When ChatGPT was released last year, many people including me were shocked by the responses. Since then, many people have written off the product as nothing more than a next-word prediction tool. Each day, I look into how I can use it and the list is growing.
Take, for example the current real estate market. It would take a good bit of analysis and knowledge of the market to try to predict what might happen next. I asked ChatGPT.
“Imagine a real estate market that had low interest rates and the Federal Reserve raised the rates significantly over a year-and-a-half to slow inflation. Now, the economy is slowing down but the real estate prices for residential real estate is still high because home owners don’t want to sell their home with a low interest rate and buy a home with a high interest rate. What do you think might be the next steps in the housing market based on past data?“
“If the scenario you described occurs – where interest rates rise significantly within a short time frame and homeowners are reluctant to sell due to interest rate disparities – several outcomes can be anticipated based on historical data and economic theories. Here are some potential developments:
- Lower Sales Volume: With higher interest rates, borrowing becomes more expensive. Prospective buyers might hesitate or be unable to afford the increased monthly mortgage payments. Thus, fewer homes would be sold even if the prices remain high.
- Price Adjustments: Initially, while homeowners might be reluctant to lower prices, if houses stay on the market for prolonged periods without selling, there may be downward pressure on prices. A glut of homes on the market with few buyers can eventually lead to price reductions.
- Increased Rental Market Activity: If buying becomes less affordable due to high interest rates, more people might opt to rent instead. This can drive up rental demand and potentially rental prices, making real estate investing attractive from a rental income perspective.
- Refinancing Drop: Homeowners who previously might have considered refinancing to tap into their home’s equity or to reduce their mortgage rates might not do so in a high-interest rate environment. This can lead to decreased activity in the refinancing sector.
- Potential Federal Reserve Actions: If the economy is indeed slowing down significantly, the Federal Reserve might reconsider its stance on high interest rates. Historically, in periods of economic downturn or stagnation, central banks have been known to reduce interest rates to stimulate borrowing and spending.
- Innovative Mortgage Products: Lenders might introduce new mortgage products or financing options to entice buyers. In the past, this has included adjustable-rate mortgages or longer-term fixed mortgages, among others. However, this can also come with risks, as seen with some subprime lending practices leading up to the 2007-2008 financial crisis.
- Shifts in Housing Types and Locations: Some buyers might start looking at more affordable housing options or consider relocating to areas with more affordable real estate. This can lead to shifts in demand dynamics in different segments of the housing market or in different regions.
- Cash Buyers May Dominate: Those with substantial financial resources, like real estate investors or wealthier individuals, might take advantage of the high-interest rate environment to make cash purchases, often at a discounted rate.
- Potential Economic Interventions: If the housing market’s slowdown becomes a significant drag on the overall economy, the government might introduce measures, like tax incentives, grants, or subsidies, to spur home buying.
- Increased Defaults: If the economic slowdown is profound and leads to job losses or reduced incomes, there might be an uptick in mortgage defaults, especially among those who recently secured their mortgages at higher interest rates and find themselves in a tight financial situation.
While these are potential outcomes based on past data and scenarios, the exact developments in any real estate market depend on numerous factors, including local economic conditions, government policies, and global economic factors.”
I further drilled into the results and asked it “What if the reluctance of sellers is causing low inventory of homes so buyers are competing for the available homes?”
If the market is characterized by both high interest rates and low inventory due to reluctance of sellers, it creates a unique situation. Here’s how the dynamics might play out:
- Increased Home Prices: Low inventory and high demand from competing buyers can drive up home prices, even in a high-interest rate environment. This phenomenon is often referred to as a “seller’s market” because sellers have more leverage to price their homes higher and negotiate more favorable terms.
- Bidding Wars: With more buyers than available homes, bidding wars can become common. Buyers might be willing to pay above the asking price or waive certain contingencies to get the home they want.
- Longer Time on Market for Overpriced Homes: While there might be competition for reasonably priced homes, those that are perceived as overpriced may still sit on the market for a longer period.
- Shifts in Buyer Behavior: Given the high costs and the competitive nature, some potential buyers might either:
- Opt to wait and see if the market cools down.
- Consider alternative housing solutions like renting, co-housing, or relocating to a more affordable area.
- Prioritize homes that need renovations or are “fixer-uppers” because they might be less competitive.
- Greater Importance of Pre-Approval: Buyers would want to have mortgage pre-approvals to move quickly when they find a home they like. Sellers are more likely to entertain offers from pre-approved buyers in such a competitive market.
- Potential For Overvaluation: With prices being driven up by competition rather than inherent value, there’s a risk of homes being overvalued. If there’s a subsequent market correction, this can leave recent buyers “underwater” on their mortgages (owing more than the home is worth).
- Rental Market Impact: As mentioned previously, some buyers might be pushed out of the buying market and into the rental market, increasing demand and potentially rental rates.
- Home Improvement Boom: If homeowners decide not to sell due to the high-interest rates and limited choices, they might opt to renovate or expand their current homes instead. This can lead to an uptick in the home improvement industry.
- Potential Policy Responses: If the low inventory continues to be a challenge and is driving up prices excessively, local governments might consider policy measures to increase supply, such as rezoning, incentives for new constructions, or policies that encourage owners of vacant properties to sell or rent.
- Investor Behavior: If prices continue to rise, real estate might continue to attract investors, especially those looking for appreciation rather than rental yield. However, high-interest rates might deter leveraged buying.
Given these dynamics, while there would be opportunities for sellers and challenges for buyers, the long-term sustainability of such a market is questionable. High prices driven by low supply rather than economic fundamentals can lead to bubble-like conditions. If and when more homes come onto the market, or if other economic conditions change (e.g., an economic downturn), there might be a sharp correction in prices.