You have heard or read a lot about real estate prices lately. But what you’ve heard and read has been inconsistent, hasn’t it? So, what’s a homeowner (or prospective homeowner) supposed to think?
There are many factors that determine whether real estate prices will rise or decline. The trouble is, they don’t all point in the same direction. In fact, they rarely have. Opinion articles claiming that real estate prices are falling (or rising) usually only consider those trends and statistics that support their hypothesis. But if you look at the bigger picture, you’ll see that all the pointers never line up in the same direction.
An article focused on one direction or the other can be reasonably short and is prime for click-bait headlines. An article that looks at more indicators with nuanced results tends to be long and, well, boring. So, grab some coffee or tea; we’re going for it with this article.
Let’s start with a quick refresher. All of the indicators I’ve used are only important because they influence one of two things: supply, or demand.
Deeper Dive: How Supply and Demand Impact Real Estate Prices
In short, demand is driven by the desire for something, and the ability to pay for it. Desire can be thought of as the want or need to have something (think shelter) and, in the case of real estate, the belief that real estate is a good long-term investment.
Supply is influenced by the cost to produce something, and the motivation sellers have to sell. (Whether for profit, or some other reason, as we saw in 2008 when the market was flooded with foreclosed properties.)
Every factor discussed below is important because it impacts either supply or demand.
Are Real Estate Prices Declining?
It’s safe to say today that many folks, if not most, believe there is a correction, or maybe even a crash in real estate prices happening right now. What is happening in the real estate market that supports this belief?
Demand is Decreasing – Let’s Take a Look
By any measure, affordability has reached a low point. According to the National Association of Realtors, housing affordability hit a 15-year low in June 2022, due to a combination of rising home prices and rising interest rates. (More on that in a minute.) Higher prices mean that more money is required for a down payment, and a home buyer will have to carry a larger mortgage. Those who waited to buy a home were hoping they could “outsave” rising home prices, but the rapid pace of the increase in real estate prices and declines in the value of their other investments meant they were losing the chase.
Interest Rates Push Affordability Even Further Out of Reach
Interest rates just reached their highest level in over 20 years, cresting 7% for a 30-year fixed conforming mortgage, even with paying 0.8 points to buy the interest rate down. As I wrote recently, we don’t expect interest rates to reverse course and decline anytime soon. How much does this affect affordability? There are two ways to look at it: the increase in mortgage payments, and the decrease in buying power.
Let’s take Bob and Sue, looking to purchase a home of about $1 million. They want to put 20% down, so they would have a mortgage of $800,000. Earlier this year they could have borrowed money at 3%, giving them a monthly payment of principal and interest of $3,372.83. Today, as we noted, rates are over 7%. The same loan today at 7% interest would have a payment of $5,322.42, almost $2,000 higher!
Looking from the other direction, let’s assume their debt-to-income ratio maxed out at the 3% for an $800,000 mortgage. In this case, they are limited by the maximum monthly payment. (I’ll spare you the math.) With interest rates at 7%, they would now be able to borrow no more than $507,000, and have a maximum buying power of $633,750, down from $1 miilion.
No matter how you look at it, higher interest rates will knock some buyers out of the market entirely, and discourage others.
Decline in Investments Reduces the Available Down Payment
We’re not yet done on the affordability question. The ability to purchase a home requires a down payment – no small matter. But many prospective home buyers have had money tied up in investment portfolios, hoping to outpace the rising real estate prices. The Dow Jones Industrial Average is down just over 13% since the beginning of the year, reducing the amount of cash many home buyers have available for their down payment.
Belief in Market Direction
Remember that one component of the demand side of the supply / demand equation is desire – in this case, the desire to buy a home. While that is driven in a significant way by life events (more on that in a minute) the belief that real estate prices are increasing – or not increasing – plays an important role, too. Up until the spring of 2022 we saw home buyers practically in panic mode. Anecdotally, they strongly believed they had to get in quickly before real estate prices rose out of reach, so they did whatever it took to get in.
Today, most real estate professionals agree that home buyers are no longer driven by panic. Some believe prices are still rising, some believe they are falling or stable, but very few believe that they are rising so out of control that they must act now. They can relax, and take their time.
There are Simply Fewer Buyers
It’s not surprising – between those that no longer qualify to buy the home they hoped for, those who still qualify but are discouraged by the higher monthly payment, and those who simply believe they can now afford to wait, there are fewer buyers now than there were at the beginning of the year.
The Fed is Determined to Fight Inflation
Add to all of this the fact that the Board of Governors of the Federal Reserve (The Fed) is determined to fight inflation by slowing down the economy. Their primary tool to do this is to raise short-term interest rates in order to slow consumer spending. This invariably leads to job losses and wage stagnation, further hampering affordability.
If it’s so Hopeless, Why Are Experts Projecting Rising Real Estate Prices?
Many of the best real estate economists in the country are still projecting rising real estate prices, albeit at a slower pace than last year. Given everything we’ve discussed so far, how can that be? Well, it turns out that not all of the news is grim.
Incomes are Rising Rapidly
Keeping in mind that demand is partially driven by the typical buyer’s ability to pay for something, it’s positive news for real estate prices that wages have been increasing in the last two years at a faster pace than anytime since the 1980s. Reuters reports that average wages rose 1.3% in the third quarter according to the Labor Department’s monthly employment report, and are up 5.1% year-over-year. That extra income will help offset some of the additional monthly costs related to higher home prices and interest rates.
Household Savings are Strong
According to a new report by the U.S. Federal Reserve, U.S. households built up strong savings during the pandemic, and are still holding onto that money. This speaks further to the ability of the average home buyer to pay for higher prices and handle higher interest rates.
