‘Just a freakish bit of data’: Sticker shock imperils spring home demand

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Last year’s real estate market quickly spun into the perfect storm as blustering mortgage rates and booming home price growth pushed battered homebuyers to the brink — sinking transactions, stock values and real estate earnings into the depths.

While the torrential rains won’t yield May flowers this year, five of the industry’s leading chief and senior economists said the next few months will set the housing market back to historical norms as existing-home sales are ultimately forecast to slide 11.1 percent to 4.47 million before rebounding in 2024.

“We are not in any housing recession,” Windermere Chief Economist Matthew Gardner said. “The phrase I’m using is housing reversion. Home prices are reverting back to the mean. They’re reverting back to that long-term trend of growth because we got way out over our skis in 2020, 2021 and part of 2022.”

Although this spring will be the “most normal” we’ve seen since 2019, Realtor.com Chief Economist Danielle Hale said, leaders must remember it will feel far from normal for most consumers as the accelerated pace of shifts in mortgages and inflation make it harder to answer the age-old question: Should I make a move or wait?

“For homesellers, the calculus of deciding whether to sell or stay has gotten more complicated as mortgage rates have surged,” she said. “The gap between the rates that existing homeowners have on their current mortgage and the rate they would face if taking on a new mortgage will be bigger this spring than any time in recent history.”

Here’s what leaders need to know about the factors that will drive consumer activity this spring.

Mortgage rates will make or break the spring

Mortgage rates will continue to sit in the driver’s seat this spring, as weekly changes in 30-year fixed rates influence homebuyers’ decisions to jump into the market or stay on the sidelines.

“The research shows a one percentage point increase in mortgage rates will lower housing sales by roughly 5 to ten percent,” Zillow Senior Economist Orphe Divounguy said. “Mortgage rates had fallen to about [6.15] percent at some point in January, and now they’re back to 6.8 percent. So we’re having this almost one full percentage point increase.”

Divounguy said the decline in mortgage rates to 6.15 percent in January sparked a 25 percent week-over-week increase in mortgage applications as illustrated in the chart above. That sudden pop in mortgage applications provided a window of hope for a robust spring.

“It was kind of a surprise to everybody,” he said. “The buyers came back.”

However, that window has narrowed as homebuyers’ mortgage applications slide in response to rising rates and homesellers remain unmoved to list their existing homes on the market.

“The trouble though is that in January, when rates dropped, there were 17 percent fewer new listings coming on the market when compared to [January 2022],” he said. “And that number is 30 percent lower than January 2021.”

Windermere Real Estate Chief Economist Matthew Gardner said homesellers’ January behavior is a result of the lock-in effect — a term to describe how historically-low mortgage rates of 2020 and 2021 have curtailed homeowners’ desire to list because they’ll be buying at a higher rate.

“We have a lot of households that have locked in mortgage rates over the last couple of years and around 3 percent,” he said. “Why would you sell into an environment where mortgage rates have more than doubled? You would lose a never-to-be-seen-again mortgage rate.”

Although today’s rates are nowhere near the historical peak, Gardner said real estate professionals must remember today’s typical homebuyer has never experienced rates above 5 percent in their adult lives — something that psychologically makes rates of 6 to 7 percent difficult to grapple with.

“Adult millennials have not seen a mortgage rate above 5 percent in their adult lives,” he said while noting more than 40 million millennials are reaching their prime homebuying age now. “That is just a freakish bit of data.”

The chart above illustrates Gardner’s point, with U.S. weekly mortgage rates reaching a peak of 18.6 percent in October 1981 — the year the first group of millennials was born.

Meanwhile, the chart below shows U.S. weekly mortgage rate trends starting in 2011 — the year the oldest cohort of millennials hit the beginning of their prime homebuying age. In 2011, 30-year mortgage rates fluctuated between 3.91 and 5.05 percent, the latter of which was the peak until rates breached the 5 percent mark in April 2022.

“Mortgage rates today are below that long-term average, but because it has been trending down since the 1980s and certainly significantly so in the last decade,” Gardner added. “It without a doubt gives a lot of first-time buyers pause, and that’s not helped by the fact of a lack of affordability, because for every one percentage point increase in mortgage rates, mathematically speaking, means a household can spend 10 percent less on a house and keep the payment the same.”

First American Chief Economist Mark Fleming echoed Gardner and said today’s consumers aren’t rate sensitive, they’re “how-much-more-per-month sensitive.”

