There has been a high degree of uncertainty around the housing market as we emerge into a post-pandemic world. Significant home price appreciation since 2020 and increases in interest rates in 2022 and 2023 have pushed home affordability to historic lows. Reduced home affordability generally results in reduced demand for housing, all else equal. Normally, when demand for an asset declines, the price of the asset similarly declines. However, given high interest rates, existing homeowners are reluctant to sell their homes to purchase a new one, as this would result in the homeowner prepaying their existing low interest rate mortgage for a new mortgage with a much higher interest rate. This is constricting housing supply.
In prior publications, we evaluated the housing market and the supply and demand1 dynamics that resulted in strong home price appreciation during the pandemic. We have also published commentary on the potential for home price growth to slow as global conditions approach normalcy and housing supply returns to the market. In this article, we evaluate the potential long-term impacts of these dynamics and provide some guidance on where home prices could be headed. We also survey current market forecasts and summarize industry views on the housing market.
Housing affordability
Home affordability generally refers to the average monthly mortgage cost of purchasing a home relative to one’s income. A common metric to evaluate affordability is the Home Affordability Index, published by the National Association of Realtors (NAR). The Home Affordability Index measures the extent to which a household with the median area income can qualify for a standard, 30-year fixed rate mortgage,2 assuming a 20% down payment. Figure 1 shows the Home Affordability Index against the Federal Housing Finance Agency (FHFA) purchase-only home price index from the start of the century to today. In Figure 1, there is a direct correlation with home affordability and home prices, and home affordability declined significantly from 2020 through 2023. Both home price increases and higher interest rates reduced home affordability. Home affordability is lower today than its previous low in 2006, just prior to the global financial crisis of 2007-2010.
Figure 1: National home prices to home affordability
Source: Federal Housing Finance Administration, National Association of Realtors.
The last decade has been marked by a strong housing market, with steady home price growth around 5% year over year as the market recovered from the recession. During this period, household income did not grow at the same speed to offset growth in home prices, leading to decreased home affordability.
Standard economic theory would dictate that, if the price of an asset (or normal good) increases, then the quantity demanded for that asset should decline. This would suggest that, over time, low home affordability due to high home prices may crowd out prospective home buyers. One way to measure changes in demand for housing is to look at the median number of days on market for homes listed for sale. If the days on market is high, then that is indicative of a lower level of demand. If the days on market is low, then that is indicative of a high level of demand. With a stark decrease in affordability, we would expect the days on market for the homes listed to subsequently increase, with fewer buyers in the market. Figure 2 shows the median days on market starting from 2016 through 2023. From this graph we can see that during the pandemic the median days on market was considerably lower than the prior years. With reduced affordability we do see an increase in the days on market; however, the days on market remains lower today than the days on market observed from 2016 through 2019. This indicates demand for housing continues to remain strong relative to prior years.
Figure 2: National median days on market
Source: National Association of Realtors.
Housing is generally considered a necessity given the basic needs that it satisfies. The consequence is that demand for housing tends to be relatively inelastic; that is, all else equal, the quantity demanded is not sensitive to changes in price. Therefore, even though prices rise, we tend to see relatively strong demand for housing. It is difficult to measure the true demand for the number of housing units, but demographic trends indicate that the United States has a shortage of housing to meet projected demand.3
Interest rates constrict housing supply
The median days on market is indicative of demand, but it is also impacted by supply. If there are fewer homes for sale, then, all else equal, we would expect the median days on market to decline.
We can measure supply of housing by looking at the available sale inventory over time. Figure 3 shows active listings in the United States from June 2017 through March 2023. When looking at inventory, there is a noticeable decline in the number of homes for sale as a result of the pandemic, where the number of active listings decline by approximately 50%. The decline in the number of homes for sale has not yet recovered.
Figure 3: U.S. active listing growth
Source: St. Louis Federal Reserve.
Housing inventory has been on a steady decline following the global financial crisis.4 The pandemic exacerbated this trend, leading to sharp declines in active listings as current homeowners were reluctant to sell their homes. Therefore, the replenishment of inventory onto the market was substantially slower than the pace at which homes were being purchased, contributing to a supply crunch. While there has been growth in listings following the pandemic, level inventory is still well below pre-pandemic amounts.
