The Housing Market Could Be in Serious Trouble Now

By TradeSmith Editorial Staff

I was wrong about real estate in 2020.

As I explained in a Money Talks column last fall, I was confident that the housing market would tank when I saw the following chart in early April 2020:

But what I couldn’t foresee at that time were three big factors that were about to drive housing demand much higher.

First, the Federal Reserve was easing monetary policy like never before, which would push U.S. mortgage rates to record lows by the end of the year.

Second, the U.S. government was about to unleash an unprecedented wave of fiscal stimulus that would make consumers flush with cash.

And finally, COVID-19 lockdowns — and the massive shift toward remote work they created – motivated many folks to want to upgrade their homes and move out of major cities.

This “perfect storm” of demand resulted in an all-out home-buying frenzy that pushed prices to absurd new highs. According to the Case-Shiller U.S. National Home Price Index, prices rose an average of 6% in 2020 and a whopping 17% in 2021.

That may not sound particularly impressive, but consider this: During the peak of the housing bubble in the early 2000s — the biggest real-estate boom in U.S. history — home prices never increased more than 14% in a single year.

We’ve never seen anything like what we saw in the housing market last year. And as 2022 began, this trend showed no signs of slowing.

However, in just the past couple of months, that appears to be changing. The factors that have been driving this frenzy are fading.

The “sugar rush” of the government’s fiscal stimulus from 2020 and 2021 has mostly worn off. And a lot of the “work from home” demand has arguably been spent. However, the most critical change has to do with monetary policy.

The Federal Reserve is no longer “easing.” Instead, it is now actively “tightening.”

The Fed has raised short-term interest rates from 0% to 0.75%, and it intends to continue raising rates to well over 2% by the end of the year. It is also planning to begin unwinding its quantitative easing (QE) program next month.

But while the Fed’s tightening cycle has only just begun, it is already having a significant impact on mortgage rates.

As you can see below, the average 30-year mortgage rate has risen from just over 3% in January to 5.3% today.

That means the cost of a monthly mortgage payment has soared nearly 65% since the beginning of the year. That is a massive increase in such a short time.

Meanwhile, thanks to the sharp increase in home prices last year, the median price of a home in the U.S. is now 6.5 times the median household income.

By this measure, housing is now more expensive relative to incomes than ever before, even though wages are also rising at the fastest pace in years.

As a result, housing affordability has quickly plummeted to some of the lowest levels on record.

This is a serious headwind for the housing market going forward. And we already see signs that this is beginning to take its toll.

The recent decline in sales also mirrors declines in several related housing measures, including Google searches for homes for sale, touring activity, mortgage applications, new home listings, and pending sales.

Barring a reversal in Fed policy or another massive round of fiscal stimulus — neither of which appears likely with inflation surging to 40-year highs — it’s likely just a matter of time before home sales slow and prices move lower.

Lower prices would be good news for prospective buyers, but they could be problematic for investors and anyone who may need to sell a home soon.

So, what do you do with this information right now?

First and foremost, I would generally avoid homebuilder stocks and other housing investments dependent on a strong housing market. These investments are likely to struggle so long as affordability remains low.

If you’re considering an investment in physical real estate, I would focus primarily on cash-flow-producing properties. You don’t want to rely on price appreciation alone to produce a return.

Finally, falling home prices shouldn’t affect most homeowners.

As long as you have an affordable fixed-rate mortgage and don’t need to sell your home in the near future, you should be fine.

However, if you’re in a situation where you’re currently struggling to afford your home or may otherwise need to sell in the next year or two, I would encourage you to seek a solution immediately.

Depending on your local market, you may still be able to sell for a sizeable premium today. Renting might also be an option. If nothing else, you may be able to lower your monthly payment to an affordable level by refinancing, even if it’s at a higher interest rate than you currently have.

You just don’t want to wait and find yourself “underwater” in a home you can’t afford and can’t easily sell.