The Truth About Falling Home Prices

Real estate doom and gloom articles are going to ramp up big time in coming months, if they haven’t already.

You’re going to hear that the second biggest housing crash since the Great Depression is upon us.

It’ll all be super scary and negative and panic-inducing. You’ll be led to believe that it’s 2008 all over again.

Except, it’s not. Nor will it be. Interestingly, this latest housing downturn, or “correction,” was manufactured by the Fed.

The same Fed that basically orchestrated the housing frenzy that preceded it. The good news is it’ll likely be short-lived and really nothing like the Great Recession.

Why Are Home Prices Falling?

First, let’s talk about why home prices are beginning to stall, and gasp, even go down.

Long story short, home price appreciation was absolutely out of control over the past couple years since the pandemic got underway. We’re talking a 50% increase in prices.

A combination of limited supply, cheap money (i.e. record low mortgage rates), and the sheer desire to own property propelled home prices to new heights.

Not only did home prices hit all-time highs, but monthly and annual gains hit records as well.

We were seeing consistent double-digit gains in property values, which we all know simply can’t be sustainable over time.

The Fed saw this happening and basically decided to pump the brakes. They discovered that recent home price gains were driven by excess demand, not just short supply.

As such, they knew that raising their own interest rate (fed funds rate) and stopping their Quantitative Easing (QE) program would eventually increase mortgage rates.

Maybe they didn’t foresee just how much they’d rise in such a short period, but mission accomplished either way.

It’s pretty much a foregone conclusion that home prices have peaked, and now after months of slowing appreciation, we’re facing actual declines in nominal prices.

In other words, a lower price than the month before, and eventually the year before.

How Much Will Home Prices Go Down?

The next logical question is how much will home prices go down. It’s important to differentiate between nominal prices and real prices, the latter of which are adjusted for inflation.

This is especially pertinent with inflation running super-hot at the moment, at 8%+.

Now high mortgage rates alone don’t necessarily lower home prices, but once you throw in a significant increase in unemployment, they do.

Per Wharton’s Susan Wachter, home prices have never fallen without “a substantial rise in unemployment,” other than during the Great Recession.

This is not the Great Recession – the mortgages underwritten at that time were utter garbage.

We’re talking 100% financing, no doc, stated income, outright fraud, and dangerous adjustable-rate mortgages like the option ARM.

Today, it’s plain vanilla, boring old 30-year fixed mortgages. And the majority of homeowners with them have absurdly low interest rates. We’re talking 2-4%. Locked in until the year 2050.

These folks don’t really care if “home prices go down” because they’ll keep paying their super-low monthly mortgage payments and let time get their home price back to new heights.

Even if they do lose their jobs, they can sell for a profit or rent out their properties and cash flow positive.

Meanwhile, a combination of a recession, increased unemployment, and much higher mortgage rates will likely push nominal home prices lower.

But how much lower? While this is really always a regional question, not so much a national one, chances are home prices will only fall 5-10%, at least if you believe Wells Fargo economists.

And when you look at how much they went up since just the year 2020, it’s a drop in the bucket.

For example, the median existing home price was $300,000 in 2020, $357,000 in 2021, and expected to be $385,000 this year.

It is then forecast to fall to $364,000 in 2023, a 5.5% decline. Because nominal home prices don’t often fall, headlines will be grim.

It’ll technically be the second worst drop in home prices since the Great Depression way back in the 1920s/1930s. And the media will love to point that out.

Sure sounds awful, doesn’t it? In reality, it will be theoretically even worse with inflation eroding the dollar and real prices falling even more.

Real home prices could fall as much as 25%, which sounds pretty bad, but again would basically put us back to the year 2020.

Home Prices Could Bounce Back as Soon as 2024

I’ve long circled the year 2024 as the date of the next housing market crash. Or at least the peak. It appears to be coming a tad earlier than expected.

But still not too far off, especially when you consider the many years of excess seen the past few years.

It would have been easy to call a housing market top a few years ago, or even earlier than that. But yet it kept rising.

Anyway, all the major pundits are now basically in agreement that nominal home prices will drop. And due to inflation, real home prices will fall even more.

But when will they recover? Or stop falling? Well, Bill McBride over at Calculated Risk sees real home prices falling +/-25% over the next five to seven years, with much of that due to inflation.

In other words, limited nominal price declines, though as noted still potentially 5-10%. But as mentioned, 5-10% isn’t much when home prices effectively doubled in preceding years.

Anyway, McBride sees a longer timeline to recovery than Wells Fargo, though not that long. And nothing like the “cascading price declines” seen during the Great Recession.

At that time, he notes that “nominal prices fell 62% in Las Vegas, 56% in Phoenix, and 51% in Miami.”

He doesn’t see that this time around largely because supply is low, underwriting is sound, and distressed sales likely won’t be a big factor.

Turning back to Wells Fargo, they expect an even faster recovery thanks to future Fed rate cuts.

Once those happen, mortgage rates should follow suit, allowing for “a modest improvement in sales activity.”

This could “reignite home price appreciation heading into 2024,” with the median existing sales price rising back to $376,000.