It’s not just about how expensive housing is – it’s about how fast it gets there. In just 24 months, U.S. home prices have risen by a staggering 37%. That compares with the biggest two-year rise of 29% that led to the 2008 housing crash.
Heading into this spring, the Fed thought it had seen enough. The central bank quickly raised interest rates, raising the average rate on a 30-year fixed-rate mortgage to 6% from 3.2% at the start of the year. These higher rates, priced in by many home buyers, finally ended the pandemic’s real estate boom. The Mortgage Bankers Association reported Wednesday that mortgage applications fell 16% year over year and we are now in the midst of a sharp deceleration.
When this shift happens, we hear very little from the Fed. Well, until Chairman Jerome Powell spoke to reporters on Wednesday.
Here’s what Powell put it: “We’ve seen [home] prices rise dramatically over the past few years. Now that’s changing. And interest rates have gone up. We know mortgage rates have risen sharply. You’re going to see a changing housing market. We Watching him to see what happens. How much will it affect housing investment exactly? I’m not sure. How big is the effect on house prices? Very tight market. So even in a world of rising interest rates, prices are likely to continue to rise for a while. So it’s a complicated situation and we’re watching it closely. I would say if you’re a home buyer, you want to Homebuyers or young people need to recalibrate a bit. We need to get back to a place where supply and demand converge again, inflation is lower again, mortgage rates are lower again.”
Three things stand out.
Powell says homebuyers ‘need to recalibrate’
In the real estate industry, the total number of active offers is called “inventory”. Annual inventories have been falling since 2014. This is partly due to changes in household preferences (i.e. staying longer), less housing construction following the 2008 housing crash, and millennials starting to buy homes for the first time. But as the pandemic real estate boom took off, inventories began to plummet. By spring 2021, inventories hit a 40-year low. That leaves home buyers no choice but to raise prices.
Clearly, Powell is hopeful that a slowdown in real estate due to rising mortgage rates will help push up inventories. Powell said it will help buyers because the thinking is that when buyers resume buying, they will find a friendlier market. Higher inventory will give buyers more time to make a decision and reduce the likelihood of having to engage in a bidding war.
Even before the Fed stepped up its inflation fight, HousingWire senior analyst Logan Mohtashami had publicly advocated for higher mortgage rates to boost inventories. The U.S. housing stock rose to 1.03 million units as of May, according to the National Association of Realtors. But to return to a “normal” housing market, Mohtashami said inventory would have to increase to between 15,200 and 1.93 million housing units. However, national inventory (see chart below) is rising rapidly, with inventory in more than half of regional housing markets still 50% below pre-pandemic levels.
“We need a balance … the housing market is still very unhealthy as the total inventory in the U.S. is still below 1.52 million,” Mohtashami said.
House prices fall? Powell seems to suggest it’s possible
Fed Chair Jerome Powell on Wednesday hypothesized that house prices would fall: “How much of an impact is this going to have on house prices? Not so sure. Obviously, we’re watching this very closely. Over time, you’ll think about it…there’s a lot of unfinished work in the housing market.” supply of housing, when they come online…”
Then he turned and said: “While the supply of ready-to-use homes is selling, the inventory of ready-to-use homes is very low, historically low. It’s still a very tight market, and even in a world of rising interest rates, prices will likely continue to rise for a while. time. So it’s a complicated situation and we’re watching it closely.”
For a moment, Powell seemed to be saying that house prices would fall. In any case, Powell did not rule out the possibility of falling house prices. This is important. Historically, outside of the Great Depression and after the housing crash of the 2000s, house prices have almost never experienced annual declines. But today’s situation could bring us into a rare phase where house prices actually fall. This shows that Powell is not closing the door on the possibility of falling house prices, he said, “We are watching it closely.”
Last month, Moody’s Analytics chief economist Mark Zandi told Fortune that rising mortgage rates have pushed us into a full-blown “real estate market correction.” In the short term, Zandi expects year-on-year house price growth to slow to 0% from 20.6%. He expects prices to fall between 5% and 10% in a clearly “overvalued” property market. In the event of a recession, Moody’s Analytics expects U.S. home prices to fall 5%, while the severely “overvalued” housing market falls 15% to 20%. (Moody’s Analytics identifies “overvalued” by comparing regional home prices to underlying local economic fundamentals, such as household income, which have been historically supported.)
Why are house prices falling so easily? The first is that house prices have strayed from underlying economic fundamentals. Basic economic theory teaches that house price growth and income growth are intertwined, and neither can outperform the other for long. Rising mortgage rates will only make this affordability crisis worse. In fact, typical new mortgage payments have increased by 52% over the past six months, according to real estate research firm Zonda.
However, property prices may fall, but inventories may need to build up more to materialize. Once U.S. inventory climbs above 2 million units, national home prices are likely to fall year-over-year, Mohtashami said.
Ralph McLaughlin, chief economist at real estate data and analytics firm Kukun, said that if the Fed’s “excessive tightening” leads to a recession, inventory could reach levels that would allow home prices to fall.
“It’s increasingly likely that we’re approaching a sharp inflection point in the market,” McLaughlin told Fortune.
Powell specifically says he wants to see mortgage rates come down
The central bank raised interest rates to stem the pandemic’s housing boom and curb runaway inflation. Once the Fed gets inflation under control again, the rise in mortgage rates could ease.
That means homebuyers eager to lower their mortgage rates may have to wait a while. The consumer price index was 8.6% last week. The Fed will not give up its fight against inflation until the CPI returns to 2%. On Thursday, the Fed made it clear that the fight could continue into 2024.
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