Would you sign a mortgage loan that compromises about half of your total income over twenty or thirty years on a home that won’t be built for months, perhaps years? This is the risk faced by nine out of ten new homebuyers in China.

In the US, higher interest rates and inflation, now flattening, make it more difficult—not easier—to access a real estate buyer’s market. And, what’s the reasoning behind soaring rental prices for apartments in cities such as New York or San Francisco when usage signs are still far from pre-pandemic times, and vacancies are suspected to be higher than disclosed?

Are entities artificially controlling inventories in bulk making things worse in the two most prominent real estate markets by volume and value? Who is to blame if not unrealistic expectations by all parties involved, including potential homebuyers? Are algorithms to blame for rental price hikes experiences in vacancy-ridden Manhattan? Is there any truth behind the conspiracy theory linking price-setting software and rent hikes?

Inflation eases, but China’s real estate is in distress

According to the IMF’s latest forecast, the economic outlook gets an upgrade as inflation eases (January 2023). Despite the coordinated interest rate increases by central banks, a global recession could be avoided thanks to consumer spending and the reopening of China, which grew only 3.2 percent in 2022 from the previous 8.1 percent in 2021.

It’s the sharpest slowdown and the second-lowest growth rate that China has experienced in 46 years (being 2020 the lowest due to the initial coronavirus outbreak and lockdowns). Consequently, the world’s industrial production, supply chains, global commerce, and internal consumption experienced dysfunctions whose consequences will resonate into the future, from the production of iPhones to car sales to the convoluted and debt-ridden Chinese real estate market.

More than a year after the bankruptcy of Evergrande, the second largest property developer in China by sales, the housing market faces systemic trouble in the country: dozens of other developers who depended on high-interest loans have also missed debt payments and the strict lockdowns endured by the country until recently.

Construction work, consumer spending, and housing sales have pushed the residential property vacancy rate to 12 percent in China’s major cities, according to Beike Research Institute, funded by the company Ke Holdings, higher than the 11.1 percent vacancy rate in the US.

Bad loans and a supply glut, but this time in China

In the US, home prices have experienced a generalized correction for the first time since 2012 (back then, they dropped 27 percent between 2006 and 2012). But, unlike during the Great Recession, the ongoing correction is not propelled by bad loans and unrealistic, unchecked borrowing, nor by a supply glut.

Yet in China, local administrative opacity and corruption begot an environment that fostered overborrowing among small construction companies, big real estate companies, and families eager to invest in housing. China’s housing market is indeed troubled by bad loans and a huge supply glut, as well as widespread mortgage defaults due to the strict lockdowns the country endured. But little is known about the dire situation among buyers and builders, other than general bad-loan ratios: bad debt climbed to 30% in the last stretch of 2022.

Other than its size and the systemic risk it holds over the Chinese economy (by some accounts, it represents 30 percent of China’s GDP), some other particularities of the Chinese real estate market are troubling, according to analysts: as opposed to strict laws that tie mortgages to finished properties declared habitable by all parts involved in a housing transaction (authorities through building codes and zoning, the bank, and buyers), common among advanced economies, the heavily deregulated Chinese housing market boosted rapid growth but also levels of speculation at a scale never seen before, fostering thousands of housing developments that would sell upon the loose promises of a presentation brochure.

The practice created a Ponzi scheme in which construction companies, freed from any serious oversight, reinvested buyers’ money across their other developments, sometimes defaulting on their debt. Developers like Evergrande sold hundreds of thousands of homes to buyers that haven’t received them, a significant percentage of whom haven’t been built yet. Fed up with the situation, borrowers have organized since the summer of 2022 to halt their mortgage payments.

Mortgage payments for a house that hasn’t been built yet

Agnes Chang and Isabelle Qian covered these developments for the New York Times, interviewing several buyers who poured their savings into homes that were never built:

“In another city, a man bought a space for a grocery business he thought would help give his young son a better future. A woman paid for an apartment where she imagined her toddler would grow up safely, and she might have a second child. In Shanghai, a technician from a small town thought she had made her parents proud by buying a new home in the big city.

“What these and hundreds of thousands of other Chinese homebuyers couldn’t have known was that the country’s decades-long real estate boom would come to a sudden halt. Developers ran out of money amid a government crackdown on excessive debt and a slowing economy. They stopped building.”

The article goes on to elaborate on a staggering reality that only came to an end after various local governments rolled new policies to protect homebuyers, months after the so-called three red lines to deter speculation and Ponzi-scheme strategies (for example, using money allocated by buyers to the construction of their home on other purposes) among big developers, virtually stopped big projects across the country.

