The impending quick reversal is mostly due to the recent surge in mortgage rates
Perspective by Mark Zandi
September 15, 2022 at 8:00 a.m. EDT
House prices have been on a tear the past decade. Since hitting bottom in the wake of the financial crisis and the housing bust in 2008-2009, prices have more than doubled nationally. But this long run of robust price gains is ending. Prices are set to fall throughout much of the country. Most places will experience only modest declines over the next couple of years, but the places where prices surged in the good times will suffer bigger declines in the tough times ahead.
This impending quick reversal in house prices is mostly due to the recent surge in mortgage rates. The rate on a 30-year fixed-rate mortgage — the loan most home buyers get — has surged from record lows well below 3 percent a year ago to around 6 percent today. Rock-bottom rates propelled housing demand, and because there is severely limited housing supply, prices rocketed higher. Now with rates up and house prices still high, housing affordability and housing demand are getting hammered.
Most potential first-time home buyers are locked out of the market. For a sense of their affordability predicament, consider a household earning the median income of about $70,000 — half of households earn more and the other half less — and hoping to purchase a median- priced existing home of a little above $400,000. And let’s assume they can come up with a 20 percent down payment, itself a massive challenge given that it comes to around $80,000. At the 6 percent mortgage rate, this household’s monthly payment will be close to $1,900. A year ago, with rates at record lows, that monthly payment was $1,300. And this doesn’t include homeowners’ insurance and property taxes, which are also rising quickly in most places.
Homeowners who were trading up to more desirable homes when rates were low are now effectively locked into their current home. Most homeowners have refinanced their mortgages over the years when rates dropped, and the typical homeowner now has a mortgage with about a low 3.5 percent rate. If she wants to sell her current home and get a new one, she will also need to give up her existing mortgage and get a new one at 6 percent. Few homeowners can afford it.
Also hitting housing demand hard is the sudden caution among housing investors. Investors who purchase homes to rent them out have become much bigger players in the housing market since they came on the scene in the wake of the financial crisis. Back then, they mostly bought homes in foreclosure at distressed prices. More recently, they were buying all kinds of homes. Indeed, nearly one-fifth of home sales in the second quarter of this year went to investors. In the Southeast and Mountain West where they are more prevalent, investors accounted for closer to one-third of home sales.
But housing investors are opportunistic, and they now sense an opportunity with the surge in mortgage rates, the collapse in affordability and what they rightly figure will soon be lower house prices. Why buy now when prices are high and very likely to decline? They’ve moved to the sidelines in recent weeks and stopped buying. They aren’t selling, either. Their buy-to-rent business model is highly successful and here to stay. So, for now they are waiting for prices to go lower before they start buying again.
The pandemic and rapid adoption of remote work, which also contributed to the surge in house prices, now will contribute to house price declines. City dwellers from the big urban areas of the Northeast Corridor fled their homes for more space in the suburbs, exurbs and cities mostly in the South, such as Atlanta, Austin, Charlotte, Orlando and Tampa. West Coast big-city dwellers have moved mostly to the Mountain West, places including Boise, Idaho, Denver, Las Vegas, Phoenix and Salt Lake City. Because they are used to high house prices, they’ve been willing to pay outsize prices for homes in the lower-priced parts of these less-urbanized areas. These movements sent house prices in such places skyward. However, with the pandemic fading and many employers requiring workers to come back for at least some in-person time, housing demand and house prices in these markets are set to return to earth.
Yes, house prices are poised to correct. But they are highly unlikely to crash. While single-digit nationwide peak-to-trough price declines seem inevitable, declines of over 20 percent — like we suffered in the housing crash over a decade ago — seem improbable. A key difference is the current shortage of homes. The percent of homes for sale that are vacant is as low as it has ever been, and the vacancy rate for homes for rent is close to its lowest. Home builders have struggled to keep up with the households that formed since the financial crisis, most recently because of the disruptions to supply chains for building materials and appliances. A decade ago, housing was vastly overbuilt, and the housing vacancy rate was at a record high. The current shortage of homes puts a figurative floor under house prices.
Another big difference now is the prudence of mortgage lenders. Home buyers who took on loans in recent years have good credit scores and are signing plain-vanilla 30-year fixed-rate mortgages, not the subprime two-year adjustable-rate mortgages that were ubiquitous before the financial crisis. When rates rose back then, homeowners with already shaky finances had to come up with more cash to make higher mortgage payments. Millions couldn’t, resulting in a flood of mortgage defaults, foreclosures and distressed sales. All those foreclosed homes sold at big price discounts, and house prices crashed. None of this will happen today. Regulatory changes in the wake of the crash made risky loans to risky borrowers no longer viable for lenders.
It is also comforting that the investors who have stepped to the sidelines and stopped purchasing homes will resume buying again long before prices crash. Institutional investors — large corporations that raise funds from global investors to buy and rent homes — have become big players in the housing market and have plenty of cash to deploy. They also have good reason to put their money to work before too long, since rents are rising quickly and will continue doing so as long as mortgage rates remain high and potential first-time home buyers have no option but to remain renters. These big investors are sure to become bigger owners of single-family homes, which poses a challenge to increasing homeownership in coming years. But the near-term benefit will be a support to house prices.
While nationwide house prices are expected to experience only a modest correction, some parts of the country won’t be so fortunate. Places where prices have risen the most in recent years, like the Southeast and Mountain West, are expected to suffer the biggest declines. Not only is affordability more of a problem in these areas given the higher prices and higher rates, but housing flippers also have often shown up. These speculators buy and quickly sell homes to make a fast buck. Active flippers juice-up house prices and inflate housing bubbles, but they burst bubbles and cause big price declines when they get wrung out. Flippers are now fleeing, and bubbles are bursting in some markets in Arizona, the Carolinas, Idaho, Georgia, Florida and Nevada.
The coming correction in house prices could thus be therapeutic in some respects. Forcing flippers out of the housing market before they infect more places is a plus. And the Federal Reserve is raising interest rates in an effort to cool off the economy and quell painfully high inflation. Housing is the most rate-sensitive part of the economy, so fewer home sales and a house-price correction is a small, necessary price to pay to rein in inflation. Of course, risks are uncomfortably high that the Fed will misjudge its rate hikes and precipitate a recession and a more serious pullback in house prices. If so, the difference between a house price correction and crash may well be a distinction without a meaning.
Mark Zandi is chief economist at Moody’s Analytics.