The equity markets boomed in 2020 and 2021, which is a natural byproduct of having more money with less to spend it on. If you didn’t buy a house last year at a historically low interest rate or didn’t take some profits in your financial portfolio at the beginning of last year, you may be (or, at least, feel) less wealthy. The idea is pretty straightforward: When you feel richer, you spend more, and vice versa. People, in general, are not great at looking far into the future or the past, so when conditions quickly change, it’s noticeable. Because economic conditions are moving less favorably, the pain of what we lost out on is experienced more strongly. (This is something called “loss aversion bias.”)
Just about every economic indicator points to a slowdown in home sales, which is exactly what’s been happening. We can attribute the slowdown to three main factors: the Fed implementing tighter monetary policy (higher interest rates and no longer purchasing Mortgage Backed Securities), mean reversion, and seasonality.
The Fed doesn’t have many tools to fight inflation, so they’ve been using the one they have, which is raising the effective federal funds rate (EFFR), which indirectly affects the rest of the financial markets. The Fed has increased the EFFR 3% this year to 3.08% — its highest level since 2008 — in an effort to combat inflation. The average 30-year mortgage rate has more than doubled in 2022, moving from 3.11% to 7.08% by the end of October 2022, which marks a 20-year high.
Mean reversion, which is the idea that over the long term, prices will tend to converge around the mean (average), can also apply to home sales. Homes aren’t bought and sold over and over in short time frames. The number of sales in 2021 was nearly 800,000 higher than the 10-year average, so it stands to reason that sales in 2022 would drop by around that much, especially considering the less favorable market conditions. We can finally say that the market is cooling, but after the hottest two years since the mid-2000s, cooling indicates a healthier market.
Lastly, the housing market has seasonal trends during which home prices and inventory generally rise in the first half of the year and fall in the second half. We can ascribe some causality for the drop in inventory and prices to seasonality, even though other factors are at play.
The U.S. housing market has certainly shifted over the past several months, and we must recognize the current conditions homebuyers and sellers face. So is this the new normal? It’s looking very likely.
The Local Lowdown
Prices may contract further before reversing
We have enough data to show that the housing market in the East Bay is cooling substantially after one of the hottest real estate markets in history. However, demand in the East Bay is somewhat evergreen. People simply always want to live here. Of course, you don’t have to be a real estate expert to realize that when interest rates shoot up, fewer buyers will be in the market, which generally puts less upward pressure on prices. Single-family home prices have declined from their peaks reached earlier this year. Moving forward, prices will likely contract slightly more through the rest of the year, which is typical during the slower holiday season. Home prices in the East Bay grew at an unsustainable rate, and a contraction is a normal response to that sort of growth. We are now entering a stage of slower longer-term growth — but still growth. In the short-term, prices may come down a little more, however. Real estate has shown itself to be one of the best investments in recent history and is, on average, the largest store of wealth for an individual or family. Price appreciation will likely move to a more normal growth rate of around 5-6% in the coming years, which makes for a much healthier market than what occurred in 2020 and 2021.
New listings decline faster than sales, dropping inventory further
Single-family home sales and new listings declined month-over-month, a trend that will likely continue through the rest of the year. The East Bay, along with the rest of the country, has not returned to pre-pandemic inventory levels after the buying boom last year. Now that we’re through most of 2022, we can see just how significant sales were in 2021 by comparison, especially in the summer months. During the summer months this year, we saw a 26% decline. Far fewer new homes have come to market in 2022, and the rising rate environment has dropped demand as well. We can tie new listings not only to supply, but also to demand, because sellers are often buying, too. Softening demand has brought the market closer to balance despite declining inventory.
As always, Arrive Real Estate Group remains committed to helping our clients achieve their current and future real estate goals. Our team of experienced professionals are happy to discuss the information we’ve shared in this newsletter. We welcome you to contact us with any questions about the current market or to request an evaluation of your home.