Despite the hype about the housing market crash and the latest interest rate increases by the Federal Reserve, the truth is that it is not the Federal Reserve that is controlling interest rates. The Fed is merely trying to keep up with soaring inflation. The Fed has raised interest rates five times in the last 12 months, and there are more planned increases this year.
In recent years, the average American household has been able to borrow a little less than 3% of their income toward a mortgage. But that rate has more than doubled in the past year. Mortgage rates are now nearing 7%.
This is the first time in more than a decade that the average American has seen rates this high. The Fed hopes that elevated interest rates will spur a housing slowdown. Those rates are causing a housing slump that's affecting home sales across the country.
Despite the Fed's efforts, housing activity is still slowing. Mortgage purchase applications are at their lowest point in more than two years. There's also a significant amount of foreclosure activity. This means more homeowners are struggling to make their mortgage payments.
As a result, the Fed is preparing for more interest rate increases, which will further slow down home sales and the housing market. There are two more 75 basis point rate hikes scheduled for November and December. The Fed expects that the housing market will slow down next year.
In the short term, the mortgage rate spike will spur a slight increase in inflation. But the real effects of the Fed's actions will be felt with lag. This is because the Fed is backing off of buying MBS securities. In fact, implied 10-year Treasury forward yields are flat over the next five quarters.
The Fed has taken the first step to taming inflation by slapping a 75 basis point hike on interest rates. However, the Federal Open Market Committee has also taken the next step, announcing a 3-point hike in the federal policy rate in 2022.
The Fed's actions are slowing the housing market, which is good news for housing investors. Home prices are now being pulled down by the forces of supply and demand. As a result, it will be easier for big investors to buy more single-family homes. However, as housing demand continues to weaken, prices could still fall in the near future.
Prices are Likely to Drop Before Leveling Off
Despite a year of record home prices, the housing market is cooling. The housing supply is nearly 57 percent of the level it was at the beginning of the year. This increase is partly due to a higher number of listings and longer sales cycles.
While a mild housing market correction is unlikely, a recession could lead to larger home price declines. Oxford Economics estimates that employment levels are the key factor in determining the severity of a downturn.
If unemployment levels rise, more homeowners will be forced to sell their homes. This could drive prices down faster, though.
Many homeowners who have owned for extended periods of time have amassed a significant amount of equity. They may finally get a chance to sell their homes and get some relief from the surging prices.
The strong labor market should increase the chances of a benign correction. Many aspiring homebuyers have delayed purchases in hopes of lower mortgage rates. However, high borrowing costs and a deteriorating economic outlook may keep buyers from buying.
The housing market is still very much overvalued, according to Fitch Ratings. It predicts that 89 percent of the nation's major metro areas are overvalued.
Moody's Analytics expects home prices to decline by 10 percent in the next few years. The company analyzed 322 regional housing markets and found that all but four would see a home price decline.
Fannie Mae's Economic and Strategic Research group expects single-family home sales to fall by 2.4% in 2022. The ESR group predicts home price growth to be 7.6%.
Goldman Sachs, in a report last week, predicted that home prices would drop by 5% to 10% over the next year. The firm's model predicts that prices will level off and stabilize around March 2024.
While many analysts have forecasted home price declines of 20%, a recession will likely lead to much larger drops. Zillow and John Burns Real Estate Consulting have predicted home prices to fall by 10 percent in the next six to 12 months.
Despite the forecasts, economists believe that the housing market will not crash in the next few years. However, mortgage rates could climb to 8.5%. In addition, demand for residential real estate is weak in many cities across the U.S., which will reduce the supply of available homes for sale.
The Housing Shortage
Despite the fact that the housing market shortage isn't new, it's not necessarily the only reason for the recent drop in home prices. A number of reasons have contributed to the recent housing market correction, including a slowdown in construction, increasing interest rates, and affordability challenges.
According to Up For Growth, a Washington-based group focused on the housing shortage, supply was decreasing in about 75% of the nation's metro areas. The group analyzed data from the U.S. Department of Housing and Urban Development and the Census Bureau.
The group found that in addition to the shortage of housing, the United States is also facing a structural deficit of homes, which stems from the nosedive in construction activity after the late 2000s housing crash.
According to the study, the nation needs about 1.6 million more homes to make the housing market more affordable. This deficit is especially acute for millennials entering the market. It's also likely to have consequences for the health of the national economy.
According to Goldman Sachs research, the housing market will experience a decline in the amount of home sales this year and will continue to shrink through 2022. However, the research firm predicts that housing market activity will start to pick up again in 2024.
Goldman Sachs' research project shows that home prices will grow at an average annual rate of 3.8% over the next five years. This rate of growth is a bit lower than it was last year, but it's still higher than in most recent years.
Despite the recent decline in home prices, the housing market shortage isn't going away. According to the National Association of Realtors, the supply of existing homes is 2.4 months. The housing shortage has remained a problem in several big metro areas over the past decade.
While the housing shortage isn't going away anytime soon, a combination of external factors should flatten the bubbling market. This will eventually lead to a healthier balance between buyers and sellers. However, it will take years to close the deficit.
Eventually, a healthy housing market will provide more affordable housing options for excluded households.
New Builds are Slowing Impacting Future Supply
Despite recent growth in housing prices, the demand for new homes is expected to continue increasing. Supply-chain constraints are still keeping the supply of housing below the level required to sustain demand. This will keep prices high for the foreseeable future.
The housing supply chain is not as efficient as it was prior to the COVID-19 pandemic. This has hampered home builders' ability to scale up construction. In addition, labor shortages have increased. This constraint will keep housing construction slow, but is unlikely to significantly influence demand.
New home permits declined in April for the fifth straight month. Permits were down 3.2% to 1.819 million units in April. The decline is likely due to a drop in housing starts. This was accompanied by a drop in single family housing starts. Single family starts decreased 3.9%, bringing the total decline in the housing starts sector to 7.3%.
Permitting activity for new construction increased slightly in October. Permits for buildings with two to four units rose 8.2%. In addition, permits for single family homes increased 2.7%. This represents the highest rate of housing starts for the five-unit or greater category since April 1986.
Despite the growth in construction activity, the demand for housing remains high. This is evident by the increase in new listings on Zillow. The median price to cost ratio remains at 2.84 in 2013, which is above the minimum profitable production cost (MPPC). The Wharton Residential Land Use Restrictions Index is the same magnitude as Saiz's elasticity measure.
Housing construction is largely a function of interest rates, but the supply chain is strained by low productivity and high labor costs. A lack of affordable housing has stymied many would-be homeowners. This has contributed to the higher prices for new homes. Moreover, the rising price of land has driven up total costs.
A backlog of housing projects has also grown. The Commerce Department reported a record backlog of houses to be constructed. This indicates that home building has been undergoing a transition.
Home prices are likely to continue rising in the near future, but at a slower rate than in recent years. There will be less new housing construction in the near future, which will also affect the price of housing.