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What happens to house prices in a recession?

The Fed has been aggressively raising interest rates to curb inflation but there are worries it could spark a recession. What will that do to house prices?

Recession effects on house prices

House prices have been rising gangbusters since the covid-19 pandemic pushed by Americans changing their living habits in light of the pandemic and ultra-low mortgage rates. Rampant inflation throughout the economy though has forced the Federal Reserve to take aggressive measures to rein in rising prices.

Policymakers, after easing into raising rates in March and April, kicked into high gear with four straight 75 basis point rate hikes, the fastest increase since the 1980s. The initial effect has been a spike in mortgage rates which is cooling the housing market but has also raised concerns that the US economy could be thrown into a recession.

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What happens to house prices in a recession?

Generally, declining home values often go hand-in-hand with economic recessions, but that isn’t always the case. As people lose their jobs, it becomes more difficult to repay a mortgage and if a borrower falls behind, they may face foreclosure.

Additionally, lenders tighten their requirements for getting a mortgage, reducing the number of people who are approved and thus able to purchase a house. Likewise, less people want to make the significant long-term commitment to buying a house when their own financial situation is uncertain. While foreclosed properties will create more supply, less people in a position to buy means fewer people competing lowering demand, and in turn prices get pushed down.

In previous recessions, the price of a home dropped on average 5 percent each year of the downturn. The Great Recession was exceptionally damaging to house prices knocking almost 13 percent from the value on average, but the dip varied from market to market felt most in the West and South.

Exceptions to the rule…

During four out of five recessions since 1980, not including the brief covid-induced recession, housing prices dropped according to the Joint Center for Housing Studies at Harvard University. The one recession besides the brief covid-19 downturn that saw prices unphased was during the dot-com recession of 2001. In both cases the Federal Reserve cut rates and injected huge amounts of money into the market.

Several factors played into the recent rise in home prices, up by 45 percent between the start of 2020 the peak in June 2022, despite the trying financial times for many Americans. Going into the pandemic there was already a supply shortage and the social distancing and work-from-home created a surge in demand away from dense urban areas.

Supply didn’t increase due to swift government action to shore up household finances through stimulus checks along with extended and expanded unemployment benefits kept the housing market from collapsing. On top of that, very accommodative federal monetary policy combined with ultra-low mortgage rates accelerated demand. Additional constraints on new supply came from supply chain bottlenecks which also produced more inflation.

The housing market is cooling but prices still rising

The imbalance saw many housing markets across the US become overvalued, pushing the average home price over the half-million-dollar mark in twenty of the top hundred markets. The high cost and increased mortgage rates, now over 7 percent, have caused more and more potential home shoppers to reconsider switching up.

The National Association of Realtors (NAR) reported that pending home sales, a measure of signed contracts on existing homes, were down in September by 10.2 percent from August. More than double what economists had expected.

Millions of homeowners want to hold onto the rock-bottom mortgages they locked in when rates were in the range of 3 percent. New survey data from the Federal Reserve Bank of New York found that the number of Americans thinking about changing their primary residence has reached its lowest level since 2013. Only 14.4 percent of respondents said they were thinking of moving in the coming year.

While the housing market may be cooling, prices still rose in 98 percent of markets according to NAR. However, the percentage of markets that saw double-digit increases dropped from 80 percent to 46 percent. The national median single-family existing-home price in the third quarter of 2022 sits at $398,500, an 8.6 percent increase from a year earlier. That though is a significant deceleration from 14.2 percent in the previous quarter.

The housing market has further to fall but this isn’t 2008

Goldman Sachs Chief Economist Jan Hatzius said at the end of August that the housing downturn has further to fall. “The sustained reduction in affordability, waning pandemic tailwind, and recent decline in purchasing intentions suggest that home sales are likely to fall further on net,” the research note from Goldman Sachs said.

As opposed to the Great Recession “household balance sheets are extremely strong and loan delinquency rates are likely to remain historically low,” the US lender noted.

The United States so far has fought off a recession, showing sustained economic growth. While the jobs report in October was a slight decrease from the previous month, it still beat expectations by over 60,000. The researchers at Goldman Sachs forecast that the labor market will likely remain robust for the time being.


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