Lower Prices And Less New Construction

Home prices and rents will decline in the next year, on average, though different parts of the country will experience somewhat differing paths. In the aggregate, housing prices will decline for both homeowners and tenants. Before getting too glum, though, homeowners should acknowledge the 45% appreciation they have had, on average, over the last three years. Giving back a bit of that won’t be so terrible. And landlords have increased their rents by 30% in the same period; they can get by on a little less.

On the owned property side, higher mortgage rates pack a very strong punch to the gut of prospective homebuyers. The recent 6.70% mortgage rate pushes monthly payments 54% higher than the 2021 average mortgage rate of 2.96% on the same loan amount. But with higher prices, buyers have to finance more. Thus homebuyers face a double-whammy pushing their mortgage payments up.

On the apartment side, those rising rents exceed other consumer prices, on average, and wage rates are not keeping up. On the positive side, employment has increased, helping those who were jobless a year ago, though a small bit of that is offset by fewer hours worked by time-clock employees. The job gains, though, don’t match the rent increases.

So for both home-buyers and renters, costs have risen far faster than incomes. What pushed demand up for both owned and rented properties was more households relative to our population. When a child moves out of the parents’ house, that’s an additional household. When two roommates decide to live separately, that’s an additional household. And when a married couple splits up, that’s an additional household. Last year’s increase in households was nearly four times higher than the increase in population.

The gain in households was driven by higher incomes, obviously not by cheaper housing. Jobs increased, wage rates rose, and people had stimulus money left over.

The outlook for housing demand is pretty dismal, but from a very high starting point. On the owned property side, the high prices and high mortgage rates have combined to make purchases by first-time buyers much more expensive than in the last two years. There are some families that are just now able to buy their first house, but most folks who did not buy in the past two years are not at all in a position to buy now.

On the rental side, the only good news is that fewer families will move out of apartments into single family homes. But the high rents and the high inflation of other household expenses mean that many tenants will need roommates to help foot the monthly payments and utilities. That shrinks demand for rental units.

Real estate advocates frequently say that we have been underbuilding in past years. From 2007 through 2020 the number of housing starts and completions lagged the long-run average. But this simple look ignores population growth, the key reason we build new housing. In the years prior to 2007, U.S. population growth averaged 2.6 million people per year; since then only 2.0 million. That old benchmark of housing starts exceeds our current needs.

Housing construction relative to population growth also ignores some things, such as the movement of people within the country. Many rural areas are losing population, but those old farmhouses cannot be moved to the city in most cases. Plus some old properties are torn down, and the wealthier population buys some vacation homes. Still, the slower population growth is the largest factor explaining less building of new housing units.

For both single family homes and apartments, quantity demanded will drop and prices will come down. The magnitude depends on local characteristics of population growth and new construction. Good news on the single family side is that some depreciation simply gives back the enormous gains of recent years. A ten percent price drop would leave most homeowners better off than they were ten months ago. And a 25% decline would only take home values back to August 2020.

The coming housing downturn will not end up as badly as the 2008-09 recession for two reasons. First, mortgage lending in recent years has been far more stringent than in the early 2000s. Most buyers started with significant down payments and documented actual income. Second, home appreciation at the peak of this cycle was about twice as great as before the 2008-09 recession. As a result of these two factors, almost all homeowners who cannot make payments can sell their homes at a profit and pay off their mortgages. A recession will certainly cause distress for some families, but without widespread repercussions for the housing market.

Real estate agents will find fewer people looking to move. So many mortgages were refinanced down to three percent that few people will abandon those cheap interest rates to buy a new house at a much higher rate. However, this will be a boon to remodeling contractors, enabling people to keep low mortgage rates but add on space or upgrade what they now have.

Developers and contractors will suffer in the coming two years as new construction wanes. We are already seeing that in single family construction. Multifamily projects typically have longer lead times, and thus more momentum going into this slump, but by next year multifamily construction will also be down.

Expansive monetary and fiscal policy over-stimulated the housing sector, and now tighter monetary policy is pulling that back. Unfortunately, roller coasters fit in better at amusement parks than in residential neighborhoods.