Yes, the Housing Market Will Come Back Down. Here’s Why

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  • A home is only worth as much as buyers are willing and able to pay.
  • There are several factors at play, each impacting home prices.

All indications are that home prices cannot continue to rise at the current rate.

In the history of the U.S., there's never been a hotter housing market than what we're seeing right now. While there have been strong markets, never before have we experienced double-digit year-over-year increases in home values. For home sellers, it's exhilarating (unless they have to overpay for their next home). For home buyers, it's been a nightmare, with investors and all-cash offers beating them out time after time.

A brewing problem

According to Freddie Mac, the U.S. had a housing supply deficit of 3.8 million units in the fourth quarter of 2020. And that was back when we had no idea that we'd still be grappling with COVID-19 two years later.

But the problem began much earlier than 2020, reports NPR. When the bottom fell out of the housing market in 2008, the Great Recession caused many home builders to go out of business. Many of those tradespeople who depended on construction to pay the bills found other work. As the U.S. came out of the recession and Americans started buying homes again, there were fewer builders to keep up with the surge in demand.

The bottom line is this: Although the current shortage of homes has driven prices sky-high, it's a problem that's been in the making for over a decade.

Maintaining realistic expectations

There is no reason to believe that the housing market will crash like it did in 2008, primarily because lenders are now so careful about who they approve for a mortgage. In some areas of the country, housing prices will drift back downward. In others, home values will continue to rise but at a dramatically slower pace than we've recently experienced.

It helps to understand that the long-standing housing shortage is not going anywhere soon. There's not going to be a sudden influx of new homes on the market that drive houses down. What we're likely to experience is a stabilization of prices.

Here's how we know prices will stabilize

Here are a few current indicators that a change is coming to the housing market:

Price + interest rate = fewer buyers

That old adage "what goes up must come down" does not just apply to gravitational force; it also applies to economics. Prices can only continue to climb if people are willing to pay those prices. Once there are too few buyers, the lack of demand pushes prices back down. For example, just look at the Beanie Babies craze.

Over the past two years, mortgage rates plummeted to below 3%. In hopes of taking advantage of low rates, home buyers flocked to look at houses. Today's average rate for a 30-year fixed mortgage is hovering around 5.5%. Historically, 5.5% is a low rate, but home values, which have been pushed up by the number of people hoping to buy vs. the number of available homes for sale, still haven't come down much.

The fact that we currently have high house prices and higher interest rates has pushed some out of the market. Here's why: Let's say a person wants to borrow $300,000. At 2.9%, principal and interest on the loan would cost that home buyer $1,249 per month. At 5.5%, principal and interest on the same home would run $1,703. Add to that property taxes and homeowners insurance, and rising interest rates are sure to price out a lot of would-be buyers.

The Federal Reserve announced earlier this year that it planned to raise the federal funds rate a total of seven times in 2022. Since it's already gone up twice since March, it's safe to assume that we'll see five more rate hikes. Each hike is designed to control inflation, including the inflated price of homes.

Pockets of waning interest

In the last week of March, tours of homes fell by 21% in California, normally a hotbed of house buying activity. In San Francisco, Boston, Seattle, Washington DC, and Los Angeles, real estate agents reported fewer calls from interested buyers. While the entire nationwide market was scorching hot a few months ago, there are pockets of cooling. Home prices may not be falling like rocks, but they are increasing at a more typical rate.

Inventory ticking up

We know that newly built homes are not coming on the market at the rate necessary to drive down prices, but for many months, too few "For Sale" signs were planted in the yards of existing homes. People were not selling for several reasons, including rolling outbreaks of COVID-19 and the knowledge that they would have to pay an inflated price for their next home.

According to CNN, the number of houses going on the market just ticked up for the first time since August 2021, with home prices expected to peak this spring.

The economy tends to be somewhat cyclical. Interest rates go up and they come down. Home prices soar and either level off or soften. While we can't predict the details, history has taught us that what goes up must come down.

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