With home sales down, why are home prices still up?

Looking at the housing market in the years 2020-2024, one risk I identified early on was that home prices could accelerate more in this period than we saw in the previous expansion if inventory channels broke to all-time lows.

I talked about having a 23% price-growth model for the housing market in the years 2020-2024 as a critical marker of balanced growth versus overheating, especially as inventory had been falling for years right into our critical demographic patch. Slow and steady always wins, but sometimes fate deals you a bad hand, and not much can be done when the marketplace overrides anyone’s desire for balance.

Over the last two and a half years of U.S. housing, one thing that will make the record books is that it wasn’t housing deflation we needed to worry about, but housing inflation on both ends: home prices and rents.

After 2021 ended and my price-growth model was broken after only two years and we started 2022 at all-time lows in inventory, I labeled the U.S. housing market as savagely unhealthy. This problem is much different than the housing credit bubble of 2002-2005. Back then, we had higher sales, higher inventory, and less price growth, but we had a massive credit bubble. Today we have fewer sales, few listings, and much hotter home-price growth.

When I talked about needing higher rates in February of 2021, it was based on the fact that we didn’t have a credit bubble, so the demand is legit. However, this also means that demand has limits. The reality was that global bond yields were still low, and getting the U.S. 10-year yield above 1.94% was going to be problematic. As inventory fell again, bidding wars became the norm, and home prices escalated. 

By October of 2021, it was apparent that inventory had no chance of showing any year-over-year growth, and we were heading to an even worse home-price growth inflation story in 2022 unless rates rose. January and February data looked so bad that I threw in the towel and said nothing else matters at this stage — we need rates to rise to try to cool this market down.

Mortgage rates of 4%-5% weren’t doing the amount of demand destruction I thought they would. I was anticipating four-week moving average year-over-year declines of 18%-22%, but we were seeing high single-digit and lower double-digit declines. Mortgage rates closer to 6% for sure are driving bigger year-over-year decline data. Still, I never got the four-week moving average decline of 18%-22% trend that I was looking for and it’s now past the traditional seasonality time for this data line.

On Wednesday, the purchase application data was down 4% week to week, 18% year over year, and the four-week moving average decline is now down 17.25%. I will assume that the growth in ARM loans this year prevented the 18%-22% year-over-year decline trends I was looking for earlier in the year.

By October of this year, the year-over-year comps will be much harder, so we can expect bigger declines if the trend stays the same.

However, mortgage rates getting to 6.25% indeed have picked up the pace on the year-over-year declines percentage wise in the purchase application data. Still, here are just a few examples of why we needed rates to rise. (This is not normal, folks. You don’t see percentage declines like this with year-over-year price growth in June.)

• Las Vegas home sales were down 24% year over year as median sales price was up 21% year over year.
• Orange County, California attached homes in June, sales were down 27.2%, and prices up 17.8%.

Redfin:

Realtor.com: 

Now just imagine how hot home prices would be if mortgage rates didn’t rise past 6% this year and we didn’t take the big hit to affordability? The housing market always sees better demand once the 10-year breaks under 2% and we have sub-4% rates.

In the middle of the drama of higher rates, my bigger fear is actually if rates go down again. Home sellers and builders had too much pricing power, pushing prices to the extreme. My five-year growth price model got smashed in two years, and things worsened in 2022 before rates rose.

Remember, we all want a balanced housing market; it’s a good thing, not bad. So the goal for me lately is to see total inventory get back to 2019 levels. That will be positive, and we are working our way there, we just need more time because the housing market of 2022 is not the forced credit selling housing market of 2008. I don’t need the housing market to have 2012, 2014, orr 2016 inventory levels to be balanced — I just need 2019 inventory data, which is between 1.52-1.93 million homes, using the NAR data.

NAR: Total Inventory

Realtor.com and others have data lines that use other inventory metrics. However, they all trend the same way.

From Altos Research:

I recently did a podcast with Mike Simonsen from Altos Research on this topic.

As the economic cycle shows more recessionary data lines, traditionally, the bond market and mortgage rates head down together.

On Wednesday we had another hot CPI print, and the 10-year yield is trading at 2.93%. This isn’t even the high we had back in 2018 when inflation growth was cooler. Many people believe mortgage rates should be higher today if they were tracking the growth rate of inflation, meaning bond yields should be much higher, too. However, since 2021, bond yields haven’t followed the growth rate of inflation.

From BLS:

The downside of higher rates
Housing construction will slow

Keeping in line with my summer of 2020 premise that for the market to change, it needs a 10-year yield above 1.94% and with duration to impact sales negatively. The new home sales sector will slow down like it always does.  Even in March of this year, when the data wasn’t terrible, the industry was at risk. 

Just last month, I raised my fifth recession red flag, knowing that the builders were at the point of pulling back on construction and focusing on selling what homes they had left and dealing with cancelation rates rising. My one argument here is that if we need 3%-4% mortgage rates for the builders to build at the expense of home prices increasing 15%-20% a year, it’s not a good trade off. 

Jobs and incomes will be lost.

As we all know, we have many companies in the real estate and mortgage sector that are laying off people. It isn’t just the companies that boomed due to COVID-19, so we have real-life material damage to households. Also, with fewer transactions happening, less transfer of commission will occur in housing.

Getting closer to a recession

With the fifth recession red flag raised due to higher mortgage rates, we are getting closer and closer to a total recession in the U.S., which in part means more Americans are losing their jobs and lives being turned upside down. With higher rates, inflation, and no employment, it is a stressful time for any household, especially those with children.

To wrap up, I labeled this market savagely unhealthy earlier this year because I knew what this data would look like. Home prices are growing even with higher rates, so we aren’t benefiting from falling home prices, even though sales are dropping. This has happened before when rates rose, sales fall, and price growth would cool down but not go negative.

However, it’s a different ball game here in 2020-2024. The S&P CoreLogic Case Shiller Home Price Index, while it lags, still shows 20% plus year-over-year growth. In the past, with higher rates, the growth rate would cool down toward single digits. Clearly, we aren’t there yet, but we should be getting there in time with the rising inventory.

Hopefully, this explains why I am part of “team higher rates” and why I believe a balanced housing market is the best. Higher rates are working; it just takes more time to get us back to 2019 levels of inventory.