The American Housing Stalemate is Triggering the Market - and Buyers

It’s a crazy housing market out there folks, and those among us who think the housing market is in a bubble continue to predict a market crash. It's an opinion I don’t share, but one that many people have formed due to the rapid rise in home prices and mortgage rates during - and after - the COVID-19 pandemic.

I certainly can’t predict whether housing prices will decline, or perhaps even crash down the road. Things are too uncertain right now to forecast any outcome - up or down. Many who talk about the possibility of falling prices suggest that such a trend would be a bad thing - like during the Great Recession – a repeat of the 2008 crash, if you will.

But would falling housing prices necessarily be bad? Some think yes, while others say, "No!" In my mind, the worst-case scenario for America’s housing market would be a continuation of the current stalemate; where home ownership remains unaffordable for increasing numbers of millennials and younger generations largely because of recent political policies (primarily too low interest rates for much too long).

Conflicting Factors

Currently, millions of people enjoy low-rate mortgages – many of whom are enjoying sizable home equities reaped from recently bloated home prices. For those fortunate individuals, that combination of positive factors adds up to a big margin of safety against a scenario of falling prices.

On the flip side, a supportive argument could be made that falling home prices might very well be a boon to the economy. How so? Well, in anticipation of falling prices, there would likely be a host of current homeowners suddenly more willing to put their homes on the market - a market already pregnant with the ample pent-up demand of countless young millennials looking for an opportunity to finally buy a home for their growing families.

Triggering Effect

This pairing of anxious current homeowners anticipating falling prices for their homes and the pent-up demand just might stimulate a major upswing of activity in the residential real estate world.

In what way(s)?

More people would likely list their homes, swelling used home inventory numbers. More people would buy due to reduced prices and lower mortgage rates. And history shows that when there is respectable activity in the housing market, buyers – and sellers, many of whom become new buyers themselves – spend lots of money on relocation costs and on indoor décor, furniture, renovations, lawn equipment, and so on.

Worst-Case Scenario

Currently, the residential real estate market is suffering from what I consider a worst-case scenario, which combines high mortgage rates (relative to the recent past) and millions of homeowners who have low mortgage rates on their homes with little incentive to sell. The result is a severely restricted inventory of used homes – a set of circumstances resulting in housing prices not falling, and in many cases, continuing to rise.

It appears that as long as today’s mortgage rates remain high relative to recent unusually low rates, affordability will be a problem. Entire segments of potential homebuyers will either be compelled to pay an uncomfortably large portion of their budget for a home…or will be locked out from buying a home because they simply can’t afford to do so.

This situation of the “haves” (who already own a home or can afford to buy one) and the “have nots” (who would like to but simply can’t afford the price) appears to be stuck in a lingering status quo. This is particularly unfortunate for many young people who entered their prime years during a stubborn housing stalemate.

Might it continue? Is there a chance the housing market might become even more untenable?

Stalemate Flashback

We should be ever mindful of the 1970s when another impactful demographic - the Baby Boomers - entered their “family formative” years. It, too, was a decade of financial turmoil. And, not unlike 2022, the 1970s was an inflation-riddled period when both stocks and bonds experienced nominal gains decimated by inflation…except for housing.

Even after considering the negative impact of Izzy the Inflation Monster, 1970s home values rose by double-digits on a real basis. But mortgage rates were rising, too – ranging from 7% to upwards of 12% on 30-year fixed rate mortgages. In fact, by 1981 - thanks to the Fed’s battle against raging inflation - I recall mortgage rates as high as 18-19%.

Affordability was also a major problem in the 1970s and early 1980s. That housing market experienced similar stalemating events like today’s through a combination of rapidly rising home prices and mortgage rates. And like today, housing prices remained strong. Without question, 2023’s events are more muted on an inflation-adjusted basis than back then, but a familiar combination of events – rapidly rising home prices accompanied by Fed-forced mortgage rates – stressed home buyers during both periods. It’s rare that economic and/or housing market environments are similar, but it seems to me that the 1970s "stalemate dynamic" is playing out in today’s housing industry.

Wouldn't it be healthier if prices declined a bit, spurring housing activity and offering relief to those millions of buyers currently priced out of the market? For prices not to drop just might be the worst-case scenario for today’s housing market. Folks with big equity position homes and low mortgage rates would likely welcome continued price increases. But might it be more beneficial to the broader economy and make for a healthier housing market if prices ratcheted down a bit?

In Sum

In summary, the affordability issue lingers at a decades-old low level, leaving potential buyers in its wake. According to NAR, existing home sales decreased 4.1% in October from the prior month to a seasonally adjusted annual rate of 3.79 million…the lowest rate since August 2010.

The quandary: Americans who want to move are trapped, locked in by low interest rates they simply can’t afford to abandon, while high interest rates and home prices continue to pummel the rest of the housing market. According to mortgage-data firm Black Knight, as of March 31, 2023, nearly two-thirds of primary mortgages had an interest rate below 4%, 73% of which were 30-year, fixed-rate contracts. Compare that with an average rate for a new 30-year fixed mortgage rate of 6.39% at the end of May 2023, according to Freddie Mac.

This continuing reluctance of existing homeowners to sell might very well keep home prices from falling significantly for some time to come. Only time will tell.