As we pass the midpoint of 2023, it’s a good time to take a look at what’s happened in the housing market so far this year and consider what could happen in the second half of the year.
The big headline from housing so far has been the resilience of home prices. Even as mortgage rates have hung around 7% and sales volume has dropped about 50% from June 2021 to June 2023, prices are somewhere between flat and -3% YoY, depending on who you ask.
No matter what data you look at, so far, the calls of a market crash have been incorrect. In fact, recent trends suggest home prices could even be up by year-end.
I’ve been pretty adamant that I didn’t see the residential market crashing in 2023, but this price resilience has outperformed my expectations. Last October, I said I thought the market would correct between 3-8%—but as of midyear, even that seems overly bearish (even though it was considered by many to be overly optimistic at the time). Of course, things could change in the second half of the year, but let’s review why prices haven’t fallen very much.
Housing prices, as with all prices in a market economy, come down to supply and demand. For most people, the expectation has been that prices would fall in 2023 because demand left the market.
And demand has left the market. As mortgage rates surged over the last 18 months, fewer people have wanted or been able to afford a new home purchase. Demand can be difficult to measure, but I think the best place is the Mortgage Brokers Association’s mortgage purchase application survey. It measures how many people apply for a mortgage to buy a new home (not refinance).
As shown, the expected demand decline has materialized. Mortgage purchase applications are down to about half of where they were in the peaks of 2020 and 2021—but have been flat for the last year or so.
So why, then, have prices not dropped? The answer is quite simple, actually. Even though demand has fallen, supply has fallen at the same time, which has kept prices stable. If you want to get a little nerdy about it, here is a good explanation of supply and demand shifts.
But for everyone else, just think about this logically: Even though there are fewer people who want to buy, there are fewer houses to buy—which means the balance between buyers and sellers has remained relatively consistent. This keeps prices consistent.
In the housing market, supply is measured by inventory (how many houses are for sale at a given time).
As shown in the chart, inventory is extremely low. It’s moved up a bit from the all-time lows during the pandemic, but we’re still seeing inventory numbers that are 46% below pre-pandemic levels. So even though demand has dropped and cooled the market down from its frenzy, lack of supply has prevented prices from declining further.
What Happens Next?
To understand what happens to home prices through the end of 2023, we just need to consider what potential changes there could be to supply and demand.
On the demand side, there are many potential impacts. Variables that could lessen demand include (just to name a few):
- Higher interest rates
- Reduced affordability due to the resumption of student loan payments
- Increases in unemployment
- Sustained inflation
Variables that could increase demand include:
- Lower mortgage rates
- Wage increases that outpace inflation
On the supply side, I find it hard to believe inventory will go much lower, but of course, it’s possible. The number of new listings is down almost 30% year over year and trending downward. If prospective sellers continue to choose not to sell, inventory could continue falling.
Supply could rise from foreclosures, new construction, or sellers adjusting to the new reality and deciding to list their properties despite higher rates.
Looking to the Future
So what will happen? No one knows for sure, of course, but I’ll give you my opinion in the form of three possible outcomes: my base case (most likely outcome), downside case (how prices could decline further than I think), and my upside case (prices outperform my expectations).
Base case
My base case is that demand remains relatively flat, or could decline slightly, through the end of the year because I don’t expect mortgage rates or affordability to change all that much.
On the supply side, I think things will remain relatively stable as well. People aren’t selling because of the “lock-in effect.” There is an economic incentive not to sell, and I don’t think that will change in the next six months (and maybe not for the next several decades). Foreclosures are rising, but not in any meaningful way that will impact inventory, and I am not convinced that the “Airbnbbust” will generate any meaningful amount of new listings on a national level.
So, if I were to redo my year-end prediction for 2023, I would revise it upward. As of now, I think the housing market will end the year flat on a year-over-year basis—or, to give myself some wiggle room, somewhere between 3% and -3%.
Downside case
Could something else happen? Of course! My downside case (price declines of more than 3%) would include a big increase in layoffs and unemployment that causes demand to deteriorate or an increase in mortgage rates due to rising bond yields.
Upside case
My upside case (price increases over 3%) would include a pause in interest rate hikes by the Federal Reserve and an easing of inflation that causes mortgage rates to drop and demand to increase. This would have to be combined with continued strength in the labor market.
Given the extreme amount of economic uncertainty, I assign the rough probabilities of each case as follows:
- Base case: 50%
- Downside case: 20%
- Upside case: 30%
What Does This Mean for Investors?
As an investor, I encourage you to think about the housing market in these terms. None of us know what will happen for sure—and it’s important to acknowledge that. But that doesn’t mean you can’t invest! By understanding the variables that impact supply and demand, you can logically think through the various scenarios that could unfold, understand and mitigate potential risks, and plan your investing decisions accordingly.
What do you see moving the housing market through the end of the year? What’s your base case? Let me know in the comments below!
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
