Home Prices in 2023: What Will Happen?
We bought our first home at the end of April, 2021. We paid 30% over the asking price to avoid a bidding war. It was crazy. Housing prices have cooled off a bit since then, but not nearly as much as I had anticipated. This go me thinking about what I think home prices will do in 2023.
As I’ve discussed already, I don’t think mortgage rates are going to decline any time soon. At the same time, home prices are sticky. So my prediction is that homes prices in 2023 will remain dramatically unaffordable, even as prices come down. If your interest in a home is purely financial, I would hold off buying for now.
If, like most people, you want to buy a home for personal reasons, now might be a good time to test home ownership by focusing on smaller/more affordable properties. The competition for starter homes is intense and you’ll be competing with professional investors. But if you can land one, your total exposure to real estate risk will be limited.
Real Estate Prices Haven’t Softened Much
Back when we purchased our home in 2021, prices for homes were going through the roof:
When we signed our mortgage at the end of April, 2021, prices were approximately 36% over the 2008 peak of 184. It looks like prices may have peaked for this cycle during June of 2022 at an eye-watering 308. That’s up another 23% over the price we paid. Crazy times.
But that’s old news. What’s interesting is what’s happened in the interim. Before we can get into unpacking what home prices in 2023 might do, we need to talk about the elephant in the room: inflation and interest rates. Anyone who has been paying attention to financial news will be familiar with this graph:
If the slope on the curve above looks steep, that’s because it is. This last bout of monetary tightening was the fastest in recent history. Visual Capitalist does a great job of showing the trends:
So the Fed has raised rates a lot and they have done so at unprecedented speed. While it’s true that the Fed funds rate doesn’t explicitly control mortgage rates, the two are correlated. So it’s really surprising to me how little this has impacted home prices. To be fair, home prices have fallen 5% in 2023 already. But if someone told me in 2021 that the cost of borrowing would double and prices would only decline 5%, I would have laughed in their face.
Will Home Prices Lag or Predict Economic Activity?
I’d love to have Case-Schiller data from the 1970s. It’s the most recent example of the Fed and the economy dealing with persistent inflation. Volker’s steps as Fed chair during that time take up whole chapters in macroeconomic textbooks.
Unfortunately that data simply doesn’t exist. Since the Case-Schiller index’s introduction in 1987, the US economy has only been through 4 recessions and there’s no obvious correlation between the timing of recessions and housing prices. National home prices barely reacted to either the 1991 or 2001 recessions. For the Great Recession in 2008, home prices actually started their decline before the recession occurred. Now, home prices appear to be lagging the bizarre lockdown-induced 2020 recession.
One of the explicit aims of the Fed rate hikes is to tamp down on bidding wars and rampant price increases for housing. To that end, the Fed has been vocal about not cutting rates anytime soon. They are planning to slow down the rate increases, though.
With that in mind, I think it’s pretty likely that interest rates will remain high. They may even increase. Absent some other massive macroeconomic shock, I think that means home prices in 2023 will continue falling. In some markets that didn’t see huge run-ups in 2020 – 2022, my bet is that price reductions will be modest. In markets like Austin (where I live), I predict bigger price declines. It just doesn’t make sense for home buyers to pay >2x more for the same house. Something has to give.
What Can History Teach Us About Home Price Declines?
If I’m right that home prices in 2023 will continue to fall, how low can they go? Here are the median home values as far back as 1952, courtesy of DQYDJ:
It’s only a sample size of 4, but the median and average are approximately 10% and 14% respectively. Prices have already come down 5%, but if history is any lesson, prices could decline much further.
Could Home Prices Fall by More than 50%?
But even the dramatic charts above understate how much more expensive homes are for homebuyers. Here are the 30-year mortgage market rates from the late 90’s to present:
If you were in the market for a home back in mid-2020, that same home would now be 2.5x more expensive to finance. That’s crazy! And we know that the Fed is likely to keep pushing rates higher.
Which begs the question: could home prices in 2023 really fall enough to equilibrate the cost of lending? Could a home worth $1M in 2020 fall 60% to $400,000 to tamp down on runaway affordability? And here we enter the realm of speculation. My personal take is that no, our government won’t let home prices fall that far for two important reasons.
Homeowners Want Expensive Homes
First, home equity is a very important part of most American’s net worth. The conventional wisdom is that home equity shouldn’t exceed 25 – 40% of your net worth. [source] That’s always seemed pretty high to me, but RetireBy40’s 2016 survey suggests it’s accurate even among readers of personal finance blogs:
The data suggest that >50% of households have >40% of their net worth tied up in their home. That’s way more than I expected.
If 50% of my home equity evaporated next week, that would be pretty alarming, and I don’t get alarmed very easily. I can’t imagine most vocal, affluent voters putting up with it. If that much wealth disappeared in the space of 12-18 months, there would be enormous repercussions. Many homeowners would be underwater on their mortgages. Less wealthy people at the end of their careers would probably need to defer retirement. And those are just the first-order effects.
