This item is from Full stack economya newsletter on economics, technology and public policy.
In March 2021, a woman in the DC area put her home on the market and received 88 offers, including 76 cash offers and 15 from people who hadn’t bothered to visit the property in person.
The offers kept coming. she told CNN at the time. “I’m thinking, ‘This is out of control.’ ”
That frothy, overflowing market has been over for a few months now, and new data suggests we may be entering a very different kind of real estate market.
US house prices fell 1.1 percent between July and August, according to new data of the Case-Shiller index. That is by far the biggest monthly drop since the last real estate crash bottomed out in 2012.
Another widely used home price index, the Zillow Home Value Index, has yet to show a full drop. But it shows that house prices have been flat in recent months after two years of strong price appreciation.
Pundits are increasingly concerned that we are headed for a major housing correction.
A modest drop in house prices would be benign, even welcome, given how expensive housing has become in recent years. But a sharp drop in house prices could have some negative effects on the broader economy. Homebuilders could react by slashing new home construction, not only putting thousands of people out of work, but worsening our long-term housing shortage.
A sharp drop in home prices could also trigger a wave of destabilizing defaults and foreclosures. And some experts believe that a large decline like that is a real possibility.
“My base case is something like a 10 percent drop in house prices relative to the peak,” said Arpit Gupta, a finance professor at New York University. But he said things could get a lot worse than that.
“A 30 per cent drop in prices would not be too out of the ordinary considering the level of volatility we have had over the last 20 years,” Gupta added. That would put the current housing crash on par with the crash that began in 2006 and triggered the Great Recession.
Many experts blame rising mortgage rates. The average rate on a 30-year mortgage soared from 3.5 percent in January to about 7 percent today. These increases have dramatically raised the cost of buying a home.
On the one hand, the cooling of the housing market is the expected result of the interest rate hikes that the Federal Reserve initiated in March. Higher interest rates push down the value of all assets, which is supposed to discourage spending and thus reduce inflation.
What especially complicates matters for the Fed is that the housing market is much less liquid than other major assets like stocks or bonds. It takes a couple of months for someone to sell their house and then another month or two for the sales to show up in the national statistics. As a result, home prices tend to have more momentum than other assets. Once prices begin to fall, they tend to continue in the same direction.
That is possibly what happened during the Great Recession: The Fed’s effort to cool down the booming housing market with rate hikes between 2004 and 2006 worked somewhat also well, ultimately producing a real estate crash that lasted until 2012.
Most experts don’t think the US financial system is as vulnerable as it was in 2008. But falling home values may well trigger a common recession.
east vs west
National averages hide significant variation at the metropolitan level.
Each of California’s major cities, including Los Angeles, San Diego and the Bay Area, some of the most expensive real estate markets in the country, have seen dramatic price drops in the past four months. Other cities in the West and Southwest, including Austin, Phoenix, Las Vegas, Portland and Seattle, have also seen big drops.
At the other extreme, several cities in the South, especially in Florida, continued to enjoy substantial increases in home prices over the last four months. The Northeast and Midwest were somewhere in the middle, with Chicagoland homes shedding 0.5 percent over the past four months and New York-area homes gaining 0.7 percent.
While the regional pattern is clear, it is not obvious why things are falling apart in this way. The experts I spoke with offered several possible explanations, but I didn’t find any completely convincing.
NYU’s Gupta argued that cities west of the Rockies have a history of housing volatility. The Phoenix and Las Vegas housing markets were famously volatile during the 2008 housing crash, for example. He blames this on less flexible housing supply in these cities.
Two factors are significant here. First, Eastern cities tend to have older housing, which means more opportunities to expand housing supply by renovating or replacing older housing. Western cities lack this safety valve and, as a result, tend to see larger booms when demand is strong, followed by steeper price declines when demand weakens.
The federal government also owns a ton of land in western states, limiting the outward expansion of cities. Some Western cities also have urban growth limits. Once again, a hard housing supply can contribute to more volatility both up and down.
The fall in house prices could also be related to the pandemic and the resulting trend of working from home. It may not be a coincidence that the three cities with the biggest price drops (San Francisco, San Jose, and Austin) are major hubs for the tech industry. Seattle, another tech hub, has also seen a significant decline in home values.
Tech workers appear to have been particularly successful in resisting employer pressure to return to a physical office. Perhaps when tech workers realized they could work remotely indefinitely, they began to question whether it made sense to pay a big premium to live physically close to their employers.
Fortune housing reporter Lance Lambert suggested to me another possible tech connection: Falling values of many tech stocks could be reducing the amount of cash flowing through West Coast housing markets.
There’s an obvious partisan ax someone could grind here: Most of the biggest losers are blue cities in blue states, while the winners are mostly smaller cities in red states. Perhaps blue state policies on COVID, crime, or something else are making those states less attractive places to live.
But I don’t think this stands up to close scrutiny. Most obviously, Salt Lake City has seen faster declines in home prices than most other cities, and Utah is not a blue state. Las Vegas and Phoenix are in swing states. On the other hand, home prices in New York City have held up better than those in Dallas, Houston, or Atlanta.
A YIMBY housing fix?
Another intriguing theory comes from Kevin Erdmann of the Mercatus Center. in a recent posthe described the decline in California property values as a “YIMBY housing correction.”
What it means is that the state has be increasingly aggressive on forcing cities to allow housing construction. For example, state law could soon force the prosperous coastal city of Santa Monica to accept the construction of thousands of new homes over objections from local elected officials. California also recently Lifted restrictions on accessory dwelling units., eliminated parking mandates near transit stops, duplexes allowed to be built across the state, and much more.
If this firestorm of pro-housing legislation works as planned, California could finally begin to address its dire housing shortage by building a slew of new homes. And Erdmann argues that California home prices are falling in anticipation of that new supply coming online in the coming months.
While this is a theory specific to California, it could also explain the drop in prices in neighboring states. For decades, home prices in cities like Phoenix, Las Vegas and Portland have been buoyed by Californians fleeing high home prices in that state. If California’s housing situation improves, the flow of housing refugees to neighboring states should slow, reducing upward pressure on home values across the region.
As a fan of pro-housing legislation, I wish this were true. But I am skeptical on two levels. First of all, I’m still not sure California has enacted policies strong enough to truly address its massive housing shortage. Second, I’m skeptical that the prospect of future home construction will have as big an impact on current home prices; some of these policies have only been enacted in the last few months. But I’ll be keeping an eye out for more testing and hopefully a lot more housing online.
Most likely, a combination of factors explains the different home price trajectories in the West Coast, Northeast, and South Coast metropolitan areas. Hopefully the patterns will become clearer as experts get more months of data to work with.
Unfortunately, the Federal Reserve cannot afford to wait for all the data to come in before making decisions, and one of its main jobs is to squash inflation that is still too high. The Fed’s Open Market Committee will meet next week to decide how much to raise short-term interest rates to try to fulfill that duty. Your decision could be very important for the house you are trying to sell, the house you are trying to buy, and the economy that no one wants to see crash. Undone.