“They don’t care [mortgage rates] used to be 18 percent,” he said. “They care how many more dollars per month it’s going to take to be able to buy that home over there. Greater affordability was why you could have significantly higher mortgage rates in the 1980s and have people still buy homes.”

“You have to look at the relative buying power and income relationship,” he added. “House prices don’t move as fast as mortgage rates. Incomes don’t change as fast as mortgage rates. Mortgage rates change by the hour in the day, and so what’s happening is the how much per month number is volatile because of the underlying component in mortgage rates moving around.”

Realtor.com Chief Economist George Ratiu put Fleming’s sentiments into numbers, saying that mortgage rates don’t operate in isolation.

“The trouble is these rates do not exist in isolation from everything else in the market in the economy,” he said. “Back in 1982, specifically when rates were in the double digits, the typical home on the market cost about $70,000, which meant the monthly burden of the cost of a mortgage at that time relative to household income was somewhere around 16 to 18 percent.”

“Compare that with today when rates are half of what they were in 1982. But because home prices are so much higher, that debt burden is basically much closer to about 35 to 40 percent,” he added. “When you add the other two important ingredients in the formula — income and home prices — you realize the reality of affordability is very different than in the 1980s or even 10 years ago.”

“The burden on a typical buyer today is significantly higher.”

Divounguy said he’s more bullish about consumers’ abilities to financially withstand pressure from elevated mortgage rates and inflation, thanks to a strong jobs market that has enabled professionals to switch jobs and garner a median net wage increase of 9.7 percent.

Plus, today’s homebuyers, he said, are the most creditworthy in history with a median FICO 8 score of 768.

“[An increase in mortgage rates] will definitely have a negative impact on sales and housing demand,” he said. “But as income catches up, it mitigates some of the effects of rising rates.”

“There’s research that shows that there’s a lot of Americans today that can still afford the typical mortgage payment in their metro area even at 7 percent mortgage rates, and with income increasing, it allows them to catch up,” he added.

All four economists said they can’t give absolutes on where mortgage rates will land this spring as it relies on the Federal Reserve’s ability to calm inflation — a pursuit that has had mixed results for the everyday American.

“Where is inflation going? Is disinflation still very much underweight? If it is, then mortgage lenders will reprice [and] bondholders will reprice. The activity and mortgage rates will fall again,” Divounguy explained. “If inflation is picking up steam, then there will be upward pressure on mortgage rates. I think that uncertainty is what’s causing activity in the housing sector to kind of slow down.”

Thirty-year fixed rates were 7.54 percent on March 3 — a scenario the Mortgage Bankers Association (MBA) and National Association of Home Builders (NAHB) predicted in reports released the last week of February.

As rates continue to fluctuate, Fleming said leaders need to remind their agents that a simple shift in strategy could help some, if not all, of their buyers still achieve their goals this spring.

“You might want your agents to talk to buyers about using an adjustable-rate mortgage (ARM) to try and get back some buying power if rates go up, right? Right now, the five-one hybrid ARM is averaging significantly less than the 30-year fixed rate, which equates to over $30,000 of buying power,” he said. “Agents can help sort of insulate the borrower from rate shock by discussing these alternative options.”

“And one more point —this is not the adjustable-rate mortgage of old that basically caused the housing finance crisis,” he added. “These hybrid arms have been around forever. They’re five, seven or even 10 years fixed, which actually matches the likely tenure length of your buyer anyway because nobody rarely stays in their home for 30 years.”

Inflation will continue to place pressure on buyers’ finances

If mortgage rates are the driver, then inflation is the instructor in the passenger seat — slyly controlling the driver’s actions with gears all their own.

“The Fed is fully committed to taming inflation, and fully committed to increasing, more importantly, interest rates until it achieves that goal. That will continue to mark capital markets,” Ratiu said. “Inflation this year is still going to run much higher than it has been over the last decade.”

The Federal Reserve increased the federal funds rate seven times in 2022 — four times by 75 basis points, two times by 50 basis points and two times by 25.

Federal Reserve Chairman Jerome Powell approved another 25 basis-point hike on Feb. 1, which took the federal funds rate to the highest level since October 2007 (4.5-4.75 percent).

As shown in the chart above, Ratiu said the Fed’s actions have reduced inflation rates from a summer 2022 peak of 9.1 percent down to 6.4 percent on the consumer pricing index.

“Inflation is still not dropping as fast as some people would hope,” he said.

Gardner said the core inflation rate, which excludes food and energy, is down 0.2 percent year over year and the inflation rate for food is down 0.3 percent over the same time period. However, he said the average American isn’t “feeling” those declines when they look at their household bills.

