Is the Real Estate Market Going to Crash?
2022 has been a year of change for the United States real estate market. Coming off of a covid-infused housing frenzy, 2020 ushered in the cheapest borrowing costs the country has ever seen, with rates on 30 year fixed mortgage dropping into the 2s, and nationwide lockdowns causing many people to re-assess their living situations. Add in remote work, which for the first time in history allowed millions of workers to live anywhere without a negative impact to income, and many people had many reasons to move. A lack of the ability to travel also left many desiring more space and better amenities at home. For the cherry on top, covid lockdowns and the resulting supply chain bottlenecks led to new home construction slowing to a snail’s pace, with homes taking longer to complete due to staffing shortages as well as major delays in supply delivery. It was the perfect storm, and home appreciation was the beneficiary. For 2 years, the US saw home appreciation see averages of 20% growth year over year. And while 2022 has seen appreciation thus far just shy of last year’s numbers, demand has slowed, and the supply chain is slowly but surely catching up.
This shift has caused a major change in the temperature gauge of the housing market, with a lot of talk about a potential crash in real estate. But real estate, despite being an immensely complex industry, largely boils down to basic economics and supply & demand. When more people demand homes and there’s not enough housing inventory, we see prices go up. If there’s a glut of inventory and no one wanting to buy, it puts downward pressure. Economics 101. One good way to get an idea of what the future holds, is to look at the past. Historically, there’s been a mentality that “home prices always go up!”, which held true, until it didn’t. 2008 saw the first and only major real estate crash the US has seen, and if we look at the many reasons why that crash occurred, one that stands out amongst all others is supply and demand. You can see in the graphic below that the gap between new home completions and household formations grew substantially, creating a situation where a tremendous amount of inventory existed for a group of buyers that simply didn’t exist (for reasons I won’t get into here).
Fast forward to today’s market, and many things have changed. One major industry shift involves spec housing. In the early 2000s it wasn’t uncommon for builders to put up hundreds or thousands of homes under the presumption they’d be sold upon completion. Since the real estate crash, builders have been far more conservative in building before demand shows itself. For this reason, inventory is taking longer today to hit the market, and is more quickly absorbed. Household growth has also taken off, with millennials and GenZ (both enormous groups) coming to age, forming households, and adding to the demand for housing. If we look at the numbers today, completions of new homes are lagging behind household growth substantially, leaving supply & demand nearly opposite what we saw during the crash of 2008.
In terms of supply and demand, in the vast majority of markets, supply is being outpaced by demand for housing. And though headlines focus on the recent uptick in inventory, it’s very important to remember the comparisons being made are to the very abnormal covid-dominated markets of 2020 and 2021. Comparing inventory today to those years gives the illusion that supply is too high, but a quick comparison to previous years shows that on a historical basis, current housing supply is still lagging well behind the needed demand.
Beyond supply and demand, it’s important to understand one of the biggest causes for the shift in the real estate market in 2022 has been due to affordability and interest rates. We noted the substantial appreciation seen in home prices the past 2 years, and 2022 ushered in the swiftest increase to interest rates the mortgage market has ever seen, with rates increasing from the 2s to the 6s in a matter of months as the markets were hammered by inflation. This huge spike in the cost of money (in a market where ~85% of real estate has been financed with mortgage money) pushed many buyers to the sidelines, reducing demand. However, inflation is under attack, with the Fed increasing their fed funds rate, and the economy beginning to sputter. We’ve seen fuel costs come down from their highs, and mortgage rates have also dipped nearly a full percent since the Fed began hiking their funds rate in mid-June. Typically, in a recessionary environment and one where the Fed is working to reduce inflation, mortgage rates drop. Should borrowing costs come down, buyers that were pushed to the sidelines with the huge mortgage rate increases seen early in the year should be enticed back to the market, a market that is still largely in need of inventory.
While 2022 is certainly a different year from 2020 & 2021, the data points to a still-healthy real estate market, and it can be argued, a healthier, more balanced market than the prior 2 years. ~20% home appreciation growth is neither sustainable, nor good for the overall market, and recent forecasts point to home appreciation going forward at estimates more in line with historical appreciation rates. While many people are nervous about a real estate market crash, it’s important to note we’re in a much different environment, with much lower housing supply and steady demand, than we saw the last (and only) time housing experienced a crash. If anything, late 2022 should present ample opportunities for buyers as a combination of more housing inventory and a reduced-interest rate environment will improve affordability.
It remains to be seen where the economy will go in terms of recession, employment numbers, and inflationary concerns, but for now, both data and history suggest that while housing has cooled from the insanity of 2020 and 2021, the industry is still in a healthy position, and more inventory is still needed to bring balance to the market.
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