For new homes, it takes considerable time and resources to plan, finance, and construct. For existing homes, there is a financial consideration for existing homeowners. If they sell their home today, most homeowners will need to finance themselves into another home. If the interest rate on their current mortgage is lower than the existing mortgage rate, they would need to consider not only the purchase price difference between their current home and the new home, but also the increased financing costs. Because interest rates increased so quickly over a short period of time, these costs can be considerable and deter existing homeowners from upsizing or downsizing from their current home.
From 2021 through 2023, the average mortgage interest rate increased from a low of less than 2.50% to an average rate of over 7.00% on August 8, 2023.
Figure 4 provides a distribution of interest rates for homeowners with a Freddie Mac or Fannie Mae loan, a substantial portion of the mortgage market. From Figure 4, we see that the majority of outstanding mortgages (approximately 96.3%) have an interest rate that is 6.00% or less. This is approximately 1.00% lower than the current average 30-year mortgage rate. Further, 50.6% of outstanding mortgages have a rate of 3% or less, which is lower than the historical average over the last decade. It is no surprise, then, that the interest rate incentive to obtain a new mortgage (either through purchase or refinance) is notably low.
Figure 4: Mortgage rate distribution
Source: Milliman M-PIRe.
Months supply
One housing market statistic that is tracked as a way to view the balance of supply and demand is the “Months Supply.” The months supply of homes estimates the amount of time it would take for all existing homes on the market to sell relative to current buying speeds. Figure 5 shows the months supply value from Q1 2000 through Q1 2023.
Figure 5: National average months supply of homes
Source: U.S. Census.
During a normal economic environment, the months supply has averaged around four months. The disruption to this trend can be observed first during the housing market crash (where high mortgage defaults led to an unusually large amount of inventory) and then again during the COVID-19 pandemic, where the months supply was about half the long-run average at the national level. While there has been a bump up to three months in 2022 and 2023, high home prices and rising interest rates have appeared to restrict the reversion back to the historical average. This indicates demand for housing still exceeds supply. It is worth noting that the data above represents national figures. There are certainly geographic-specific markets within the United States where these trends are not consistent and where home prices have declined by over 10% year over year.
The market looking to stabilize
While cost of borrowing is one part of the equation underlying housing affordability, median income is also a key component. When the economy is performing well and the purchasing power of households grows, housing affordability increases. Figure 6 tracks year-over-year household growth relative to median household income growth, adjusted for inflation using the consumer price index.
Figure 6: National Home price growth to median household income growth
Source: Federal Housing Finance Agency, U.S. Census.
During the pandemic, the spread between home price growth and median income growth climbed as high as 22.67 percentage points, a significant gap that explains the sharp drop in housing affordability. This is coming on the heels of roughly five years where home price growth slightly outpaced real income growth (by about 4.00 percentage points on average).
Home price growth decelerated (or was negative in certain markets) in 2023. Contractionary policy by the Federal Reserve appears to have had an impact on home price growth. At the same time, median income growth is starting to pick up. The gap between income growth and home price growth has begun to shrink down to pre-pandemic levels, at about 4.28 percentage points as of Q2 2023. Homes may not become substantially less affordable for the foreseeable future. If housing supply continues to increase, and inflation is sufficiently curbed, this trend suggests the market may eventually become more affordable, particularly if interest rates fall. However, this market correction is not likely to be quick.
A return to more affordable housing can occur through increases in wages, declines in home prices, or declines in the 30-year mortgage rate. The table in Figure 7 provides the average time in years that it would take for home affordability to return to a longer-term average by assuming different levels of annual home price appreciation, wage growth, and mortgage rates. Specifically, Figure 7 calculates the average number of years it would take for the Home Affordability Index to return to a value of 125 from a current value of 81.25 (indexed where the year 2000 = 100), assuming a return to a 5% mortgage interest rate. A drop in the mortgage rate would result in a lower monthly mortgage payment, all else equal.
