Home buyers on a budget have faced two years of misery.
Prices soared thanks to the 2020 Covid pandemic and plunging mortgage rates. Builders that normally would have jumped in to add supply instead struggled with worker shortages and ballooning commodity costs.
But good news is ahead. These dynamics are finally changing, and, in time, buyers might catch a break.
Home values seem to have peaked. The S&P/Case-Shiller national home price index dropped 0.2% from June to July, the first monthly decline in a decade. A one-month decline in any indicator doesn’t normally reveal a trend. But economists think this is the beginning of a modest correction, with home values continuing to flatten out or decline in the coming months.
That makes sense, given the rapid jump in interest rates. Mortgage rates have surged from 3% a year ago to around 6.7% now, sharply raising the monthly payment on a typical home. Since higher rates make home-buying more expensive, demand for homes is softening.
The culprit has been the Federal Reserve, which has been jacking up interest rates to get inflation under control. By making borrowing more expensive, the Fed depresses demand. And when fewer people want to buy, prices ought to slow or decline.
The Fed won’t spell this out, but housing is one of the areas where it is hoping to torpedo demand. At the moment, that makes it an inopportune time to buy, since prices are still relatively high and mortgages are more expensive. The National Association of Realtors calls this an “increasing affordability crisis,” and says the typical buyer has lost $107,000 worth of purchasing power this year. This all helps explain why existing home sales have declined for seven months in a row.
But affordability problems will eventually help lower prices, since sellers will, at some point, have to price homes at levels that buyers can afford. The following chart, showing the S&P/Case-Shiller national home value index, helps explain what might be coming. The first thing to notice is the tiny flattening at the far-right end of the charted line. That’s the small drop in prices in July, the first sign of leveling out.
The historical trend from 1987 through 2002 was a modest yet steady gain in home values, with average growth of 4.2% per year. Then the housing boom began—the first steepening on the chart. From 2003 through 2006, home prices rose by an annual average of 10.7%, or two-and-a-half times the average of the previous 15 years. We know now that it was an unsustainable bubble driven by fraud, terrible lending standards, bad regulation, excess supply and greed. But sales kept surging, and prices soaring, because the coming wipeout wasn’t apparent at the time.
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The crash that followed was ugly and ruinous. Average home prices fell 26% from the peak in 2007 to the bottom in 2011. On an annual basis, the average drop in prices during those five years was 5.3%. In the frothiest markets, values fell by a lot more.
A robust recovery followed, which leads to the most tantalizing section of the chart: The sharp run-up in prices that began in the middle of 2020, just as Covid was driving people from cities and fueling a frenzy of suburban and vacation property buying. From June 2020 through June 2022, home prices rose by an unprecedented 40%. During the 2003-2006 housing bubble, the largest two-year period of home-price appreciation registered a mere 31%. After that bubble burst, many economists argued that we’d never again see such rapid gains in home prices.
Yet we just have.
For buyers, that raises the tantalizing prospect that we may be on the verge of another drop in prices and, for once, a buyer’s market. “Home price growth has moderated, and the correction in home prices is likely to deepen,” Oxford Economics advised in a Sept. 29 research note. “But we think a sharp outright drop in prices at the national level on a year-on-year basis is unlikely. We anticipate annual home price growth slowing to about 2% in 2023.”
The types of fire-sale deals that popped up during the last housing crash are unlikely this time around, largely because many things are different today. Lending standards are solid, so there aren’t millions of foreclosures in the pipeline. Instead of too many homes, there are too few. Where sales are soft and prices are beginning to fall, corporate entities sometimes buy homes and convert them to rentals, pre-empting individual buyers.
Still, the market is likely to improve for buyers, and looking at longer-term trends shows that prices tend to revert to historical averages after unusual ups or downs.
That suggests the steep price curve of the last two years is likely to look a lot flatter by 2024 or 2025, and it may dip for a period of time, with prices declining. This is also happening at a time of high inflation, which is pushing wages up by more than usual, and if wage gains continue while home prices flatten, buying power will improve.
The wait for buyers desperate to get into the market isn’t over, but the end may be coming into view.
Rick Newman is a senior columnist for Yahoo Finance. Follow him on Twitter at @rickjnewman
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