“We tend, as individuals and as households, to focus far more on things that we buy every day,” he said. “And so we kind of tend to feel that inflation actually isn’t softening because we go to the grocery store and buy our morning cereal that keeps on costing more and never seems to come down.”

“That is true from an economic standpoint — economists tend to use the term sticky,” he added. “Prices can go up very quickly. If they’re sticky, it means they are slow to come back down again, and they only tend to come down when demand softens.”

Divounguy said the Fed has been largely unable to soften demand because of wage inflation, which gives consumers a better ability to keep up with price hikes, thanks to higher wages and salaries.

“The Fed is trying to bring inflation back down to their 2 percent target,” he said. “So if people’s incomes are rising 6 percent every year, and people tend to spend a large share of that income — 60 to 70 percent — then it’s going to be very difficult to bring consumer prices down.”

“That’s why the Fed has been kind of focused on the labor market and is basically hinting that the labor market needs to cool down somewhat,” he added. “We still see there’s still a ton of hiring out there. Layoffs are very are still very low even though we hear a lot of high-profile layoffs.”

In its latest Employment Situation report, the Bureau of Labor and Statistics (BLS) said the unemployment rate (3.4 percent) and the number of unemployed people (5.7 million) have held steady since early 2022, with a seasonally adjusted net increase of 1.04 percent from January 2022 to January 2023.

Total nonfarm payroll employment rose by 517,000 in January, with the leisure and hospitality industry leading the way with 128,000 new jobs. Professional and business services took the No. 2 spot with 82,000 new jobs, and government employment closed out the top three with 74,000 new jobs in January, half of which represented the return of striking university workers.

Although the Fed has struggled to cool the labor market, the BLS’s latest Employment Cost Index shows wage and salary growth is pacing ahead of 2021.

The seasonally-adjusted compensation costs for civilian workers increased by 1.0 percent during the fourth quarter of 2021. Meanwhile, the compensation costs for civilian and private workers both increased by 5.1 percent for the 12-month period ending in December 2022 — which means the inflation in wages and goods is quite close, with inflation for the latter slightly outpacing the former.

“The theory under which the Fed has operated is that if we kill people’s ability to demand higher wages, they won’t have the ability to pay more as a result, companies will have to adjust and sell products at lower prices,” Ratiu said of the delicate balance between managing inflation for wages and goods. “That’s, you know, that’s straightforward.”

However, Ratiu said the struggle to get control of inflation has been compounded by international supply chain issues that still hang over from the early days of the COVID-19 pandemic, which means there’s still more demand than supply.

“For the Fed to simply say it will slow wage growth down [and] we’re going to take care of inflation is a more simplistic approach to a more complex problem,” he said.

Ratiu also noted that although “most Americans in the last two years have had really healthy pay gains,” the slight edge in inflation for consumer goods still puts some people — especially those who are working on an hourly basis — behind the 8-ball.

For example, the BLS’s January Real Earnings Summary shows the real average hourly earnings for all employees decreased 0.2 percent from December to January, which the BLS said was due to “an increase of 0.3 percent in average hourly earnings combined with an increase of 0.5 percent in the Consumer Price Index for All Urban Consumers (CPI-U).”

Real average weekly earnings still increased 0.7 percent month over month, due to longer workweeks. Real average hourly earnings for all employees decreased 1.8 percent from January 2022 to January 2023.

“If you throw in the fact that prices were outpacing that wage growth, most Americans are actually getting a pay cut in real terms,” he said.”You got a four percent pay raise, but now you’re paying 40 percent more for eggs.”

“So the argument that in a sense if wages slowed down right now we would all be better off is partly true, but partly faulty,” he added. “Partly true because yes, it would slow price growth down. Partly faulty because wage inflation is the main factor that still keeps Americans in many cases able to afford their rent or their home.”

“It’s about slowly slowing wage gains, without necessarily putting Americans in so much of a financial bind.”

Don’t count on new homes to save sales, affordability

All four economists said the upward pressure of mortgage rates and inflation means most homeowners won’t place their homes on the market unless there’s a life circumstance — a new job, divorce, more children, etc. — that makes moving a necessity.

“There’s no incentive for sellers to get into this market and trade that low payment for higher payment because we know 71 percent of sellers are buying again,” Divounguy said. “We’re aware that a lot of sellers will end up buying again but sellers have very little incentive to part with that low monthly payment and end up buying again, at least in today’s market.”

