Housing Market 2025 Forecast: Predicting the Real Estate Year Ahead

Well how is it that the real estate market is doing right now as we finish out 2024 and head into 2025? There are a variety of questions that need to be answered on both the commercial but also the residential side and a pleasure to be joined here in studio by a Wharton real estate professor Susan Wachter who is also co-director of the Penn Institute for Urban Research. Great to see you again. How are you? Good to be here. Good to see you Dan. I remember when we talked a year ago your phrase about what we were going to see coming up was survive until 2025. Have we survived? Just. We've just survived yes and many waters ahead but it's the big surprise of 2024 is this incredible GNP growth on all cylinders. Atlanta GNP now is saying 3.3 percent right now which is almost twice as high as anticipated and that of course is affecting across the board demand but it's also affecting inflation expectations going forward and the expectations about rate decreases. As I said there's a lot of questions to be asked and still lots of things to be answered so when you look at the two segments commercial versus residential where's probably more of the questions have to be addressed you think moving forward? Well I think we know more about residential and we know more the long-run outcomes of residential the demographics is a big driver and the supply conditions are what they are and they're not going to change rapidly except for the locked-in effect. So there is that really narrow point which we can talk about. On the commercial side so much is short-term and things can change very quickly. All right so let's start with residential and the lock-in which obviously you saw so many people going to refinance their mortgages when the rates were down three, three and a quarter, three and a half percent. You still have a lot of those people in there and I think the expectation is they're going to stay in there. How do you kind of make the residential market more palatable so that people can feel like you know they're getting the best type of deal moving forward? Well right now the supply side is locked up because of the lock-in effect. So homeowners with their three, four even five percent mortgages are staying put. They're not going to move when the mortgage market is 6.8 percent today. So we've got to unlock that tight embrace in the sense of your home is where you're going to stay and then supply could increase by about a third. That all depends on the future of the 10-year treasury and mortgage rates. And that has hasn't come down as much as one would have hoped. They were coming down. Totally depends on inflation expectations which were coming down but then we had this big surprise in terms of economy going on all cylinders and inflation has come back. Inflation latest number just this morning is not so bad on the PCE. The core is two percent so that's really a good number. But the non-core is four percent reflecting demand for food items which always heats up when the economy heats up. And there we are and that is going to affect of course 10-year treasury and it affects the mortgage rate even more which means that that three percent mortgage which majority people have less than four percent looks better and better all the time. And I guess you also have to throw in the fact that I think there's still some hesitancy out there amongst the homebuilder segment. You know those companies that are putting those properties into the mix about a finding the property but b what they're building. Well I wouldn't say it that way. They're all in. The homebuilders are all in producing more than they ever have. The percentage of supplies coming from new construction is at a height and the housing prices which normally new construction is considerably higher than existing are now converging which reflects the fact that homebuilders are building to demand. They're building to they know that they're facing resistance because prices are just simply too damn high. Rent and price too damn high and they're facing resistance. So in fact margins are down and the large builders are feeling all that but they're trying to get affordable product out and they're doing a pretty good job of it. However all that said their cost structure, their cost structure just as you're saying in terms of lot availability, in terms of labor supply, in terms of raw materials that's a bit down but labor supply is more than compensating and availability of lots. So they're having a hard time getting affordable product. In fact affordability is at all time 40-year lows for new construction. But what are new construction, what are construction firms doing? They're making deals. They're doing buy downs. If interest rates fall a bit more and they have fallen since last since their height about almost a full 10 years, a full percent and mortgage rates are down from their height for about 100 basis points. So all that's good but if they fall a bit more they'll be able to make more deals. We'll be able to get more homes out there. But right now construction is really what we've got. Existing sales are down and out. And they've relied on the multifamily market significantly over the last few years. Correct. Because when homeownership's not affordable what happens you go to the rental market and in the rental market supplies up so much that we are seeing relief. So we're not seeing price relief but we are seeing rent relief. In many markets rent on average if you look at newly built rents are flat. Some markets rents are down the southeast. Austin where we actually have oversupply. So we are seeing relief in the new rental supply and that is feeding in to the CPI actually. For the first time in a few years we've actually seen the shelter component of CPI rents fall. Now it's less than the inflation rate which is a good news because that was what was driving inflation. So that's a good news factor going forward and as you say rental supply is helping the overall supply considerably at this point. Is there a way then to kind of loosen up the existing home market? That's going to happen when we have the big picture issues dealt with which is interest rates, mortgage rates and inflation expectations come under control. But when you hear from some of the analysts out there it doesn't feel like that that's you know something that we're pushing more towards 2026 almost to get to that point. I agree. What about the commercial side and the concerns of the volume of commercial property that you have out there right now? Well the