Bubble or Balloon? A Housing Market Update

In January 2022, the housing market was at the hottest it had been in 15 years, with a run of new demand spurred by the loosening of pandemic restrictions. As remote work opportunities became more common, some buyers were looking for more space to work from home and found opportunities to move farther from their employers’ base to purchase their dream house.

Near-record low mortgage rates added fuel to the rally; bidding wars became commonplace as demand for homes outpaced supply by a wide margin. In desperation, some buyers, now facing months of steep home-price increases, even waived contingencies for appraisals and inspections.

However, by the summer of 2022 the U.S. housing market had entered a sharp slowdown. Home-building slowed to a snail’s pace, while more buyers moved to the sidelines, causing a drop in mortgage applications.

By October 2022, the once-booming housing market appeared to be stalling out. According to Realtor.com, the national inventory of active listings increased by 33.5% over last year in October. The total inventory of unsold homes, including pending listings, increased by just 0.5% year-over-year due to a 30% decline in pending inventory. Also, sellers were less active than in 2022, as newly listed homes declined by 15.9% on a year-over-year basis.

Low Affordability Driving Down Demand

The average contract rate on a 30-year fixed-rate mortgage rose to 7.16% for the week ended Oct. 21, 2022, the highest reading since 2001. The Mortgage Banker Association’s Market Composite Index, a measure of mortgage loan application volume, was down roughly 69% from September 2021.

The decline in buyer demand has been spurred by rising interest rates and continuously growing home list prices that have increased the cost of financing the typical home by nearly $1,000 each month or 77.1% compared to a year ago, far outpacing recent rent growth (7.8%) and inflation (8.2%).

The median existing home price for all housing types in September 2022 was $384,800, an 8.4% jump from the September 2021 median price; prices ascended in all regions of the country. This increase marked 127 consecutive months of year-over-year increases, the longest-running streak on record. However, it was the third month in a row that the median sales price retracted after reaching a record high of $413,800 in June 2022, which seems to reflect the normal seasonal trend of prices declining after peaking in the early summer.

Prices are cooling and falling hard, particularly on the lower end of the market, where inventory is much leaner. In September 2022 sales of homes priced between $100,000 and $250,000 dropped 28.4% from a year ago, while sales of homes priced between $750,000 and $1 million declined 9.5%. “The median home sales price is shining a light on how downshifting buyer demand is moving the housing market back toward a more normal pace of activity,” said Danielle Hale, chief economist at Realtor.com.

First-time buyers represented just 26% of buyers in September 2022. Historically, first-time buyers usually make up about 40% of sales, but many are struggling to afford a home. High rents are also making it harder for them to save for a down payment.

Predictions of a stabilizing rental market are coming closer to reality after rental data from September 2022 showed national rent prices trending down month-over-month for the first time this year. On a month-over-month basis, the median U.S. asking rent decreased 2.5%, the slowest growth since December 2021, down from a 1.6% increase a year earlier. U.S. asking rents slowed nationally to $2002, an increase of 8.8% in September on year-over-year basis compared to a 12.3% increase in August 2022. That’s the smallest annual increase in a year, down from a peak gain of 17.5% in March 2022.

Count the “For Sale” Signs

The best housing indicator to watch is inventory. If a housing market is going to experience falling home prices, it will first see a huge uptick in inventory levels.

“We’re witnessing a housing recession in terms of declining home sales and home building,” said Lawrence Yun, chief economist for the National Association of Realtors. “However, it’s not a recession in home prices. Inventory remains tight and prices continue to rise nationally with nearly 40% of homes still commanding the full list price.”

Housing economists measure the stockpile of homes for sale in terms of months of supply. The real estate rule of thumb is that a balanced market—one that favors neither buyers nor sellers—is characterized by five to six months of supply. In January 2022, the number was just 1.6 months, a record low, according to the National Association of Realtors. The figure has ticked up each month since, reaching 1.7 months in February, 1.9 months in March, and 2.2 months in April. In September, the number rose all the way to 3.2 months.

The silver lining for buyers grappling with higher prices and rates has been that more homes are now on the market. Inventory of active listings was up 33.5% in October 2022 compared to the same time last year, according to Realtor.com data. However, as with everything else in the housing market, it’s a double-edged sword. It’s not that sellers and builders are putting more homes up for sale—they’re doing the opposite. But homes aren’t selling as quickly, so what’s been listed is sitting longer, boosting inventory. In fact, new listings were down 15.9% year-over-year in October 2022.