Unbuilt houses, vacant buildings

Conscious of the critical situation of developers, unable to fulfill their obligations, China’s cabinet decided last November to order banks (most of them are state-owned) to lend more money so unfinished apartment buildings could be completed on time. It was a coordinated effort by regulators, China’s central bank, and the government, amid one of the last strict lockdowns before the demonstrations that led to loosened Covid-19 policies on December 7, 2022.

Unveiled in August 2020, the “three red lines” policy aimed at putting caps on debt-to-cash, debt-to-assets, and debt-to-equity ratios among developers, as well as the mandate of filing paperwork that makes it more difficult to use cash inflows from banks and homebuyers with impunity. But the regulation became too effective, and China has announced it may “ease” such property rules.

The potential for misconduct in the Chinese real estate market is staggering, considering that:

“In China, about 90 percent of new homes are sold before they are built. This presale model allows developers to raise cash quickly but shifts much of the risk to buyers like Ms. Xu. They are expected to pay in full before construction starts, often taking out mortgages to do so.

“Regulations require that the money from presales only be used for construction of that project. But until recently, supervision was lax, and developers would use the funds for whatever they wanted, including starting other projects.”

What the algorithm advises to NYC landlords

Homebuyers across the US share an overview that casts similar doubts on the housing market fairness; only the evidence isn’t as blatant as it is in China, and sometimes perceptions are misleading, turning into baseless conspiracies.

Despite the dim outlook of real estate sales for as long as fixed interest rates remain dramatically higher than in the last years, neither the excess inventory in urban cores nor the economic trouble of real estate companies big and small is driving prices down.

On the contrary, explains Lane Brown in Curbed: New Yorkers didn’t come back in droves after the pandemic, as several companies maintained a flexible policy regarding remote work; therefore, services that depend on the daily influx of such workers, from restaurants to retail, adapted to the new circumstances (as rodents did too). One would have thought —explains Brown— that the rental market would have cooled down.

It did the opposite despite flagrant signs of less activity not only in the street and in office buildings or public transportation ridership but also in residential buildings as well. With the assistance of management software such as RealPage, which helps landlords set a price for their property up for lease, rent is going up https://www.propublica.org/article/yieldstar-rent-increase-realpage-rent instead of down. According to Propublica:

“For tenants, the system upends the practice of negotiating with apartment building staff. RealPage discourages bargaining with renters and has even recommended that landlords, in some cases, accept a lower occupancy rate in order to raise rents and make more money.

“One of the algorithm’s developers told ProPublica that leasing agents had ‘too much empathy’ compared to computer-generated pricing.”

Did New Yorkers come flooding back post-Covid?

Mentioning the Propublica investigation, Lane Brown speculates about the possibility of some landlords controlling big portions of the supply of new rentals in high-end buildings keeping empty apartments out of the market (to “warehouse” some of the supply), hence creating artificial scarcity:

“It was the neighborhoods with these expensive high-rises that saw some of the city’s steepest peak-Covid population losses, and the people who fled were probably the types most likely to rent in them. According to IRS data, New York’s pandemic deserters had average incomes that were 28 percent higher than residents who stayed. One new rental tower in the Financial District reportedly saw occupancy drop 24 percent in 2020. And yet, somehow, by January 2022, the glut was gone as prices in luxury buildings reached all-time highs.”

He goes on to clarify that he has no proof that apartments in these towers are being “warehoused,” yet the lack of activity in such buildings is troubling:

“Why not just list all of their vacant apartments, even if that depressed prices, since collecting some rent is better than collecting none at all? Maybe because owners take out large loans to develop these buildings, and their lender agreements often require that they charge minimum amounts. This is also the thinking behind the deliberately confusing “net effective rent” scheme whereby an apartment’s advertised price includes prorated rent-free months to soften the blow of its actual (potentially lender-mandated) asking price.”

Stable or even momentarily negative population growth accompanied by higher supply doesn’t always mean a drop in prices, at least when it comes to the high-end rental market in the world’s priciest cities: when not financially forced to do so to avoid bankruptcy, companies seem determined to explore algorithm strategies to artificially keep “market” prices from falling steeply rather than dropping rent prices en masse for their —sometimes big and undiversified— inventory.

Resilient now: “slow and steady” markets

Is this the case for home sales? It’s not that simple, especially outside markets such as the big metro areas, where owners (corporate and private) either wait for a drop in interest rates to put their inventory on the market or offer it as rentals. Analysts predict some resilience in sales despite the slowdown in mid-sized markets where properties are within reach for the median homebuyer —even at higher interest rates.