“Let’s say you own a home that’s worth about $300,000, you got a loan and you’re paying that mortgage. If you had $300,000 in cash invested, even in a one-year treasury bond, the return on that would pay for your housing payments,” he added. “You have sellers almost living for free in their home because [homeownership] is really a castle against rising inflation.”

The lock-in effect means existing-home sales will likely continue their descent throughout the spring, building upon a 12-month trend of monthly and annual declines. In January, existing-home sales declined 0.7 percent month over month and 36.9 percent year over year to a seasonally adjusted annual rate of 4.00 million.

“Home sales are bottoming out,” National Association of Realtors Chief Economist Lawrence Yun said in a prepared statement on Feb. 21. “Prices vary depending on a market’s affordability, with lower-priced regions witnessing modest growth and more expensive regions experiencing declines.”

Ratiu said existing-home sales will likely struggle throughout the spring and summer but will still be an upgrade from the last half of 2022.

However, he’s hopeful homesellers will be more willing to enter the market this spring and negotiate  — a change in attitude that has already been reflected in NAR and Realtor.com data.

In January, total housing inventory increased 2.1 percent month over month and 15.3 percent year over year to 980,000 units, which NAR said equals a 2.9-month supply at the current sales pace. Median existing-home price growth slowed to 1.3 percent year over year, breaking away from years of double-digit growth.

“What we saw this fall and winter was that homesellers prefer to pull their homes off the market or not even bring it to market, rather than reduce the price,” he said. “But we’ll see more [inventory], not as much as a typical spring, but we’ll see more inventory.”

“I think inventory will continue improving, and we’ll see more existing-home sales, but it will take a while to get people, depending on the life stage, to necessarily move,” he said after noting Realtor.com tracked a double-digit increase in new listings from December to January.

While the existing-home segment finds its balance, Ratiu, Divounguy and Gardner said some homebuyers will turn to the new-home market to find opportunities.

New-home sales increased 7.2 percent from December to January, with many builders still offering an array of incentives to get their inventory sold, which according to the U.S. Census Bureau and the U.S. Department of Housing and Urban Development stands at a 7.9-month supply.

“I think a lot of people are hopeful that new homes will come to fill in the gaps because inventory is so low and the existing homeowners are not listing their homes,” Divounguy said. “You’re going to get more builders that are ready and willing to sell, and they’ll be willing to give buyers many incentives like rate buydowns and different types of rebates.”

Although homebuyers will benefit from incentives, there are still several long-term challenges that will plague the new-home market throughout the spring — increased construction costs, long zoning, and permitting timelines and a lack of available land in denser, coastal markets.

Gardner, Divounguy and Ratiu are torn on how those headwinds will ultimately impact homebuilders, with Gardner being more bearish on builders’ ability to overcome material costs.

“I don’t think that we’ll see much in the way of growth in the new home industry this year,” he said. “Not just the fact that it’s very expensive to build a home that quite frankly, the biggest concern I have is in a lot of markets there isn’t enough land. Labor costs are too high. Even though inflation is pulling back marginally, material costs are still very expensive.”

“Yes, lumber prices have come down. That’s a good thing,” he added while noting the cost of framing lumber has dropped 72 percent year over year, with the price per thousand board feet dropping from $1,411 to $369. “But building is still going to be that much higher from a builder’s perspective.”

“[Exterior] paint is up 45 percent year over year. Why? Because outside exterior paint is oil-based. PVC pipe which again, is based on the price of oil, is still very expensive.”

The increase in material and labor costs has been passed onto homebuyers, with the median sales price for new homes reaching $427,500 in February — 19 percent higher than the median cost for existing homes ($359,000).

All five economists acknowledged the song and dance between existing-home sales and new-home sales is nothing new, and that homesellers have always been sensitive to mortgage rate changes. However, Hale said the velocity at which these factors have changed is what makes 2023 stand out.

“Most homeowners with a mortgage have a rate under 4 percent whereas the rate homebuyers would pay to mortgage a home with a 30-year fixed rate loan is creeping up toward 7 percent and creates a monthly payment gap of roughly $190 per month for every $100,000 borrowed,” she said. “The calculus of deciding whether to sell or stay has gotten more complicated as mortgage rates have surged.

Hale said homeowners with a minimal mortgage balance on their current home may be more apt to take their profits and move to a more affordable locale. Meanwhile, homeowners who still have a bigger balance will be more likely to stay put and improve their homes with small upgrades.