good news on the commercial is that the bad news may be bottoming and we're seeing capital markets open a bit. The deal flow which has been zero is coming back. So REITs have done quite well this year actually because off of a really bad bottom. Real estate is still in a recession, commercial real estate, but it's coming back. We can see the growth of the overall economy and the overall economy is growing strong. And what we were really worried about last year, what I was worried about was a potential systemic crisis because the banks holding so much real estate, especially the regional real estate holders, the real estate, the regional banks which are considerably in real estate, were in a difficult spot. But at this point the banks are actually quite solid and that combination of short-term rates down and long-term rates up is very bullish for banks. So that's good for real estate because that means that debt market is open again. So we can see deals being made, we can see some come back in, well, you know, office market conversions, very small to housing, but, you know, that's beginning to happen. So we're seeing the fear of a systemic crisis unless, and of course, this is always possible, we have an interest rate surge again because of some geopolitical problem, geopolitical stress problem. I see that curing over this year and getting better, not that we're going to, we still have vacancies are far greater than normal, 20% in some markets. But, you know, there are markets which are actually beginning to lease up again, New York City, and the overall economy is just doing so well that the demand for office space, it's not, we're not, remote work is not over, we're not going to fill those old buildings, but the class A buildings are happening and are being leased. Right, and that's kind of the interesting thing is because I had wondered whether or not we were going to start to see, and obviously, as you said, remote work is going to stay as a component to what level, we're still trying to figure out. We're still figuring it out, still figuring it out. But companies are calling their employees back in, whether they were maybe, they were remote a day a week or two days a week, they want them back in the office now three or four days a week, and that changes the dynamic of how these companies are thinking about that footage, that square footage footprint that they have. That's right. They are, and they're optimizing, and that's a good sign for the overall economy. They're optimizing it, who needs to be there, and where can they actually get an advantage of getting workers that are remote that may be a little bit less expensive, that don't need to be there. So we're working that out. But the remote work drain is, if anything, turning in the other direction, not much, but somewhat. So that's helping out too on the commercial side, the demand side. And on the supply side, the multifamily, when you have 0% rent growth, the new supply is down and out, and that is going to help with filling up and absorption. It's happening right now in the multifamily space. That does mean that we're not likely to see this rent relief that feeds into the CPI forever, but I'll take it over the next few years. I think then, if you look longer term, isn't it going to be more interesting to watch that dynamic of multifamily versus single-family homes and how we see the progression between the two moving forward? Because if we do see that push back towards more single-family, then obviously you're going to have potentially more issues with the multifamily properties, which obviously have grown and surged in the last decade as well. That's going to continue. I don't see owner-occupied, even if, and I hope they do, and I believe they will, rates will come down. It's not going to be enough to make them affordable. So the rental market is still where the demand will be. The supply is more than sufficient right now, but the demand is so high that that supply is going to be absorbed in another year, year and a half, two years, and we'll start seeing rents go up again. Right. Can you start to theorize then with some of the dynamics we have in play? And the other component of this is the new administration that's going to go in and how that's going to impact a lot of different elements of the economy. But a lot of people said there's no way we're going to go back to seeing mortgage rates at 3% ever again. Is there a territory that you believe we will go to and we will feel comfortable in as we move forward? Is it five, five and a half, six in that range that maybe we will see come up in the next couple of years? If all goes well, we could be at high fives at the end of 2025. That's a hope, that's not a prediction, but it's possible. So how do you get to that point? Well, 10 years have to, you know, the last few days have headed up, they've got to head down. So inflation, we've got to see some more good numbers like we saw on the PCE, which was the non-COVID-2, we have to see that. You know, we're at a very tentative moment here. It's amazing how we have such extraordinary growth and we haven't really seen a resurgence of severe inflation. So in fact, even with this growth, there is signs of easing in the economy, allowing for a slow, it's going to be not every month we can see it happen, but a slow decline in inflation. And inflation expectations are probably a bit on the high side anyway, so that those can come down. It's a combination of there is some slack, you can see that in the unemployment rates, slightly gone up, there's a little bit of slack. And, you know, the fact that wage growth is not what it was and buying power is actually pulling back, you see that even the resistance of housing presence. So all of this at the same time that we've had this surge in growth is a very interesting combination. The bottom line is we could continue, this is the good picture that I'm drawing now, is that we could continue to see 3% plus growth and inflation heading from the 3% high point, which I think is where it is, to closer to 2.5%. And when that happens, when we get under 2.5%, between 2 and 2.5%, we can see mortgage rates coming to that 5.5% or 5.5% towards the 6%. And that could happen. That's the best case scenario, but it's okay, it's holiday season. So if we're not surviving till 2025, is this just kind of a year to see how things play out? This year forward, I've never felt more in a sense of there are so many known unknowns. Susan, great to see you again. Thanks very much. Thank you. Susan Wachter, real estate professor here at the Wharton School.