During the first 24 months of the pandemic, U.S. home prices soared 38.5%. In some markets, such as Phoenix and Dallas, home prices rose by more than 50%.
The Fed is no fan. As the real estate boom of the pandemic raged, it pushed up prices throughout the economy. Higher home prices have pushed up rents. Increased levels of home construction – which reached a 15-year high during the pandemic – put upward pressure on prices for everything from windows to lumber, while adding pressure to an already tight global supply chain. Not to mention, cash flowing into the economy from homeowners taking advantage of record home equity.
That’s why central banks, mandated by Congress to address runaway inflation, are targeting the U.S. housing market. How? It puts enormous upward pressure on mortgage rates. While the Fed doesn’t set mortgage rates directly, it has the leverage to see financial markets do so. Once the Fed made the prospect of monetary tightening clear this year, the market quickly pushed the average 30-year fixed mortgage rate above 5%.
In June, Federal Reserve Chairman Jerome Powell finally made it clear that this was all by design. Powell wants to see the U.S. housing market return to a more balanced state. In his own words, he called it a “reset.
“I would say if you’re a homebuyer, or a young person looking to buy a home, you need to rebalance a little bit. We need to get back to a place where supply and demand are converging again and inflation is down again and mortgage rates are low again,” Powell told reporters last month. “Over the last couple of years, we’ve seen [housing] prices rise very, very strongly. So now things have changed. Interest rates have gone up. We’re well aware that mortgage rates have gone up a lot. You’re seeing a change in the real estate market. We’re watching it and seeing what happens. How much will it really affect residential investment? Not really sure. How much will it affect home prices? Not sure.
Already, soaring mortgage rates have pushed the U.S. housing market into cooling mode. With housing data coming out in April and May, it’s clear that the pandemic housing boom is subsiding. In June and July, the pace of cooling accelerated.
To find evidence of the accelerating rate of cooling, just look at the inventory data. According to a Fortune analysis of realtor.com data, among the nation’s 100 largest real estate markets, the market’s median inventory increased by 1 percent between January and April. That was before the housing correction triggered by soaring mortgage rates. Among the 100 largest real estate markets, the median market’s inventory grew by 50 percent between April and June.
Nationwide, the U.S. housing market is slowing. Mortgage applications are down 17 percent on an annualized basis, according to the Mortgage Bankers Association. New home sales and manufactured home sales are falling sharply. Home construction is slowing. And more sellers are cutting their asking prices.
That said, this housing correction – or as Fortune calls it, the big slowdown – is barely uniform across the country. It has hit the Southwest, Mountain West and West Coast real estate markets particularly hard. Each of the 10 real estate markets with the largest increases in inventory levels this year are located in these regions. The group is led by Sherman, Texas (332% increase in inventory); San Francisco (+285%); Santa Fe (+272%); Denver (+247%); and Austin (+220%).
The reason? Nationwide, the pandemic real estate boom has disconnected home prices from underlying economic fundamentals. This separation is more pronounced in markets in the Southwest, Mountain West and West Coast. With mortgage rates now above 5%, buyers in those “overvalued” markets are feeling particularly squeezed. Some potential buyers are choosing to stay on the sidelines. Others simply can’t afford a 5% mortgage.
Going into this year, Logan Mohtashami, HousingWire’s chief analyst, was already calling for higher mortgage rates. His thinking is that higher mortgage rates would be the only way to get buyers to step aside and allow inventory breathing room to climb to healthier levels. So far, Mohtashami likes what he sees.
We still have some work to do to bring balance to the market,” Mohtashami said. But with higher rates, we have a chance to get back to peak inventory levels in 2019, which is a balanced market.” “Once we get back to 2019 levels, all of my inventory issues will go away, and only then will I be able to eliminate the theme of a seriously unhealthy real estate market.”
Despite the rapid rise in inventory, it is still well below pre-pandemic levels: of the 917 regional housing markets measured by realtor.com, 601 are still at least 50 percent below pre-pandemic levels. Mohtashami hopes to close the gap.
For months, Moody’s Analytics chief economist Mark Zandi has been calling the slowdown a “housing adjustment. He doesn’t think it will stop this year. Throughout the summer, he expects home sales to continue to fall. By this time next year, Zandi expects home price growth to slow to 0% year-over-year. With that in mind, that would be quite a deceleration from the latest reading of 20.4%.
But not every real estate market will be so lucky. The pandemic real estate boom has made markets like Phoenix, Boise and Las Vegas what Moody’s analysis considers to be significantly “overvalued. Now they are at risk of a price correction. As inventory continues to rise in these places, Zandi predicts that those markets that are significantly “overvalued” will cause home prices to fall by 5 to 10 percent. But if a recession does occur, Moody’s analysis predicts that U.S. home prices will fall by 5 percent, while significantly “overvalued” markets, such as Charlotte and Tampa, will see home prices fall by 15 to 20 percent.