Supply is Not Likely to Jump
Economic theory tells us that prices won’t crash unless the supply side increases at the same time demand decreases. Consistently, there is no reason to believe that housing inventory is about to jump. Quite the opposite.
Analysts and pundits opining about the real estate market’s health not only are not calling for a crash, they mostly argue that the cooling off of appreciation is actually making the market healthier. They note – as we’ve discussed – that demand has declined, but also note that inventory has remained low enough that the market seems to be in balance. In other words, healthy.
In fact, according to YCharts, existing housing inventory is down slightly from September to 1.25 million units. While higher than the existing inventory last winter (when we were at historical lows) the typical inventory in late summer / early fall over the last five years has run close to 1.8 million units. And keep in mind, that number represented a tight market.
We are moving into the time of year when inventory typically declines anyway, and despite today’s low inventory it looks like that trend will hold. Look for declining inventory over the next three months.
2008-Style Panic Selling is Not Likely
In 2008 millions of homeowners found themselves holding mortgages with payments doubling or tripling, and owing more than their homes were worth. The resulting explosion in inventory was predictable. Over the last 12 years, however, lending has been limited by rules promulgated by the Consumer Financial Protection Bureau that forced lenders to make responsible loans without toxic terms. Borrowers have had to prove (document) that they had the ability to repay their mortgage, and for the most part had to have some skin in the game in the form of down payment.
Will Demand Increase in 2023?
Real estate prices will not continue to rise unless demand increases. Is there any reason to believe that could happen?
In the news out of left field department, Xi Jinping won an unprecedented third term as the leader of China’s Communist party, and has pledged to tax the rich. Up until now, China’s tax policies have favored the wealthy. China has no real history of letting the wealthy keep their wealth, however, until very recently. The fear that eventually the government would come for wealthy folks drove massive movement of cash out of China into U.S. Investments over the last few years, particularly real estate on the West coast. From British Columbia, Canada to San Diego, cash buyers from China have been driving up real estate prices. With Xi’s new pledge to tax wealth, expect to see a new round of Chinese cash chasing real estate, even at today’s prices. Keep in mind, mortgage rates won’t impact their desire to invest, since many will be cash buyers and if they do need financing, current U.S. mortgage rates are far less than the proposed taxes Xi has floated.
U.S. Buyers are in a Strong Position, Too
Depressed stock prices have certainly depleted potential sources of down payment money, impacting down payment sources. However, since bottoming out in September the Dow Jones has had its best October in history, gaining 14.25%. This may (or may not) mark the beginning of a broad rally for stocks. But if it does, the increase in available funds for prospective home buyers means an increased ability to pay, which of course means increasing demand.
So Now What? Where are Real Estate Prices headed?
With low affordability and interest rates higher than we’ve enjoyed the last ten years, it could be easy to believe the naysayers who say that real estate prices are headed south.
When you factor in rising incomes, strong savings, increasing household wealth as the stock market recovers, stubbornly low inventory and competition from outside the country, the argument that real estate market bulls make also sounds reasonable.
All real estate is local, so in your market you may find prices sliding a bit. Across the country most economists still see real estate prices rising, albeit more slowly. What matters more moving forward is what home buyers believe. Buyers won’t wait forever for the market to drop. If real estate prices remain stubbornly high, even a flat market will bring buyers back.
If you think you want to buy in 2023, watch for two major events:
- Demand will increase in February of 2023 (it always does that time of year.) Will inventory increase to match increasing demand, or will home sellers continue to sit on the sidelines?
- Will the Fed finally tame inflation? There are signs that inflation is moderating. Since the three most important factors in mortgage interest rates are inflation, inflation and inflation, if the Consumer Price Index (CPI) falls and shows a downward trend for several months, expect mortgage interest rates to come down (slowly) in the months following.
More than anything, these two factors will drive real estate prices in 2023.
But is Now a Good Time to Buy?
What if you don’t want to wait? Marriage, babies, divorce and death don’t stop for the economy. (Well, maybe babies do a little, but only a little.) There are always folks for whom now is the right time to buy or the right time to sell. If that’s you, the months of November through January are typically an excellent time to find deals. While inventory is lower during these months, sellers are typically more motivated and willing to negotiate price or terms, so real estate prices are softer.
If you are ready to buy, get pre-qualified first. I’m available and ready to help. If you are located outside of California and need a great real estate agent, I have a strong network of competent, ethical professionals and can help you find what you need.
Casey Fleming, Mortgage Advisor and Author of The Loan Guide: How to Get the Best Possible Mortgage
About Casey Fleming:
Casey Fleming is a veteran mortgage advisor (NMLS 344375) and Author of The Loan Guide: How to Get the Best Possible Mortgage. Casey advises clients throughout California, and is based in the heart of Silicon Valley. He writes articles regularly for several online publications, is a subject-matter expert for two prominent finance-related sites, and is regularly quoted in articles for many other publications.
This article represents the opinions of Casey Fleming, and not necessarily those of any company or organization cited or mentioned in this web site. This analysis was prepared with the best information available at the time it was written. We do not have any magical insider information about bond markets, real estate markets or mortgage markets that would make economic projections any more reliable than any other source. No warranty is made that the outcome will reflect the projections in this article, and neither the author nor LoanGuide.com are responsible for decisions that you make regarding your own choices about your real estate or mortgage or those of your clients.
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Resources used in this article:
Housing Affordability 2022 (Norada Real Estate Blog)
Housing Affordability Index (NAR)
Wages Increased in Q3, but Wage Growth is Slowing (Reuters)
U.S. Households Still Sitting on Excess Savings (Investment Executive)
U.S. Existing Home Inventory (YCharts)