Key takeaways

  • As mortgage rates rise and inflation remains stubborn, there are signs that the housing market is slowing down
  • Real estate brokerage Redfin predicts that housing sales will sink to their lowest level since 2011
  • Elevated prices and inadequate build rates will likely prop up prices, preventing a massive wave of foreclosures

In the past year, rising inflation and soaring interest rates have spilled into the turbulent housing market.

Just a year ago, mortgage rates set near record lows as home prices soared. Now, interest rates near 7%, while home prices have jumped nearly 40% since March 2022.

Unsurprisingly, that level of home growth is unsustainable in the current market. Now, there’s hope that the housing market is slowing down – albeit gradually.

The impact of Covid-19 on the housing market

The Covid-19 performed a hefty number on the housing market.

As millions lost their jobs and the economy slowed substantially overnight, the government responded with unprecedented stimulus. Checks went out to nearly every Tom, Rick and Mary. Lower interest rates cheapened the price of debt to nearly nothing. Mortgage rates slammed down to an all-time low of 2.65% in January 2021.

And then, households began to move.

Between work-from-home allowances and individuals reprioritizing their lives, people sought homes in new locales. The housing market, stimulated by incredibly affordable mortgages, began to heat up. Values soared, and soon, everyday people found themselves priced out of one of the hottest markets in decades.

Soaring housing and rental rates, combined with a tight labor market and supply chain issues, contributed to outstanding inflation. Price increases peaked at 9.1% in June 2022. To cool down markets of all descriptions, the Federal Reserve implemented rate hikes to increase the price of debt and slow expenditures.

Now, the Fed’s benchmark interest rate sits near 4% – and mortgage rates have climbed with it.

Is the housing market slowing down?

The conflation of high prices and high rates suggests that the housing market should be in a steep decline. And while parts of the housing market are slowing down, it appears that the changes could be surprisingly gradual.

Spiking mortgage rates make a difference

As the federal funds rate has soared, mortgage rates have moved up, too. (In some cases, before Fed rate hikes actually took effect.)

In early December, 30-year mortgage rates averaged nearly 6.5% – over double January 2021’s average rate. While far below the 18% rates seen in the 1980s, it’s still been nearly 15 years since average rates have exceeded 15%.

Even when home prices remain stagnant, the impact of such high rates is astronomical.

Consider a $300,000, 30-year fixed-rate loan (excluding taxes and interest).

At 6.5% interest, your monthly payment comes out to just under $1,900. Over 30 years, you’ll pay nearly $683,000. In other words, you’ll pay more in interest than your home itself was originally worth.

But at 3% interest, your monthly payment comes out near $1,265 per month, or just over $455,330 over 30 years. At such low rates, you’ll only pay half your home’s initial value in interest.

Home values and a long-term shortage

Usually, when interest rates climb, home prices fall to compensate. Unfortunately, this hasn’t been the case in 2022.

One of the biggest reasons is a simple matter of supply and demand.

Even before the pandemic hit, the U.S. grappled with a housing shortage. The National Association of Realtors (NAR) predicted in 2021 that a whopping 5.5 to 6.8 million new homes were required to fill the gap.

As a result, home values may remain elevated. Though fewer people can afford to buy, supply shortages will likely constrain price declines to marginal levels. That said, with a more secure job market and improved application eligibility compared to the 2008 crisis, it’s unlikely that foreclosures will hit en masse.

However, that doesn’t mean home prices won’t – or haven’t – come down a little.

According to the S&P Case-Shiller Index, home values increased 7.8% YOY in September 2022. However, between June and September, prices fell 2.6%, indicating that some relief is on the way.

These declines were more pronounced in cities where homes had further to fall. San Francisco and Seattle saw three-month declines of 10%, while Denver and LA slipped around 5.6%.

Declining mortgage and sales demand

Despite stubbornly high interest rates and home values, construction is on the decline. New home starts slipped 8.8% on an annual basis in October, while applications for new home permits plunged 10% in the same period.