The financial system luckily isn’t built on the quicksand of subprime mortgages anymore. But the US residential real estate market is vast. In late 2022 alone, the value of real estate held by households increased by $1.5 trillion. [source] Nobody knows what would happen if 50% of home value evaporated, but it wouldn’t be good.
We Have Been Very Successful at Propping Up Home Prices
Tools like zoning, permitting, HOAs, and environmental impact assessments have proven very successful at keeping home prices up across America. I know the most about the Bay Area housing problems, so I’ll include an example from SF to illustrate the point. Here’s what Wikipedia has to say about the SF housing crisis:
“Since the 1960s, San Francisco and the surrounding Bay Area have enacted strict zoning regulations … partly as a result of these codes, from 2007 to 2014, the Bay Area issued building permits for only half the number of needed houses.” [source]
Meanwhile, up in Seattle, a 2,000 square foot home costs almost $14,000 just in application and permitting fees. [source]
Wealthy Americans have proven themselves very capable of using fees and zoning to get their way. I don’t see much changing on that front any time soon.
So What Do I think Will Happen to Home Prices in 2023?
In the above sections I showed that home prices would have to fall by more than 50% to keep housing affordability constant compared to 2021. I also outlined what I see as the two biggest reasons that such a big price decline is unlikely to happen. So what do I think is likely?
Forget About the National Picture
First and foremost, I don’t think it’s useful to look at national statistics about home prices. The reason that news outlets use national stats is that they are easy. But those national statistics obscure huge variations in price movements. Here’s what quarter-on-quarter housing price changes looked like across 100 metros [source]:
So the national average change in home price (-.7%) papers over a range of nearly 15%. If you live in San Jose, you are seeing prices decline by more than 10x the national average. With this in mind, I like to think about the fate of specific metros, not the nation as a whole.
Getting Down to Individual Metros
Here in Austin, Texas where I live, the real estate market got out of hand in the last cycle. We also haven’t seen home prices come down much in 2023 so far. My sense is that metros that overheated in the last cycles will fall the most.
In places like Austin, especially, the methods that NIMBYs have for controlling construction are blunted by the size of the place. I live on the northern border of Travis county, which is only a 30 minute drive to downtown. It’s easy to commute in from far outside of Austin proper, and zoning is substantially more lax outside of Travis county.
So unlike places that are hemmed in by water like the Bay, Seattle, or Miami, there’s plenty of land to develop. And sure enough, the number of authorized building permits in and around Austin have been elevated for the last 2 years:
Eventually, those permits will turn into homes for people. That additional supply should create enough supply that home prices will dip substantially later this year, potentially in early 2024.
But as I discussed above, I think there is a psychological limit to how much homeowners will allow prices to fall. At some point, wealthy homeowners will start making irate calls to their representatives and creative politicians will figure out a way to curb the price declines. I think the Great Recession in ‘08 serves as a powerful anchor in this regard. Any price dips that exceed the 30% that people recall from that period will feel really bad.
So my prediction is that in Austin, TX home prices will fall 20-30% from peak. I think that home prices will reach that level either in late 2023 or early 2024. Given we’ve only seen ~5% drop to date, that leaves approximately another ~20%. The effects will be more muted in wealthier neighborhoods like in previous downswings.
In metros that have already seen substantial price declines like San Jose, CA, I think they probably have another 10-20% to go before they reach the bottom of the price trough.
If you got this far, you’re probably wondering what all of this means for you. Here are some baseline recommendations that should help you navigate the next 12 months or so of home price declines:
If You are a Property Investor, Now’s a Great Time to Hold
If you are buying home(s) for the purposes of flipping or turning them into investment properties, I would definitely hold off. Even if you’re investing for cashflow, not long-term value accumulation, price is key in determining your returns. The only angle I can see here is if you had strong evidence that rates would come down very quickly. Otherwise, you’re locking in at least a couple years of paying 2.5x more than you would have been able to as little as 2 years ago.
If it’s Not a Hardship, Renting is Pretty Safe Right Now
Renting isn’t a bad option if you are risk averse, don’t know if you want to live in a particular place long-term, or just want to lower your risk exposure to the real estate market. My family and I spent more than a decade living in single family rentals prior to purchasing our place. If you are able to find the right landlord, rentals can be a lot cheaper to live in than a home that you own yourself.
Long-Term First-Time Home Buyers: Do What Feels Right
As always with real estate, if you are a first time primary homebuyer and you expect to live in your home for more than 7-10 years, do whatever you want.
Over long periods of time, the market will go up and the market will go down. There’s no sense trying to time these things and you’re probably buying a home not as an asset, but as a consumable. For you, a home is a place for you and your family to live in. You can just do whatever you want. Of course, please be financially responsible and don’t stretch yourself too thin. If I were buying today, I would assume that the current rates will persist for at least 5 years.
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