The Resilient Housing Market of 2023: Why No Crash Yet?
With soaring property prices, historically high mortgage rates, and economic uncertainties looming, the housing market seemed poised for a significant correction in 2023.
Yet, the expected downturn has not materialized. Instead, property prices have largely held steady and, in some cases, even risen. How is this phenomenon possible? Despite numerous challenges, why have housing prices remained so resilient?
The Economics at Play
To comprehend this resilience, we must delve into the fundamental economics of supply and demand, the driving forces behind prices in any market economy.
Supply, in the context of housing, equates to available inventory. Demand signifies the number of individuals desiring to purchase these properties. These two factors interact on a continuum, forming supply and demand curves, ultimately intersecting at a point called equilibrium. Equilibrium represents the market’s balance at a given time, determining both the price and quantity of transactions.
For example, in July 2022, the housing market’s equilibrium was set at 527,000 houses sold with an average price of $415,000. These figures represented the market’s capacity in terms of price and quantity at that moment.
However, supply and demand are not static entities; they evolve over time based on changing factors. For instance, if supply increases (more properties for sale) while demand remains stable, more homes are sold at lower prices, as per basic supply and demand principles.
The Current Landscape
Since the past summer, supply and demand dynamics have significantly shifted. Rising inflation prompted the Federal Reserve to increase the federal funds rate, subsequently causing mortgage rates to surge, leading to a predictable drop in demand.
As the chart depicting the Mortgage Bankers Association’s Purchase Index illustrates, demand for purchase mortgages, rather than refinancing, plummeted well below the levels witnessed in the aftermath of the financial crisis.
This decrease in demand, as the chart demonstrates, causes the equilibrium to shift downward. The number of home sales (quantity) declines, along with the average transaction price. However, this concept of declining prices hinges on a constant supply, which is not the case.
Instead, supply has diminished from 2022 levels, primarily due to the lock-in effect. In July 2022, inventory stood at around 1.24 million homes, while in July 2023, it was approximately 980,000.
When both supply and demand decrease proportionally, prices remain relatively steady, and only the sales volume experiences a decline. Consequently, we have witnessed home prices maintaining year-over-year stability while sales volume has dropped by 15% throughout the summer of 2023.
Of course, the future remains uncertain, as supply and demand are ever-shifting variables. However, to understand the developments of 2023 and the absence of a market crash, one must acknowledge that higher prices have deterred some demand, while the reduction in supply has matched this decrease in demand, thus stabilizing prices.
Looking Ahead to 2024
The critical question for 2024 is what factors will influence supply and demand dynamics. How will these uncertain market forces impact equilibrium?
As of now, it seems that supply will remain relatively static. The lock-in effect is real, and foreclosure rates still hover below historical averages. While new construction remains steady, it won’t significantly bolster inventory anytime soon. Therefore, a substantial increase in new listings may only materialize when mortgage rates approach 6%.
Demand, on the other hand, is a less predictable variable. If interest rates remain at their current levels, around 7.5% at the time of writing, or rise further, one can anticipate a decline in demand. Additionally, significant labor market disruptions and rising unemployment could further dampen demand. Should any of these scenarios unfold, prices may experience a slight reduction, though supply remains stable.
Conversely, if mortgage rates decrease, and economic prospects brighten, 2024 might see an upturn in demand, almost certainly propelling prices upward.
The exact unfolding of these scenarios remains elusive, making predictions for the upcoming year challenging. More time is needed to observe how inflation, labor market data, and Federal Reserve policy evolve in the coming months.
What are your expectations for what will drive supply and demand in 2024? Share your thoughts in the comments.
Additionally, I would greatly appreciate your feedback on this article. I’ve been contemplating writing a more technical-style piece like this for months, and I was somewhat hesitant. Your input, whether positive or critical, would be immensely valuable. If there are ways I can enhance the clarity of these concepts or areas where confusion arose, please don’t hesitate to let me know.