Are Home Prices About To Crash?

Are Home Prices About To Crash?
Stéphane Renevier, CFA

over 1 year ago5 mins

  • Housing markets are showing some worrying signs: prices in the hottest markets have fallen, leading indicators are pointing downward, and houses are becoming awfully unaffordable.

  • With home prices likely to stagnate, or in some places fall, in the coming months, you may do well to wait on the sidelines for now.

  • But a 2008-style crash is unlikely: mortgages are healthier today, the supply of available homes is low, and the demand for housing is strong.

Housing markets are showing some worrying signs: prices in the hottest markets have fallen, leading indicators are pointing downward, and houses are becoming awfully unaffordable.

With home prices likely to stagnate, or in some places fall, in the coming months, you may do well to wait on the sidelines for now.

But a 2008-style crash is unlikely: mortgages are healthier today, the supply of available homes is low, and the demand for housing is strong.

Covid really brought out the best in the global housing market. Homeowners with more cash to spend, lower mortgage rates to pay, and a newfound remote-working freedom lined up to move into bigger and better things. But there are finally signs that its run of form is starting to lose its puff, as rising interest rates and slowing economic growth drag the market down. The big question now is just how fast things could go south…

What are the signs the market is slowing down?

Prices are falling in the hottest markets.

While house prices are still going up in the US and most of Europe, they’ve started to fall in Canada, New Zealand, Australia, and Sweden – the countries that have had the hottest markets over the past few years. That suggests that speculators are jumping ship as interest rates rise in those places and as doubts grow about the health of global real estate markets. In time, that could lead buyers everywhere to turn more cautious, spreading weaknesses more globally.

Leading indicators are pointed downward.

In most of the world’s top industrialized countries, three things have recently fallen: the number of home sales, builder confidence, and mortgage approvals. House prices tend to follow these early, or leading, indicators with a lag of a few months. What’s more, as we explained last week, housing sector weaknesses have a way of spreading to the wider economy, which could add even more downward pressures on house prices.

Houses are becoming awfully unaffordable.

Faced with higher home prices and higher mortgage rates, prospective buyers are finding it hard to buy a home. In fact, many economists are pointing to deteriorating affordability measures like price-to-income and price-to-rent ratios as evidence that prices have reached bubble territory. In finance, when home prices are out of whack with what people earn, we say they’ve become detached from their fundamentals. And, we warn that the further detached they get, the more brutal the potential reversal could be.

The supply-demand balance isn’t balanced.

This post-pandemic moment is a weird time. High inflation and rising mortgage rates are taking a big bite out of consumer budgets and are slowing the demand for housing. Meanwhile, the pipeline of houses under construction has been rising rapidly, as supply chain disruptions finally begin to ease. And while there’s still a shortage of houses in most regions, a faster-than-expected rising supply coupled with falling demand could lead investors to reassess their view, and become more downbeat about the housing market.

It’s all part of the Fed’s plan.

In the US, the Federal Reserve (the Fed) has made it crystal clear that fighting inflation is its top priority. To achieve this, it’s got to slow the country’s red-hot housing market. Not just because lower housing costs directly feed into how inflation is calculated, but also because it would cool the rest of the economy – real estate isn’t just the largest asset class in the world, it also directly impacts credit creation.

So is the market going to crash?

Deteriorating fundamentals and souring sentiment will clearly add downward pressure to house prices over the next few months, particularly in the regions that saw the biggest excesses. But even if prices do drop – which most investors still don’t expect – a repeat of the 2008 housing crash is unlikely.

First, there are still too few houses available right now. Although more houses are being built, there are still fewer homes than buyers, and that should put a floor under prices even if sentiment sours.

Second, the housing market is just healthier than it was in 2008. Lending standards are much stricter, far fewer homeowners have rate-sensitive variable mortgage rates, and the recent spike in prices has more to do with a pandemic-era demand boost than pure speculation. In other words, no, we’re not likely to see a meltdown like we saw during the global financial crisis.

Third, structurally, the demand for housing is still strong. More millennials are in their prime home-buying years, and permanent shifts in working conditions – such as hybrid work arrangements – have been positive for prices. What’s more, real estate is a pretty good hedge against inflation – and that’s something that’s not that easy to find. If that’s not enough to convince prospective buyers to buy, it’s probably enough to prevent some current homeowners from selling.

So where does that leave us?

The most likely scenario for global housing markets is that prices will stagnate, or even fall, over the coming months. But good investors don’t just look at the most likely scenario, they also look at the less likely ones. And if past crises have taught us anything, it’s that linkages between the real estate market, the economy, and financial markets aren’t always evident – few people expected mortgage-backed securities to wreak so much havoc during the global financial crisis, after all. Today, new players like private equity firms might be the weak link as it’s hard to know how much they’ve really borrowed and how deeply they are involved with real estate.

So if you’re wondering whether it’s a good time to go long on real estate, or even whether it’s a good time to buy your dream house, my answer is the same as it was a few months ago: no. The current downside risks more than offset your potential gains, so it’s better to wait. You could short real estate via an inverse ETF like the ProShares Short Real Estate (ticker: REK, expense ratio: 0.95%), you could short individual REITs (see my screen here), or you could even short – or buying put options on – banks like Commonwealth Bank of Australia (ASX ticker: CBA), Westpac (WBC), National Australia Bank (NAB), and Australia and New Zealand Banking Group (ANZ), which are heavily involved in the hottest housing markets. But each of those shorts are expensive and might work differently than you’d expect, because other factors impact their prices too.

To me, the best strategy remains to stay on the sidelines, and be ready to pounce if a good opportunity presents itself. Not exactly “Big Short” excitement, I know. But as the late trading legend Jesse Livermore said, “There is a time to go long. There is a time to go short. And a time to go fishing.”

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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