Figure 7: Years to return to pre-pandemic affordability
| Annual Home Price Appreciation |
Annual Growth in Wages |
30-Year Mortgage Rate |
Years to Return to Pre- Pandemic Affordability (Affordability Index = 125) |
|---|---|---|---|
| -5% | 4% | 5% | 5 |
| -5% | 2% | 5% | 6 |
| 0% | 4% | 5% | 11 |
| 0% | 2% | 5% | 22 |
| 3% | 4% | 5% | 44 |
Under a scenario in which we assume the housing market cools considerably (5% annual declines in price), it would take approximately five to six years for housing affordability to return to pre-pandemic levels. Sustained declines like this haven’t been observed in the data since the global financial crisis and are not expected. A case more consistent with a stable market outlook (0% home price growth) estimates an 11-year affordability correction. The amount of time it might take to return to more affordable housing is highly sensitive to income growth. If home price growth exceeds income growth, then, under the NAR calculation for home affordability, the gap between prices and ability to pay will continue to increase. Given the massive acceleration in home prices (the driving factor in reduced affordability through the pandemic), we anticipate that home affordability will remain low for the next several years.
Note that these estimates are illustrative only, given that we assume these growth rates are constant over time and uncorrelated with each other. Unpredictable events, such as the pandemic, can cause a significant degree of long-run disruptions in markets. Policy action taken can sometimes have unintended consequences that affect the speed at which economic forces recover.
Industry outlook
Various mortgage experts have weighed in on where the housing market is headed in the short term. There is some disagreement as to whether growth is merely slowing or if there will be a downturn in prices, but the consensus is that there will be a market stabilization relative to the rapid growth seen during the pandemic, rather than a major correction. Industry experts also tend to agree that the main drivers of present market activity are low affordability and constrained supply caused by high interest rates. Because locality plays a large role in determining home prices, it is likely that most expert opinions will be simultaneously correct and incorrect as to what exogenous forces will play the largest impact moving forward.
The table in Figure 8 provides a summary of housing market expectations from a variety of market forecasts.
Figure 8: Housing market expectations
Moody’s5 and Redfin6 share a slightly pessimistic outlook, forecasting national price declines of approximately 4% in both of the next two years. They believe the reduced demand due to poor home affordability is enough to outweigh the supply constraint, which overall drives prices down. Moody’s also acknowledges that regional markets may be hit with more volatility. Similarly, Redfin notes that the Midwest and Northeast are markets that will be more resilient to the market cooldowns given their historical stability relative to coastal areas.
Fannie Mae7, Freddie Mac8, and Realtor.com9 all forecast home price growth to be somewhere between zero and -1%. The narrative is consistent: low home affordability and housing supply constraints are offsetting factors. While there have been some gains in the labor market, increasing the total income of potential home buyers, it has not been enough to significantly move the needle on housing demand given the present cost of a mortgage.
Economist Robert Shiller10, as well as the Housing and Mortgage Market Review11 (HaMMR) point to the role of monetary policy and the Fed as the determinant of home prices over the next two years. If monetary policy shifts to lower interest rates, even slightly, as inflation cools, this may ease pressure on housing supply. While lower rates traditionally lead to higher demand, historically high interest rates have kept homeowners seeking to move off the market. Lowering interest rates to a certain extent may provide a downward pressure on prices as existing homes enter the market, which runs counter to standard intuition of interest rate theory.
Goldman Sachs12 and the Mortgage Bankers Association13 (MBA) are more bullish, predicting roughly a 1% increase in home prices for 2023 and 2024. While they predict prices will continue to grow, they do fall in line with other industry experts in that it is likely the beginning of stagnation in the housing market. Growth is not expected to be as steep in the years leading up to and during the pandemic.
Barring a major economic recession, the occurrence of which has less consensus, market forces would indicate that home prices are likely to stay high for the foreseeable future, but housing affordability may start to turn upward over the next decade, especially if the Fed decides it wants to pivot and cut rates. It would not appear that there are any major changes coming in the next few years as the market reaches stability following the pandemic.