Existing home sales have also begun to slip.

According to the National Association of Realtors, pending home sales on existing properties fell 4.6% in October. That marks the fifth straight month of declines. Meanwhile, existing home sales plunged 32% between January and October 2022.

Overall, new loan applications have plunged over 41%, while refinancing applications have – unsurprisingly – plummeted nearly 90%.

Mark Zandi, chief economist at Moody’s Analytics, sums up the U.S. housing market neatly: It’s “evaporating,” he reports.

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Paul Ashworth, a chief economist at Capital Economics, mirrors this view. He describes U.S. housing market activity as “absolutely decimated.”

Redfin’s housing market predictions for 2023

The housing market may be slowing down somewhat – but so far, annual price declines haven’t materialized. Still, housing market experts predict that won’t last forever.

For instance, Morgan Stanley predicts that average housing prices could decline as much as 10% between June 2022 and early 2024. While that number appears drastic, it’s small potatoes against the market’s 40% price jump since early 2020.

In other words, Morgan Stanley’s experts aren’t preparing for a crash; rather, a small correction to bring an overheated market back in line.

And Redfin, a North American real estate brokerage, has compiled a list of predictions for the housing market in 2023. We won’t cover the whole kit here – just the highlights.

The main takeaway: the U.S. housing market has begun to slow already – and will continue for at least another year.

Home sales will sink to their lowest in a decade

Redfin’s first major prediction is that home sales will drop about 16% in 2023, landing around 4.3 million. Newly-built homes are also predicted to decline around 20%. That would drive home sales to their lowest level since 2011, with a predicted 32 out of every 1,000 households selling in 2023.

The brokerage’s data suggests that high mortgage rates, high inflation and a potential recession will keep people where they are for now. (Redfin predicts sales could plunge as much as 27% if inflation persists higher or longer than expected.) That said, high equity and a resilient job market will stave off panic-inducing foreclosure rates.

Mortgage rates will decline, too

Redfin also expects 30-year fixed mortgage rates to gradually decline in 2023, ending the year around 5.8%. This drop could save homeowners an average of $150 per month on a $400,000 home. However, the rate of decline for both inflation and interest rates depends on how spending and GDP growth (or declines) in the year to come.

Home prices will decline

Overall, Redfin expects median U.S. home sales prices to drop around 4% to $368,000 in 2023. While housing will remain less affordable than it was pre-pandemic due to high rates and values outpacing wage growth, that would still mark the first annual decline since 2012.

Redfin analysts believe prices would decline more if the housing crunch weren’t so prominent. However, the company expects new listings to decline through more of 2023, keeping inventory low and propping up prices.

Rents will fall, too

Redfin also sees U.S. rental rates declining slightly in 2023.

In the single-family housing market, high interest rates will promote reluctance for homeowners to buy and sell, meaning that single-family rentals may become more common.

Meanwhile, multi-family construction sits at a 50-year high, which will flood the market with hundreds of thousands of new units in 2023. That growth trend will likely continue as multifamily units become more financially sensible for builders compared to single-family units.

The U.S. housing market is slowing down – gradually

Buying a home has long been the quintessential American dream. But for modern families caught between inflation and interest rates, that dream has largely slipped out of reach.

But it’s not just consumers feeling the sting of today’s housing market. As housing activity slows, purchase prices remain stubborn and rental values drop, investors could see the profit potential of their investments decline.

In that regard, a slowing housing market may actually spell good news, as it provides investors an opportunity to invest for cheaper.

Of course, Redfin has predictions on that, too, suggesting that many investors will bow out entirely in favor of more profitable ventures elsewhere. Others will slow their activity until the decline passes and future returns are less distant.

Still, that leaves a lot of unanswered questions for investors. And if you’re a fan of greater tangibility in your portfolio, we don’t blame you.

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