, at first. Inflation jumped, followed by interest rate increases. In response, the housing market began to slow down, with prices decreasing moderately since May.

In other words, the housing market didn’t crash in 2022. Instead, it experienced a moderate correction as housing prices slipped back within more affordable parameters. 

What can cause a housing market crash?

Generally, a housing market crash occurs due to a recession, housing market bubble burst or both. 

A housing market bubble typically forms when buyer demand increases faster than supply. A shortage may follow, driving up prices until they exceed an affordable threshold. At some point, the bubble will likely burst. This could be due to an economic recession, or some sort of shock which shakes confidence in the market

During a recession, buyers may tighten their budgets as unemployment rises and uncertainty grows. Disposable incomes often decline, leading creditors to limit risk by tightening credit standards. Together, these factors can decrease homebuyer demand, prompting prices to drop as sellers try to offload their property. 

What happens when the housing market crashes?

In general, when the housing market crashes, supply tends to overshadow demand. At the same time, housing grows cheaper as home sales or foreclosures rise. If a market crash coincides with – or causes – an economic recession, interest rates may decline, too, allowing buyers to take advantage of lower mortgage rates. 

Housing market crashes can drastically affect homeowners, sellers and buyers alike. 

When property values decline suddenly, homeowners may find themselves underwater on their mortgages. (You’re underwater if you owe more on your home than it’s worth.) 

Underwater homeowners may have to choose between selling at a loss or remaining in the home until the market evens out. But if you also lose your job (say, due to an ongoing recession), failing to make payments may see your home foreclosed upon. 

Meanwhile, a housing market crash may force sellers to lower their asking prices or negotiate on certain concessions. Some investors may struggle to maintain their profits as rents or home prices decrease. 

Conversely, buyers may demand more concessions or bargain hunt for the perfect home or investment property. Other buyers may view any current economic uncertainty with skepticism and be hesitant to enter the market. Buyers willing to take the plunge may still have to contend with stricter lending regulations. 

Profiting from the housing market

Whether you buy low and sell high or invest in a steady income stream, the housing market can be both lucrative and satisfying. 

The key is knowing how to invest in real estate

Buy rental properties

Rental properties can provide investors with a steady income stream for years or decades. This method involves buying a property with cash or a mortgage and taking on tenants. Rental properties offer the dual promise of income and price appreciation, as well as a plethora of potential tax deductions. 

The downside is that you have to manage tenants (or hire someone to do it for you). You’ll also need substantial capital to buy the property or the credit and income to qualify for a mortgage. And of course, you’ll need to make or set aside income to cover any vacancies in your lease. 

Flip houses

House flipping involves purchasing a house at a discount to sell when (and if) the market improves. Alternatively, you can buy a fixer-upper and sell the house after making improvements and repairs. 

House flipping is a capital-intensive endeavor that requires expertise in marketing, real estate valuation and potentially renovation. Since your goal is to flip undervalued properties at a profit, you’ll need to be well acquainted with current market trends. You’ll also need to move quickly when an opportunity arises to buy or sell. 

But house flipping has its upsides – namely, a comparatively short window on generating returns. 

Purchase shares in a real estate investment trust (REIT) 

REITs are ideal if you want exposure to property property without the hassle of managing tenants or repairs. 

With an REIT, a company buys or builds real estate, then allows investors to purchase company stock on an exchange. The company operates the property while you sit back and collect the revenues. Depending on the REIT, the underlying company may own anything from medical centers to apartment complexes to mortgages. 

Each type of REIT comes with its own profit and risk potential to consider. 

On one hand, REITs are hands-off investments that provide appreciation, dividends, and high liquidity. You may even be able to purchase them through your regular broker, simplifying the investing process. 

However, they can also come with hefty tax bills, and share prices fluctuate with the market. It’s also essential to research the underlying company before buying. 

The pros and cons of investing in real estate

Naturally, investing in real estate comes with its upsides and downsides, no matter the method. Here’s what to consider. 

Pros

  • Can enjoy regular income, price appreciation or both
  • Real estate investing comes with many tax-deductible expenses
  • You can choose your liquidity preferences, from REITs to flipping houses
  • Real estate investments may hedge against inflation
  • You can leverage a mortgage to purchase more expensive properties

Cons:

  • The initial investment may require substantial financial resources
  • Renting runs the risk of getting a bad tenant or losing income to vacancies
  • You can incur high tax and maintenance bills
  • Prices fluctuate with market factors
  • Appreciation isn’t guaranteed
  • Physical real estate carries liquidity challenges
  • Transaction costs can eat your profits

The housing market is rife with risk and opportunity

The housing market offers investors a way to diversify their portfolios while hedging against inflation. That said, it’s a risky market, and you may need substantial capital to get started. 

For investors who prefer to skip the hassle and headache, Q.ai has an alternative: a suite of AI-backed Investment Kits. 

Each Kit is fully managed by our in-house artificial intelligence to balance risk and reward in your portfolio. Plus, many of our Kits capitalize on ongoing market trends, so you can build a solid foundation while still profiting off current activities. 

With Q.ai, you can invest like a hedge fund from your couch, with no hidden fees or catches – ever. 

Now that’s smart investing. 

Disclosures

Q.ai is the trade name of Quantalytics Holdings, LLC. Q.ai, LLC is a wholly-owned subsidiary of Quantalytics Holdings, LLC ("Quantalytics"). Quantalytics offers automated financial advice tools through Quantalytics Investment Advisors, LLC ("QAI"), an SEC-registered investment advisor. QIA’s investment advisory services are ONLY available only to residents of the United States. Disclosures concerning QIA’s investment advisory services are available on its Form ADV filed with the SEC. The content in this newsletter is for informational purposes only and does not constitute a comprehensive description of Q.ai's investment advisory services.

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