1 Glowacki, J.B., Brelih, J.-A., & Netter, A. (November 11, 2022). The Housing Market Is Slowing Down...What Does That Mean? Retrieved August 30, 2023, from https://www.milliman.com/en/insight/housing-market-is-slowing-down-what-does-that-mean.
2 NAR. Methodology: Housing Affordability Index. Retrieved August 30, 2023, from https://www.nar.realtor/research-and-statistics/housing-statistics/housing-affordability-index/methodology.
3 See https://www.businessinsider.com/us-underbuilding-housing-over-the-past-decade-2020-9, https://www.cnbc.com/2021/09/14/america-is-short-more-than-5-million-homes-study-says.html, and https://www.nar.realtor/sites/default/files/documents/Housing-is-Critical-Infrastructure-Social-and-Economic-Benefits-of-Building-More-Housing-6-15-2021.pdf.
4 Trading Economics (July 2023). United States Total Housing Inventory – July 2023 Data – 1982-2022 Historical. Retrieved August 30, 2023, from https://tradingeconomics.com/united-states/total-housing-inventory.
5 Weil, D. (April 3, 2023). U.S. Housing Market in Trouble: Moody's Predicts Home Prices Will Fall in 2023 and 2024. TheStreet. Retrieved August 30, 2023, from https://www.thestreet.com/housing/us-housing-market-in-trouble-moodys-predicts-home-prices-will-fall-in-2023-and-2024#:~:text=%E2%80%9COn%20a%20national%20basis%2C%20we%20expect%20home%20prices,homes%20sales%20to%20drop%20about%2020%25%20this%20year.
6 Redfin (December 6, 2022). Redfin’s 2023 Housing Outlook: A Post-Pandemic Sales Slump Will Push Home Prices Down for the First Time in a Decade. Retrieved August 30, 2023, from https://investors.redfin.com/news-events/press-releases/detail/845/redfins-2023-housing-outlook-a-post-pandemic-sales#:~:text=Redfin%20predicts%20the%20median%20U.S.%20home-sale%20price%20to,homes%20that%20went%20under%20contract%20in%20late%202022.
7 Fannie Mae (July 10, 2023). Housing Forecast: July 2023. Retrieved August 30, 2023, from https://www.fanniemae.com/media/48386/display.
8 Freddie Mac (October 21, 2022). Quarterly Forecast: Rapidly Rising Rates and Declining Demand Driving a Housing Market Slowdown. Retrieved August 30, 2023, from https://www.freddiemac.com/research/forecast/20221021-quarterly-forecast-rapidly-rising-rates-declining-demand-driving-housing-market.
9 Realtor.com. National Housing and Economic Forecast 2023 Midyear Update: Despite Easing Home Prices, Costs Remain High. Retrieved August 30, 2023, from https://www.realtor.com/research/2023-national-housing-forecast-midyear-update/.
10 De Mott, F. (July 21, 2023). Robert Shiller says decade-long rally in home prices could end when the Fed wraps its hiking cycle. MSN. Retrieved August 30, 2023, from https://www.msn.com/en-us/money/realestate/robert-shiller-says-decade-long-rally-in-home-prices-could-end-when-the-fed-wraps-its-hiking-cycle/ar-AA1ebf1A.
11 Ross, P. & Mourelatos, L. (July 17, 2023). HaMMR Digest. Arch Mortgage Insurance Company. Retrieved August 30, 2023, from https://mortgage.archgroup.com/wp-content/uploads/sites/4/MCUS-B1633B-HaMMR-Digest-071723.pdf.
12 Lambert, L. (July 18, 2023). Four years of housing market gridlock? Goldman Sachs issues U.S. home price predictions through 2026. Fortune. Retrieved August 30, 2023, from https://fortune.com/2023/07/18/sideways-housing-market-goldman-sachs-home-price-forecast-for-2024-2025-2026/.
13 MBA (July 20, 2023). MBA Mortgage Finance Forecast. Retrieved August 30, 2023, from https://www.mba.org/docs/default-source/research-and-forecasts/forecasts/mortgage-finance-forecast-jul-2023.pdf?sfvrsn=130f078e_1.