Investors and homeowners can maximize equity to meet life goals.
The U.S. real estate market has experienced an unprecedented surge in home price appreciation during the past three years. Since 2020, the average national price for a home in the U.S. has increased by 29%. In the previous decade, the annual price of a home increased by an average of 3% to 5%, but the annual increase in home prices bounced to 12% from 2020 to 2021 and 15% from 2021 to 2022. In fact, the amount of equity in mortgaged real estate increased by more than $3.2 trillion in the fourth quarter of 2021, an annual increase of 29.3%.
This development has left many homeowners and investors wondering about potential opportunities—and whether this “bubble” will burst. This is not an unfounded concern, as both the first and second quarter of 2023 are showing a trend toward equity loss for many homeowners.
During the past 12 to 18 months, supply-side dynamics—as opposed to demand, as in the past—have driven the surge in home prices. As mortgage rates increased, homeowners were less inclined to sell their homes, especially since many secured their mortgages at historically low rates. In fact, 62% of homeowners currently have a mortgage rate under 4%. As a result, fewer homes are coming on the market for sale, and there is limited supply. This is driving prices up in many major cities, despite high interest rates. New home construction has not been able to make up for the shortfall in supply.
This is quite a departure from housing market behavior during the last 10 years, when the demand side —not the supply side—drove the market. Consistent but reasonable demand and higher mortgage rates kept the housing market steady for most of a decade. But historically low mortgage rates beginning around 2020 and more “easy money” monetary policies provided a strong tail wind for homebuyers, significantly driving demand and driving up prices.
We also saw institutional buying increase during the past decade, meaning multinational companies bought homes as investments and rented them to would-be homebuyers, further fueling demand and exaggerating the effects of the supply-side dynamic even more.
Will the “Bubble” Burst?
There appears to be consensus among experts that the answer is “no.” This run-up in home equity is fundamentally different from what we saw in 2008, which led to the housing crisis and the Great Recession. Recent homebuyers have been more conservative than speculative homebuyers during that time. Lending standards have tightened considerably, and with the rising cost of houses, lending demand has decreased, leading to less lending overall.
Plus, homebuyers have stronger personal financial situations and balance sheets. The COVID-19 pandemic prompted a spike in personal savings rates that lasted until summer 2022, bolstering the financial resilience of homeowners. With 62% of current homeowners having locked in ultralow mortgage rates (below 4%), they are shielded from the effects of rising interest rates.
Opportunities for Homeowners and Real Estate Investors
The surge in home values presents numerous opportunities for homeowners and residential real estate investors. One of the most obvious advantages is that a significant number of homeowners now have positive equity in their home. Here’s how to leverage this equity for various purposes.
Access Cash. Consider leveraging home equity through options such as cash-out refinancing, home equity lines of credit, or reverse mortgages. Reverse mortgages are for older homeowners who occupy their home as a primary residence. Loan proceeds can be used for various financial goals, such as paying down high-interest debts, diversifying investments, investing in a secondary property, or financing a vacation. Investors can use these funds to bridge short-term cash gaps for investment opportunities they didn’t originally prepare for but just can’t miss out on.
Invest in Home Improvements. Use home equity to fund renovations and repairs that will not only enhance the living space but also can increase the home’s value, effectively recouping the investment. It’s a win-win. For new (or seasoned) investors, this can be an option to pool additional funds to fix up another property for sale. Although using equity for other investments will likely incur additional risk, a seasoned investor will know just the right dividend margins they need to come out on top.
Downsize for Retirement. An individual nearing retirement can consider selling their current home to lock in gains and downsize to a more suitable property for retirement. Be patient and watch for opportunities to purchase when mortgage rates are favorable. Those with flexibility can rent for a period and wait for mortgage rates to stabilize before purchasing a smaller “forever home.” Someone selling their home at a high profit can consider purchasing a second property to rent to others for additional retirement funds. Of course, this strategy may not be right for everyone, but it may help retirees who have additional income from a rental agreement feel more secure in their retirement journeys.
The recent surge in home values during the past few years presents an opportunity to leverage home equity for various financial goals. By understanding the dynamics at play and employing smart strategies, individuals can make the most of this historic jump in home value appreciation and work toward other life goals.