Housing is, by pretty much anyone’s definition, becoming unaffordable in many or most parts of the country. Between the high cost of buying a home and the high cost of the mortgage needed to purchase it, the investment to become a homeowner has become daunting.
A drop in home prices would be welcome news to everyone who is currently priced out of the market. But home values are also the biggest part of whatever wealth most Americans have, especially older retired people.
A drop in home prices would generally benefit younger people who don’t already own a home and hurt older people who are hoping that the equity in their home will get them through retirement. Lower house prices and lower mortgage rates are the only way that housing will ever be generally affordable to most, but Americans have become used to the idea that a home is not just a place to live, it is an investment that will always be worth more in the future.
Prior to 2008, the conventional wisdom was that housing prices never go down, and certainly not all across the country at once. But it happened in the 1930’s and then again in 2008, so we have to realize that house prices can go down as well as up.
Currently in America, most homeowners are locked into long term 3% mortgages. They won’t be anxious to sell for anything but top dollar when a replacement house would require a 7% mortgage, so there is no reason for them to drop prices if they don’t have to move. That reluctance and the high number of homeowners that currently have a very low mortgage interest rate is keeping a lid on the inventory of houses available for sale. And the low housing inventory leaves sellers in the driver’s seat if they don’t want to budge on price.
But current mortgage rates are more than twice as high as the recent averages. The pool of buyers who are willing and able to pay those high home prices financed by 7% interest rates is significantly smaller than the number of buyers who could afford the same prices at 3% mortgage rates. The smaller pool of buyers gives buyers significant leverage to negotiate prices down.
There is, effectively, a stalemate in the market. The real estate market is “frozen”. The law of supply and demand says that either more supply on the market or more demand from buyers will jump start the real estate market, but it’s not obvious if, or when, either will happen.
One obvious addition to the low housing inventory that would change this equation would be a flood of newly built homes, and builders are definitely building. But building takes time and there are still shortages of some of the materials and the labor needed to build. In many parts of the country there are still relatively few new homes available.
Sometimes people have to sell, even if they have to hold their nose and take a low price. If layoffs pick up, and the businesses quit hiring, people will lose their jobs, or see a reduction in income, or at least start feeling less secure about their future. People who have lost or are worried about their jobs may choose to sell or even be foreclosed on. There are some statistics pointing to a small increase in foreclosures already. If foreclosures were to pick up it could quickly add to the pool of available houses. And a lot of foreclosures selling at distress prices could quickly pull down price comparisons for all homes in the area.
Other homeowners still need to relocate for a new job, or to get back near family, or perhaps even to move in with someone else. There is some level of “organic” selling that always happens. So there will be houses available.
But I just listened to a fascinating podcast (1) that points out that there is another source of houses that could flood the market. There is a huge pool of homes that are not occupied by their owners. They were purchased by institutional buyers to rent out, or for resale, or by house flippers, or by individuals who turned them into short term rentals, or they are second homes that are not being lived in.
These vacant homes are off the market right now, but they could flood the market at any time, especially if they don’t look like good investments when prices are dropping.
Institutional buyers need to get whatever return on their investment they can. If they can’t sell houses at current prices they will need to reduce prices. They have no emotional or business reasons to hang on. Their costs are sunk costs and they need to get their money out. They already are effectively reducing costs by buying down mortgage interest rates and offering seller financing. Institutional buyers would likely be the first wave of sellers of the vacant house inventory if they see anything that makes them think their investment is going down in value.
Individuals who bought houses to rent or flip are already experiencing cash flow problems. There have been reports that short term rentals have dried up in many places, and flippers are paying so much interest on interim loans that their margins are at risk when they can’t get the sale price they expected. Individual landlords and flippers won’t want to admit they may not get their original investment out, and they may hang on too long trying to get higher prices, but eventually they may have to sell at whatever price they can get, or they might get foreclosed on by their lenders.
If all these homes flood the market and the pool of buyers isn’t any bigger due to continued high mortgage interest rates and/or recession, the market will collapse. Every sale at a lower price sets a new, lower, comp value for the whole neighborhood. Eventually there will be a cascade effect where those who need to sell will realize they had better take what they can get quickly before the price drops even further.
The whole process will take a long time, several years. In recent recessions the lag between the highest real estate prices and the eventual market lows is anywhere from 4-8 years.
There would be winners and losers if this happens. People without homes might be able to finally buy them. But home builders, and retired people who have a lot of home equity, and individuals who jumped in, especially at the highs, to buy houses to rent or flip might be in a lot of trouble.
There is no way for house prices to collapse without a lot of pain, but it would be so much better if home prices were generally affordable for most Americans. Treating housing as an investment worked well for anyone could afford to buy before prices spiraled out of control, but it hurts everyone else.
A recession would be tragic, and I hope we don’t see one. But what if we go back to an America where housing is affordable and a house is just a place to live?
Footnotes
(1) Wealthion Podcast, Home Foreclosures are Surging. Repeat of 2008 Mortgage Bust Coming? | Nick Gerli & Amy Nixon