25% Home price decreases to come, says economist

  • Home prices have been booming since the start of 2020.
  • But as the Federal Reserve tightens policy to cool inflation, the demand for homes is falling.
  • José Torres of Interactive Brokers believes home prices are headed for double-digit declines.

When Interactive Brokers senior economist José Torres said last July that he saw a 2008-like home price crash coming, 30-year mortgage rates were around 5.5% and the June reading of the S&P/Case-Shiller US National Home Price Index had just hit new highs.

Shortly thereafter, mortgage rates have continued to rise this year, exceeding 7%.

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Freddy Mac

Domestic home prices have also officially started to fall.

house prices houses killer

Federal Reserve Bank of St. Louis

Given the shifting data, consensus views on the housing market have generally turned more bearish in recent months, swinging towards Torres’ outlook.

But falling inflation could once again mean brighter prospects for investors and homeowners.

The consumer price index cooled in October, with inflation reaching 7.7% year-on-year, down from 8.2% in September and 8.5% in August. While the Federal Reserve has said it will continue to tighten policy in the coming months (and intend to keep it tight once they halt rate hikes) to reduce inflation, the CPI’s downward trend suggests the central bank will be able to return to accommodative policy next year.

Mortgage rates, like bond yields, have started to fall in recent weeks, which is good for demand.

But Torres disagrees with the idea that inflation will continue to fall rapidly and that the Fed will be able to change course. Those views are at the heart of his call, which he reiterated this week, that home prices will fall about 25% on the Case-Shiller index by the second half of 2023.

Such a nationwide decline would be similar to the house price collapse observed during the 2008 crisis, when the index fell 27% from its July 2006 peak to its February 2012 low. The Case-Shiller data, being an average for the previous three months, it lagged other home price data. But individual cities like Phoenix and San Francisco fared worse during the crisis, with price drops of up to 30%. As of September 2022, the median home price in Phoenix was down 10% from June, according to Realtor.com.

Torres told Insider that he expects the federal funds rate to peak at around 5.38%, while the market consensus is 5.13%. He also said that inflation will remain higher for longer than consensus due to the number of jobs still remaining and the high wages employers will continue to have to pay. If inflation falls rapidly and the Fed shifts to accommodative policy, the declines won’t be as big, Torres said.

The dynamics of supply and demand have created a “perfect storm”

Torres believes the dynamics of supply and demand have moved in a way that will create significant future declines.

Affordability paints the picture of Torres’ decline in demand, with monthly housing costs historically high relative to incomes. The change is due to skyrocketing home prices over the past two years, coupled with the jump in mortgage rates since earlier this year. There are “no buyers in sight,” Torres said of the transfer market.

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Research Yardeni

“Similar to the months leading up to the 2008 housing market debacle, the average monthly payments percentage of household income and personal income has been at record highs throughout the year, which is creating demand for rental units among Americans who can’t afford homes,” Torres said in the statement.

On the supply side, builders have scrambled to scale up to keep pace with strong demand. New home inventory has increased about 25 percent since the summer of last year to nearly one million homes, he said.

But now that demand has been cut by low affordability, homebuilders will have to offer lower prices to offload their inventory, which will cause existing home prices to drop, Torres said.

“The supply of new homes has increased significantly, and homebuilders have resorted to discounts and concessions to make sales. The supply of existing homes, on the other hand, remains subdued, as landlords who have locked in low rates they have little incentive to sell,” Torres said. “At some point early next year, homeowners who are due to sell will have to lower prices to compete with new home prices.”

He continued: “The macroeconomic backdrop for homebuilders continues to deteriorate and is likely to get worse as the Federal Reserve continues to raise rates and shrink its balance sheet, leading to higher borrowing costs, reduced credit availability and falling debt.” liquidity levels. This headwind is already causing a drop in home values, with two consecutive months of falling prices earlier this year.”

Post-COVID-19 normalization in cities is also contributing to the decline in high demand for more suburban properties seen during the pandemic, Torres said. Additionally, falls in other asset classes such as equities are bearish for housing demand, a phenomenon known as the negative wealth effect.

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