Homebuyers on a budget have faced two years of misery.
Prices skyrocketed thanks to the 2020 Covid pandemic and falling mortgage rates. Builders who normally would have jumped in to add supply instead struggled with worker shortages and rising commodity costs.
But there is good news ahead. These dynamics are finally changing, and in time, buyers could catch a break.
Home values appear to have peaked. The S&P/Case-Shiller national home price index fell 0.2% from June to July, the first monthly drop in a decade. A one month drop in any indicator does not normally reveal a trend. But economists believe this is the start of a modest correction, with home values stabilizing or declining in the coming months.
That makes sense, given the rapid jump in interest rates. Mortgage rates have risen from 3% a year ago to about 6.7% now, greatly increasing the monthly payment on a typical home. As higher rates make home purchases more expensive, demand for homes is weakening.
The culprit has been the Federal Reserve, which has been raising interest rates to control inflation. By making loans more expensive, the Fed depresses demand. And when fewer people want to buy, prices should go down or down.
The Fed won’t go into detail, but housing is one area where it hopes to torpedo demand. At the moment, that makes it an inopportune time to buy, as prices remain relatively high and mortgages are more expensive. The National Association of Realtors calls this a “growing affordability crisis,” and says the typical shopper has lost $107,000 in spending power this year. All of this helps explain why existing home sales have been down for seven months in a row.
But affordability issues will eventually help drive prices down, as sellers will, at some point, have to price homes at levels buyers can afford. The chart below, showing the S&P/Case-Shiller National Home Value Index, helps explain what could happen. The first thing you should notice is the small flattening at the far right of the traced line. That is the small drop in prices in July, the first sign of leveling off.
The historical trend from 1987 to 2002 was a modest but steady increase in home values, averaging 4.2% growth per year. Then the housing boom began, the first slope on the chart. From 2003 to 2006, home prices increased an average of 10.7% per year, or two and a half times the average of the previous 15 years. We now know that it was an unsustainable bubble fueled by fraud, terrible credit standards, poor regulation, oversupply, and greed. But sales continued to rise and prices skyrocketed, because the looming sale was not apparent at the time.
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The crash that followed was ugly and ruinous. Median home prices fell 26% from the high in 2007 to the low in 2011. On an annual basis, the average price drop over those five years was 5.3%. In the foamier markets, values fell much more.
A solid recovery followed, leading to the most tantalizing section of the chart: the sharp rise in prices that began in mid-2020, just as Covid was driving people out of cities and fueling a frenzy of suburban and vacation property purchases. . From June 2020 to June 2022, home prices increased an unprecedented 40%. During the 2003-2006 housing bubble, the largest two-year period of home price appreciation was just 31%. After the bubble burst, many economists argued that we would never see such rapid increases in home prices again.
However, we only have
For buyers, that raises the tantalizing prospect that we may be on the brink of another price decline and, for once, a buyer’s market. “House price growth has moderated and the correction in house prices is likely to deepen,” Oxford Economics warned in a Sept. 29 research note. “But we think a sharp decline in prices domestically year on year is unlikely. We anticipate annual house price growth to slow to around 2% in 2023.”
The kinds of fire sale deals that emerged during the last real estate crisis are unlikely this time around, largely because so much is different today. The lending standards are solid, so there aren’t millions of foreclosures on the way. Instead of too many houses, there are too few. Where sales are weak and prices begin to fall, corporate entities sometimes buy homes and convert them to rentals, preempting individual buyers.
Still, the market is likely to improve for buyers, and looking at longer-term trends shows that prices tend to return to historical averages after unusual highs or lows.
That suggests the steep price curve of the past two years is likely to look much flatter by 2024 or 2025, and may decline over a period of time, as prices fall. This is also happening at a time of high inflation, which is driving up wages higher than usual, and if wage gains continue while house prices are stagnating, purchasing power will improve.
The wait for desperate buyers to enter the market is not over, but the end may be in sight.
Rick Newman is a columnist for Yahoo Finance. Follow him on Twitter at @rickjnewman
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