When it comes to homebuyers, Hale said they’ll just have to remain patient.

“This [lock-in] effect is going to mean that the inventory recovery we started to see in 2022 may not progress as quickly in the months ahead as we saw over the last 8 months, and patience and persistence are still going to be needed,” she said.

The Great Recession, 2019 and ‘the new normal’

All things considered, all four economists said affordability will continue to be a persistent issue for homebuyers — an unwelcome piece of news for first-timers who grimly hoped for a 2008-esque housing crash that would tank prices back down to the low six figures.

“We had a housing boom, just like before the Great Recession,” Divounguy said of the parallels between the years leading up to 2008 and 2023. “But here’s the difference between that boom and the one we just experienced: We had a lot of buyers [in the early 2000s] that were not necessarily qualified to buy a home. We had a lot of issues with mortgage financing at the time.”

“The slowdown after the global financial crisis really came from sellers not being able to write people with homes, not being able to make their mortgage payments and having to flood the market with units, and of course at that time foreclosures increased right? Today, it’s just not there,” he added. “Today, buyers have the best credits we’ve ever seen. They’re in the best financial condition we’ve ever seen.”

Gardner and Ratiu said millennials and the oldest Gen-Zers will bear the brunt of worsening affordability as homebuyers of older generations have the income and equity to better deal with higher housing costs.

“It’s just gonna be very hard for first-time buyers going forward,” Gardner said.

Although overall pricing trends aren’t in their favor, Ratiu said millennials and Gen-Zers — especially singles or couples without children — have greater flexibility that enables them to take advantage of great career opportunities in cities with more affordable housing.

“Amazon opened their second [HQ] in Northern Virginia. Apple built a second HQ in Raleigh, North Carolina. Seeing trends like that is actually another bit of good news because it gives workers a more balanced financial ability to make a living and afford a home,” he said. “There are also places like Cincinnati, Cleveland and Columbus that were written off but have seen a resurgence, because young people are moving there to take advantage of stronger job opportunities with companies like Intel.”

Gardner, Ratiu, Divounguy and Fleming were torn on whether a ‘Silver Tsunami’ of downsizing baby boomers would give millennials their big break this spring. Two argued that baby boomers will be hard-pressed to give up a low mortgage rate or paid-off property and are more apt to keep bigger homes as a landing place for their kids or grandchildren.

The other two said the lure of warm weather and cheaper living costs are still strong, giving well-off buyers in younger generations the opportunity to scoop up a home.

“There’s a bit of a debate amongst the economists in the sector, whether or not you know, we’re going to see this kind of silver tsunami,” Divounguy said. “I don’t think we have a strong, strong stance on this. My general idea is that there’s nothing stopping baby boomers, especially those who have paid off their homes, from selling their homes and moving to an area where the cost of living is relatively lower.”

Gardner said 2023 will be the year the housing market moves even closer to historical means — something that’s uncomfortable at the moment for real estate leaders, agents and consumers alike after two years of unprecedented housing activity.

“All we’re doing now is we’re pulling back to that, that long-term trend,” he said. “We’ll hit it this spring and then I believe that we’ll start to see prices start to grow again in the fall, at a significantly slower pace than we’ve been used to for the last few years.”

Divounguy said this spring will outperform 2018 and 2019, with 2023 likely becoming the new benchmark for sales activity going forward.

“You can clearly see that activity is below 2022 and 2021 levels but still higher than 2019 and 2018. It’s right on par with the beginning of 2020,” he said. As of February, we had 54,000 newly pending listings and in 2019, we had 47,000. The newly pending listings in 2018 were only 45,000.”

“So you could clearly see that activity in 2023 is still much higher than what we’d consider normal times,” he added. “Part of the healing process for the housing market is for things to kind of slow down a little bit, but for inventory to come back on and give homebuyers a chance to compete without needing all-cash offers and other extreme measures.”

As the spring market goes into full swing, these economists encouraged leaders to track leading indicators (i.e. pending home sales), BLS employment data, Fed composite household data, and TransUnion credit data alongside mortgage and inflation rates — both of which are the biggest determining factors on how the spring will go.

“Everybody needs to be an armchair economist at the moment because it’s watching inflation. It’s watching how the stock market responds to inflation. It’s about the Fed and whether the Fed will or won’t increase their federal funds’ rate by this much or that much and when will they hit the terminal rate?” Fleming said. “So, being an armchair economist is the place to sort of really understand what’s likely to happen from week to week in the spring homebuying season.”

Email Marian McPherson