Watch the Fed

At the end of the day, the Federal Reserve’s inflation fight is the clear culprit for the U.S. housing market slowdown. As activity declines in rate-sensitive sectors like housing, the overall economy weakens, which puts price growth in check.

“The housing sector is the most sensitive to and experiences the most immediate impact from the Federal Reserve’s interest rate policy changes,” said NAR’s Yun. “The softness in home sales reflects this year’s escalating mortgage rates. … Inventory will remain tight in the coming months and even for the next couple of years. Some homeowners are unwilling to trade up or trade down after locking in historically low mortgage rates in recent years, increasing the need for more new-home construction to boost supply.”

Morgan Stanley, the investment management firm, predicted home prices will fall 7 percent, from the peak of pricing in June 2022 to December 2023. Moody’s Analytics expects prices to drop 10 percent, from June to summer 2024. NAR’s most recent forecast is for flat home prices in 2023. That means prices will increase in about half of the areas that NAR tracks, but decrease in the other half, NAR’s Yun said. This follows similar forecasts by Freddie Mac, Fannie Mae, and Zillow. That’s because demand for homes remains strong, primarily due to strong employment numbers and an inadequate supply of homes.

It’s Not 2008

Some may undoubtedly worry about a repeat of the housing boom and subsequent crash of the mid-2000s that was largely responsible for triggering the global financial crisis. But back then, there was a near-universal optimism about home prices, which made way for unreasonably lax lending practices and high-risk financial innovations that made the towering mortgage market much more fragile than many experts believed.

Things are very different 15 years later. Lenders have been much more disciplined with their lending practices. According to New York Fed data, most of the new mortgage loans in recent years have gone to prime borrowers with the highest credit scores. Adjustable-rate mortgages are nowhere near as popular as they were during the housing bubble. This means very few new buyers are vulnerable to interest rate volatility.

About 99% of outstanding mortgages have a locked-in rate that’s lower than the current market rate, according to Goldman Sachs analysts. In other words, most homeowners are not materially affected by rising mortgage rates.

Because the housing market has a higher demand than supply, it’s unlikely home prices will fall dramatically the way they did during the 2008 Great Recession caused by the financial crisis. Sellers won’t drop prices unless they must—especially when their neighbors’ homes sold for record prices just a few months earlier. While a steadily rising rate of 19.5% of sellers cut prices in September, most sellers have held firm. That disconnect is already resulting in fewer home sales—which experts believe will continue as the uncertainty in the economy grows.

Sellers know they’ve missed the peak of the market. Most sellers are also buyers. Higher mortgage rates are also creating a deterrent effect known as “rate lock-in” for homeowners who are thinking twice when it comes to selling their home and re-entering the market as buyers. Those who locked in lower mortgage rates will be reluctant to give those up to buy a new home as they could wind up paying a lot more for a lot less. That narrows the seller pool down to those who need to move.

Most real estate experts don’t expect another flood of low-priced foreclosures and short sales to hit the market, as occurred in the housing crash. Much of this expectation is due to lenders only giving mortgages to the most qualified borrowers and the eradication of the bad subprime loans that got borrowers in trouble during the Great Recession. Even if Fed chair Jerome Powell’s projections are correct and unemployment rises from 3.7% in August to 4.4%, another tsunami of foreclosures is unlikely.

Conclusion: Reach for the Salt

Why are 2023 home price forecasts all over the place? It boils down to uncertainty at the macro level. If inflation proves stubborn, the Fed could tighten more than financial markets are currently pricing in. If that occurs, mortgage rates would go even higher. Conversely, if inflation recedes sooner than expected or a recession manifests itself soon, the Fed could loosen financial conditions.

Any deviation in the Fed’s plan for fighting inflation, of course, will have consequences for the U.S. housing market. For that reason, it might be wise to take all 2023 housing forecasts with a grain of salt. There are just too many unknowns.

What most experts seem to agree upon is that this is not a normal housing market or even a normal correction in prices. Inflation, global economic uncertainty, rising mortgage rates, and a still tight supply of homes for sale are all weighing on potential buyers. It remains to be seen how far they will pull back and how much that pullback will cool prices.

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