Housing market outlook: Is a crash coming?

The housing market is an important barometer for economic health and the key source of equity for most households. The sector has seen strong growth over the past two years with elevated sales activity and strong demand driving rapid valuation gains for homeowners. But the winds have changed in 2022 with economic growth fading from the initial highs during the recovery from the Covid recession and the Fed raising interest rates sharply to combat inflation. Home sales have declined so far in early 2022 and price appreciation looks to have peaked — leading many owners to ask if another market crash is starting.

What can cause a housing crash, and what happens during a housing crash?

It is important to differentiate between a typical pullback in housing that occurs around an economic downturn and a true crash in market conditions. Home sales have historically peaked well in advance of recessions as weaker job growth and higher interest rates in the late-expansion period slow activity even before the economy slips into a downturn. House price gains also slow in most pre-recession periods, ultimately leveling off or even showing a modest annual decline in home values during a recession.

Housing market crashes, while also occurring around recessions, are much rarer and much more severe than a more standard slowdown for the sector. During the housing market collapse around the Great Financial Crisis of 2008-09, home sales fell by more than 50 percent from their pre-downturn peak. The CoreLogic Case-Shiller home price index dropped by more than 25 percent from its peak in 2006 to the low point in late 2011. The pain felt by many homeowners was exacerbated by a jump in foreclosures as households fell behind on payments or were underwater on their mortgages.

What causes a housing market to crash? History shows that there a few usual conditions.

Signs of a housing market crash

• Price rise sharply. A telltale predictor of a housing market crash has been the formation of a bubble where home prices inflate much faster than household incomes. As costs increase for homes, buyers are increasingly leveraged relative to the equity within the home — raising the risk of a sustained drop in values if the bubble bursts.
• Risky loans/mortgages are being given out. As occurred in the runup to the 2000s housing market crash, excessively loose lending conditions can feed price increases by boosting market demand beyond supply. Moreover, a larger share of less qualified buyers increases the risk of default and foreclosure for mortgages if market conditions turn negative as occurs during an economic recession.
• Interest rates rise. Eventually, mortgage rates will rise later in an economic cycle as the Fed tightens monetary policy to cool off the economy. The drop in demand plus reduced income from job losses cause the bubble to burst. Owners who try to sell find little demand in the market while some households are forced to walk away from overpriced mortgages — driving a sharp decline in sales and prices.

Is a housing market crash coming?

As the economy enters a period of slower growth and higher interest rates, it’s natural to ask if the housing market will crash over the next few years. House prices had climbed by around 20 percent over the past year as of February 2022, even surpassing the rates from the early 2000s housing bubble. Home sales dropped for three consecutive months through April 2022 as higher prices and mortgage rates weighed on activity. Fortunately, despite these recent trends, the housing market does not appear to be on the verge of a crash due to the following factors:

Demand fundamentals still solid

While home sales have likely peaked for this cycle, buyer demand is expected to remain solid in coming years even with higher mortgage rates. Job and income growth have been strong over the past year and should continue to support market activity even if the labor market decelerates somewhat. Moreover, demographics remain positive for housing needs with many millennials in prime home buying years and household growth still robust. This suggests that demand should hold firm in the face of cost headwinds and keep the price environment from crashing.

Tighter lending standards

Changes to lending standards following the housing market collapse of the mid-2000s have prevented the market from becoming overextended. Most mortgages over the past decade have gone to well-qualified owners, reducing the overall default risk within the mortgage market. While delinquencies and foreclosures typically climb during recessions, the risk of a widespread shakeup of the market are relatively low at present. This should prevent a rush foreclosed properties driving down house prices across the market as occurred during the last housing market crash.

Housing does appear to be in the early stages of a slowdown, but an outright market crash is not likely over the next few years. Higher mortgage rates will cool sales and house price gains in 2022 and 2023 as buyers react to the increased costs. There may even be some price declines in local or regional areas when the economy does eventually slip into a recession. But strong demand fundamentals and a well-positioned lending market should prevent a significant decline in home sales or prices at a national level. A more typical pull back in the housing market remains the most likely scenario in the years ahead.

Keep up to date on housing markets trends and other economic commentary here.

For related resources about housing market trends, visit the following pages:

A resilient consumer, but housing weakens further – 06/01/22

Housing market may have peaked – 04/25/22

Signs of a housing market slowdown – 04/20/22