Why aren’t house prices collapsing?

The latest data from the Case-Shiller National Home Price Index was released this week. Here’s where we are in terms of peak price drops:

This is the third national decline in house prices since 1987, but I’m sure many people are surprised that prices haven’t come down more, with mortgage rates at 7% and unsustainable price increases these last years.

The latest data shows a year-over-year gain of less than 6%:

These types of gains are still relatively high, but they are declining from pandemic levels of nosebleeds.

To be fair, this data is only for the end of December 2022. House prices have probably fallen a bit more this year.

Some areas are seeing bigger price drops – places like San Francisco, Phoenix, Boise, Seattle Austin, etc. But these are also the places that saw bigger gains during the boom years.

There has yet to be a complete collapse of the national housing market despite the worst levels of affordability we have probably ever seen.

With the caveat that house prices can and likely will fall further from current levels if mortgage rates remain at 7%, let’s examine the data to see why prices have remained relatively stable even in a rising rate environment. .

The simplest reason is that rapidly rising mortgage rates have slowed real estate activity.

Inventory levels have gone up a bit but are plummeting again, so there just aren’t many homes on the market:

Mortgage purchase application activity, essentially the number of loans starting, has fallen off a cliff to the lowest levels this century:

This makes sense considering that no one wants to sell and no one wants to refinance since the majority of homeowners have mortgage rates well below current levels:

The CFO of The Home Depot explained how this dynamic has been a boon to his business, as all those people with 3% mortgages are choosing to renovate rather than move:

It’s hard to see market prices balance out when there isn’t much of a market left.

Homeowners were already staying at home longer than in the past, and this trend is likely to continue (via Redfin):

Younger generations may not stay in their homes as long as older generations due to changing tastes, but 3% mortgage rates will make this decision harder:

The good news is that demographics will eventually force people’s hands. Baby boomers will downsize, move to Florida, or die.

Millennials will want bigger homes once more as they start having families.

Real estate activity will resume at some point.

But if mortgage rates don’t drop back below 5% or 6%, it’s hard to see the impetus for existing homeowners to put their homes up for sale in large numbers.

The endowment effect is also strong in the housing market. It is inertia that causes people to place greater value on something they already have.

That house four blocks away is way too expensive, but there’s no way I’m going to lower the price of my house.

This behavioral bias could also mean that people waiting for lower prices will have to be patient.

Cullen Roche had an article this week comparing housing prices to rents since 2000:

Logically, one would think that this gap should close at some point.

Cullen says we have to be patient to see prices come down:

If there are very few sellers and even fewer buyers, it is not unreasonable to assume that the sellers will drive prices down because the low number of buyers demand lower prices. That is, to use a stock market analogy, if we were looking to buy a stock with a restricted set of ask prices and a fundamental price that a bidder thinks is significantly lower than the current market price, then that single bidder has a pricing power despite the fact that there are only a few asking prices. And if demands get desperate enough with a patient bidder, prices will drop regardless of “low inventory.”

I’ve been saying this for over a year now, but this environment remains one where patience is required. Housing is an inherently slow moving beast and we cannot expect anything to happen quickly here.

There could be something to it. You can’t buy and sell your home as quickly as you can buy and sell a stock (and for good reason).

It may take time for people who really need to sell to bring prices down to more affordable levels.

If house prices fall significantly, it will likely be more of a slow burn than a crash.

Michael and I discussed the housing market and more in this week’s Animal Spirits video:

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Further reading:
What happens if house prices fall by 20%?

Here’s what I’ve read lately:

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