That pandemic construction boom coincided with a staggering 42% rise in US home prices between March 2020 and June 2022. At least 60% of that appreciation, researchers from the Federal Reserve Bank of San Francisco estimate, can be attributed to high demand for “space” that occurred during the pandemic.
Of course, that demand boom has not only faded, but is making a 180: on an annual basis, mortgage requests are down by 41%. There are actually fewer purchase requests now than at the bottom of the 2008 crash.
This rapid drop in demand also has more economists uttering the most feared word in real estate: Bubble.
“It was an induced pandemic [housing] bubble, which has been fueled by trends in labor migration from home: high-wage workers who will shrink middle tier markets for more space, “said Diane Swonk, chief economist at KPMG.” We went to the ‘ extreme on WFH [spurred housing demand], but it pretty much ended abruptly. It’s part of the reason why I think house prices are falling too. Local incomes do not support many of these domestic values. ”
We have already seen the rollover in home price growth on a nationwide basis. Between June and August, the Case-Shiller National Home Index showed a 1.3% decline in US home prices. This marks the first decline since 2012.
“Once the nationwide price fall process starts, there’s a self-fulfilling momentum because no one wants to catch a falling knife,” says Swonk. “We will easily see big double-digit drops. I think 15% next year is very cautious. We are already shooting.”
when Fortune coined the term Pandemic Housing Boom, we did it knowing that if the boom ended in failure, we would have to rename it a Pandemic Housing Bubble. We’ve also established a criterion for this: Any market that sees a peak-to-low drop of more than 10% gets the Pandemic Housing Bubble label. If KPMG’s prediction comes true, the whole country will get our “bubble” label.
Here are the four great takeaways from FortuneChat with Swonk.
Rising Mortgage Rates Burst the “Bubble”
View this interactive chart on Fortune.com
Whenever the Federal Reserve goes into rate hike mode, it will create problems for rate sensitive sectors such as the US housing market. When those rate hikes become aggressive because the central bank has lagged behind in its fight against inflation, it will be much more intense.
Of course, this is exactly what we saw in 2022. The Fed’s monetary tightening saw the average 30-year mortgage rate rise over the past year from 2.98% to 7.1%. This marks the biggest mortgage rate shock since Fed Chairman Paul Volcker’s infamous tightening in 1981.
That mortgage rate shock is important for two reasons. First, historically low mortgage rates, which also helped fuel the pandemic housing boom, have disappeared. Second, the spike means that many potential buyers have either lost the price or lost their mortgage altogether.
Home prices are falling, but that’s not the story of 2008
If house prices in the United States actually fell 15%, it would mark the second largest housing price correction of the post-World War II era. Only the 27% correction between 2006 and 2012 would have beaten it.
That said, the Federal Reserve says this is not a repeat of the 2008 crisis.
“From a financial stability standpoint, in this cycle we have not seen the types of poor underwriting credit that we saw before the Great Financial Crisis. Real estate credit was handled much more carefully by lenders. It’s a very different situation. [in 2022]has no potential, [well] it does not appear to present financial stability problems. But we understand it [housing] this is where a very large effect of our policies lies, ”Fed Chairman Jerome Powell told reporters earlier this month.
Swonk agrees with Powell: “This isn’t a subprime mortgage crisis, I am [the fed] right for it “.
However, while improved lending standards and reduced supply should prevent a repeat in 2008, they are not enough to prevent a real estate correction. At least that’s how Swonk sees it.
“The interesting thing for me is how quickly some of these markets are correcting themselves with still very limited inventories,” says Swonk.
Phoenix is very bubbly, Chicago not so much
View this interactive chart on Fortune.com
How Fortune noted earlier, the textbook definition of a housing bubble requires three things. First, you would see exuberant demand, fueled by speculation, rushing into the housing market. Second, the rise in house prices rises well above what incomes can support and reaches levels of “overvaluation”. Third, the housing bubble bursts and house prices fall.
The pandemic construction boom saw the “investor mania” return to the market. Historically low mortgage rates have attracted mom and dad owners and Airbnb hosts alike. Short-term pinball machines, attracted by record levels of home price appreciation, also came into play. In fact, a total of 114,706 homes were “turned upside down” in the first quarter of 2022, according to ATTOM Data. It’s higher than any quarter in the years leading up to the 2008 bubble. Speculation? Check.
Each quarter, Moody’s Analytics calculates an “overvalued” or “undervalued” figure for approximately 400 markets. The company’s goal is to find out if fundamentals, including local income levels, could support local house prices. It is only worrying when a housing market becomes significantly “overvalued”. In the second quarter of 2022, the typical market was “overvalued” by 23%. It is up from 3% in the second quarter of 2019 and to above 14% in the second quarter of 2006. Overvaluation? Check.
While the first two elements of the housing bubble actually returned during the pandemic, the third element has yet to strike. Swonk says “burst” is starting, but it will vary by market.
Why does Swonk think the bust will vary? Some markets have gotten a lot hotter than others.
For example, look at Chicago and Phoenix. Last time, both markets saw a boom and bust. It’s easy to see why, given that in 2006 Chicago and Phoenix were “overvalued” by 32% and 48% respectively. However, this time around Phoenix (which is now “overvalued” by 54%) saw a wave of speculators and out-of-town buyers, while Chicago (which is now “overvalued” by 3%) remained relatively quiet.
Moving forward, real estate economists expect markets like Phoenix to be at greater risk of sharp falls in home prices. In fact, Moody’s Analytics currently expects an 18.7% drop from peak to low in bubbly Phoenix. In Chicago, the analyst firm expects house prices to drop only 3.6%. (You can find Moody’s forecasts for 322 markets here.)
Falling house prices help the Fed
Fed Chairman Jerome Powell made it clear that the US housing market is in a “difficult correction”. Once completed, buyers and sellers will return to a “reset” market.
Reading between the lines, some economists consider “reset” to mean “house prices will fall”.
“Let’s face it, where is one of the biggest pushes to inflation right now? It’s in the housing costs. And this is where [the Fed] they have more power, “says Swonk.” And so, yes, it’s been a tremendous rise [home] prices. An unsustainable increase: some sort of correction is needed. The problem is, you can’t choose how big that fix is. ”
A slight correction in house prices, Swonk says, would help the Fed keep both housing costs and headline inflation in check. In such a scenario, buyers could return to a market with lower prices, more inventory and lower mortgage rates.
Hungry for more housing data? Follow me on Twitter at @NewsLambert.
This story was originally posted on Fortune.com
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