The Decline of Home Prices
The downturn in US home prices continues to intensify with the Case-Shiller Index falling for the sixth consecutive month and the Census Bureau reporting that the median new home selling price has declined by 15%.
Several months ago, we heard that the US housing market was facing a supply shortage and that meant home prices couldn’t fall.
Fast forward to today and home prices are falling in many areas of the country with all 20 major cities reporting price declines in December’s Case-Shiller report.
In this article, we’re going to look at the real reason home prices are declining and why these price declines will continue.
Over the summer, we made a video discussing several leading indicators of home prices and said that home prices would turn down and by potentially a large amount in late 2022 and early 2023.
We’re now seeing swift declines in many regions of the country, specifically areas like Phoenix and Las Vegas, two areas that have a high volume of new construction, which was the area of the market that we noted had very elevated levels of supply.
Let’s now review the state of the US housing market and what to expect in 2023.
Existing & New Home Markets
There are two housing markets in the United States. There is the existing home market and the new home market.
The existing home market is the buying and selling of homes with previous owners and the new home market is the purchase of a newly constructed home.
The existing home market represents almost 85% of all transactions so most people focus their attention on this market.
The new home market, while only 15% of all transactions, is far more important for the overall economy because of the impact to the construction sector and construction employment.
We want to focus on the new construction market because this is what sets the tone of the rest of the housing market. The builders and speculators always get squeezed first and set the price on the margin.
In the existing home market, there is only 3 months of inventory which is extremely low. Prices normally rise when inventory is this low.
But in the new home market, inventory is still very high at nearly 8 months. Prices generally fall whenever inventory is higher than 5 or 6 months.
Because the existing market is bigger, total US housing only has 4 months of supply which is very low, but home prices are still falling.
Everyone got this wrong because home building companies are like any other industry. They will only keep inventory on their books for so long and then they will cut the price and move on. When home builders slash their prices to move inventory, eventually these prices declines bleed into the existing home market, even though there is still tight supply.
This is exactly what happened in January. Both the Average and median sales prices for new homes are now down about 15% from the peak. In fact, the current decline in median new home prices is the second largest in the 50 years of data, only exceeded by the 2008 crisis.
In January, prices fell and the months supply of new homes fell from 10 to 7.9 which shows that homebuilders slashed prices to drive an increase in sales.
Also, in January, mortgage rates fell into the low 6% range, even the high 5% range in some cases, so the combination of lower mortgage rates and lower prices helped buyers in January and allowed homebuilders to move some of their stale inventory.
Future Outlook
But where do we go from here? Are homebuilders going to cut prices more than 15% and will existing homes follow?
In January, the combination of a 15% price cut and lower mortgage rates caused an increase in affordability. In February and early March, mortgage rates surged back towards 7%.
Buyers immediately felt the sudden decline in affordability and pulled back, even with new homes marked down 15%.
Applications for new mortgages fell to the lowest level since 1995.
When we zoom out and look at the broader picture, we see that the Federal Reserve is still raising interest rates and contracting the money supply. This is putting pressure on mortgage rates and buyer demand is slowing as a result.
The Federal Reserve and Federal Government injected a huge amount of money into the system but after we adjust for the increase in prices, we can see this money mountain is just about back to the long-term trend level and it certainly will be over the next few months.
What’s also interesting is that as soon as this excess liquidity started to get reversed, at the start of 2022, is when the housing momentum stalled.
Right now, home builders still have too much supply and are going to see supply numbers jump again as new buyer demand slows under the higher mortgage rates and a reversal of all the excess liquidity.
So the factors that have contributed to the home price declines so far, particularly on the new construction side, are going to continue. Price declines will bleed slowly into the existing market but will continue to be led by the areas of the country that had excessive and speculative home building.