Those “slow and steady” markets didn’t experience the frenzy of the so-called “Covid boomtowns.” Several of them are places that want to incentivize an urban and suburban renaissance after deindustrialization: Hartford-West Hartford, Connecticut, followed by El Paso, Texas; Louisville, Kentucky; Worcester, Massachusetts; Buffalo-Cheektowaga, New York; Augusta, Georgia; Grand Rapids-City of Wyoming, Michigan; Columbia, South Carolina; Chattanooga, Tennessee; and Toledo, Ohio. In these areas, 23 percent of the housing inventory is affordable to the median income level, compared to a mere 17 percent for the country as a whole. According to Danielle Hale from Realtor.com:

“Because these midsize markets didn’t really surge to new degrees during the pandemic, they are still relatively affordable. (…) These are the markets that have been relatively slow and steady, and that slow and steadiness is going to help keep the real estate markets relatively active in 2023 in these areas.”

If analysts at Realtor.com forecast a 5.2 percent year-over-year growth of a few second-tier markets, US home sales will decline in 2023 from their peak amid the desire to explore rural areas and small cities during the Coronavirus pandemic; the question is how much. Projections set the number at -14.1 percent. The dichotomy between “slow and steady” markets as opposed to the US market as a whole not only shows in projected sales but also in average home prices as expected.

iBuyers got disrupted by mom-and-pop buyers

When real estate startups Zillow and Opendoor announced their intention to turn the old mom-and-pop traditional operation of house flipping into the business of “iBuying” (read “instant buyer”: not that Steve Jobs would have liked better the copycat expression “iFlipping”), their expectations were grand, expecting a soon-to-be multibillion-dollar business whose algorithms would disrupt real estate across the US.

The idea behind iBuying looked good on paper: why deal with realtors’ secrecy, relations (and percentage on any transaction) if one can plan an efficient sale while looking for a new dream home? Zillow Offers, Opendoor (also RedfinNow, Offerpad, Flyhomes, Homeward, Orchard, or ExpressOffers). Zillow decided to accelerate the planned disruption by buying homes in bulk in the upmarket during the pandemic. The business turned out to be ruinous, buying during the hot housing season post-2020 and intending to sell once inflation was beginning to kick in.

In a year, the Seattle-based company lost close to a billion in their planned house-flipping operation, selling their inventory with big price reductions. According to Business Insider, almost two-thirds of the homes Zillow owned in its five biggest markets listed at a loss and closed sales under the reported, already lower price. And the last remnants of the company’s inventory went away in markets such as Sacramento with bigger discounts.

If iBuyers were supposed to increase their market share in real estate in their 2020 plans, potentially monopolizing sales and controlling prices, now the strategy looks very different. Zillow and other iBuyers thought their business was transformative; however, they decided to experiment in the least profitable moment for flipped homes in a decade, according to Attom Home Solutions.

Hedge funds outbidding people: a marginal or generalized phenomenon?

Bulk house flippers have not disrupted nor monopolized the real estate market, and their operation doesn’t seem to have benefited any iBuying stakeholders other than those companies and individuals acquiring homes at a big discount from their previously listed prices (if buying more affordably than before signals any accomplishment at all in second-tier markets heavily inflated during the pandemic buying frenzy.

Skeptics say that, despite evidence of big actors not affecting the market as conspiracies say they do, now it’s harder to buy despite the price slump due to higher fixed rates that allow people to reach less for the same money, while rents are also going up. Could it be that actors such as Opendoor, Airbnb hosts, and even hedge funds are effectively taking houses out of the conventional rental market, constraining supply? High vacancy explains a different story.

Prashant Gopal and Patrick Clark analyze in Bloomberg how “Wall Street is losing out to amateur buyers in the housing slump.” The knowledge accumulated by individuals following local markets is out of the radar of big investment operations. They explain how Raad Yousif, a 31-year-old Iraqi immigrant from the Phoenix area who is getting ahead as a house-flipper in his spare time. The little opportunities around him require a confident follow-up and a sense of possibility that no remote investor has been able to replicate at scale without taking huge risks.

Yet other articles point out that hedge funds are outbidding people by tens of thousands of dollars on appealing homes. “These buyers often come armed with the kind of financial firepower ordinary Americans can’t hope to match, housing experts say,” wrote Martha C. White for NBCNews back in July 2021, when the market was at its apex.

