Why don’t house prices crash?

The latest Case-Shillers National Home Price Index data was released this week. Here’s where we stand when it comes to deductions from peak prices:

This is the third largest national home price decline since 1987, but I’m sure many people are surprised that prices haven’t fallen more than with 7% mortgage rates and unsustainable price gains in recent years.

The latest data shows an annual gain of less than 6%:

These kinds of gains are still relatively high, but come down from nosebleed pandemic levels.

To be fair, this data is only up to the end of December 2022. House prices have probably come down a bit more this year.

There are certain areas that experience larger price declines – places like San Francisco, Phoenix, Boise, Seattle Austin, etc. But those are also the places that experienced larger gains during the boom years.

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

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

The simplest reason is that the rapid rise in mortgage rates has slowed housing activity to a crawl.

Inventory levels rose a bit, but are crashing again, so there just aren’t that many houses on the market:

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

This makes sense when you consider that no one wants to sell and no one wants to refinance since the majority of homeowners have mortgage rates that are well below today’s levels:

Home Depot’s CFO talked about how this dynamic has been a boon to their business because all those people with 3% mortgages are choosing to renovate instead of move:

It’s hard to see market clearing prices when there isn’t much of a market anymore.

Homeowners are already living in their homes longer than they did in the past, and this trend is likely to continue (via Redfin):

It’s possible that younger generations won’t want to stay in their homes as long as older generations have because of changing tastes, but 3% mortgage rates are going to make that decision harder:

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

Millennials will want bigger homes again as they begin to have families.

Housing activity will pick up again at some point.

But if mortgage rates don’t return below 5% or 6%, it’s hard to see the impetus for existing homeowners to list their homes for sale in a big way.

The capital effect is also strong in the housing market. This is the inertia that causes people to place a higher value on something they already own.

That house four blocks over is way overpriced, but there’s no way I’m cutting the price of my house.

This behavioral bias may also mean that people waiting for lower prices need to be patient.

Cullen Roche had a piece this week comparing house prices to rents since 2000:

Logically, you would think that this gap would have to be closed at some point.

Cullen says we’ll have to be patient to see prices drop:

If there are very few sellers and even fewer buyers, it is not unreasonable to assume that the sellers will push prices down as the low number of buyers demand lower prices. Put differently, to use a stock market analogy, if we were looking to buy a stock with a thin set of bids and a fundamental price that one bidder believes is significantly lower than the current market price, then that individual bidder has pricing power despite the fact that only a few are asking prices. And if the asking gets desperate enough with a patient bidder, prices will drop regardless of the “low inventory”.

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

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

It may just be that those who really need to sell will take some time to bring prices down to more reasonable levels.

If housing prices fall in a meaningful way, it will likely be more of a slow burn than a crash.

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

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

Here’s what I’ve been reading lately:

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