Every good tale needs a Disney-level villain

The article opens up with Nathan Saunders’ experience. This homebuyer from the Dallas area was losing his patience:

“My wife and I have been looking for a house for roughly the past year,” he said, adding that they have made multiple offers. “On each of those, we had contractors or investment groups outbidding us on the properties.”

Blaming the housing crisis on hedge funds would be easy but also wrong, stated Jerusalem Demsas on The Atlantic at the end of January 2023. The “latest housing-crisis scapegoat,” as he calls hedge funds with stakes in residential real estate. In the simple stories about the housing crisis:

“…the villain can be Airbnb or developers; it can be deep-pocketed foreigners or iBuyers. The story is compelling because it does not directly implicate regular people, sympathetic institutions, or elected officials.

“To state the obvious, stories can be compelling without being true. Especially suspect are stories that scapegoat a group or an entity that is impossible or at least very difficult to defend: banks or oil companies or criminals, say. The scapegoat takes the blame for a complex problem. The trick is to cast a villain such that the surrounding facts become irrelevant.”

Demsas goes on to explain that false narratives do double harm; they aren’t true to begin with, and also, “they distract attention from real problems, and plausible solutions.”

Despite the downturn, home-seeking goes on, and dreaming of a new home continues to be an important drive in people’s lives. In most advanced markets, buying a home continues to be the most important financial decision for individuals and families; in the US, buying a home is a national activity that explains phenomena like “Zillow surfing” (visiting homes one can’t buy through listing websites) or “property porn” (checking on house prices across cities and neighborhoods, comparing home valuations to keep up with the Joneses, etc.). Opportunities —real or perceived— seem always to abound, and so do buying and selling sprees, real estate bubbles, and downturns.

In China, property carries a similar cultural weight, if not a burden. When young people want to marry, owning a family is a necessary first step before even planning for future offspring. Instead of stocks and bonds, Chinese households have tied their fortunes to real estate (at more than twice the rate of US households).

Entering the market now

In the US, those who thought that buying a house would be easy during the current downturn have realized that, unless they belong to the minority that can buy a house with a big down payment or fully on cash, things won’t be that easy, especially for those who counted on selling their prior house advantageously as a way to better their position when asking for a new loan.

High mortgage rates bring sales and listings down, but the most desirable markets won’t become more “affordable,” especially for those potential buyers unable to use cash (that is, all but a privileged minority).

In the United States, house prices are experiencing severe corrections in secondary markets that had grown during the pandemic (the so-called “Covid boomtowns), but this is not the case in the most dynamic metro areas. Whether in a seller’s or a buyer’s market, the pressure inflicted upon the most looked-after markets limits the intensity of generalized corrections such as the one that international real estate markets are undergoing.

The subprime crisis that led to the Great Recession transformed the US mortgage market, and now the majority of mortgage loans have fixed interest rates. However, new contracts have much higher rates than the historic low of 2.85 percent in December 2020.

Fixed interest rates for mortgages end January 2023 below 6.2 percent after rising over 7 percent in the fall of 2022. Lower inflation and an economy cooling down could mean smaller interest rate hikes by the Federal Reserve, though the risk of a recession could maintain the real estate market in its downtrend for the first half of 2023.

Macro vs. micro: study your field before making a move

No matter the light downward correction, borrowers’ power has collapsed in the last months, and buyers that have to borrow to enter the market can’t afford the homes they are aiming at. Only those forced to sell will feel prompted to accept offers below previous expectations.

The housing market correction isn’t an American phenomenon but one that affects advanced and several emerging countries, and analysts warn about those mortgage markets most exposed to debt after borrowing accelerations, such as the ones experienced in South Korea and the Nordic countries.

By the scale of their markets, the US and China are experiencing some phenomena that are counterintuitive and/or difficult to explain with simple narratives. Or, as explained by Nassim Taleb regarding complex phenomena, it’s much easier to elaborate plausible but partial (or outright false) narratives at the macro level than it is to do the same at the micro level.

Two months after China abandoned the strict Covid rules, the worst wave of infections seems to be behind. Now officials focus on the necessary economic recovery after the successive lockdowns. It’s as if, suddenly, Xi Jinping were conscious of China’s sole ruling party’s weakness in the eyes of the country’s public opinion: only by keeping its promise of economic prosperity can China forge ahead with relative social stability.

Meanwhile, American buyers with a substantial down payment have recouped their negotiating upper hand; well-priced homes in good condition are selling for the price advertised for the first time in years in markets such as the San Francisco Bay Area. The National Association of Realtors (NAR) predicts that median existing home prices will flatten after rising 9.6 percent in 2022 and 18.2 percent in 2020.