- Chatter about a housing bubble has grown increasingly loud amid surging home prices and dwindling demand.
- Housing-bubble collapses across history have seen three main elements: an economic downturn, higher rates, and lower demand.
- With new-home sales fresh off a four-month low, at least one piece of that equation appears to be intensifying.
There's a great debate raging in the US right now over whether the nation is in the midst of a housing bubble.
But as that discussion takes place, at least one of the elements responsible for popping the theoretical bubble is intensifying.
Housing-bubble collapses across history have seen three main elements: an economic downturn, higher rates, and lower demand. That last element could be showing itself, with new data released this week showing US new-home sales falling to a four-month low, having declined every month in 2022 — a far cry from their early-2021 heyday.
Americans are reacting to the difficult combination of home prices rising alongside mortgage rates, and the result has been a marked hit to demand. Of the remaining two parts needed to pop a bubble, one is a given and the other is quickly getting worse.
Home affordability is getting slammed left and right
Until recently, buyers still had one big reason to go out and spend big on a home: mortgage rates sat at historic lows throughout the pandemic thanks to the Federal Reserve's decision to set interest rates close to zero. The last two months have seen that crutch swiftly disappear as the Fed pushes rates higher. The average rate for a 30-year fixed-rate mortgage now stands at 5.11%, its highest level in 12 years. And it's due to keep soaring.
Shoppers are already forking over more of their cash just to cover their home loans. Data from mortgage technology and data provider Black Knight shows that the typical American household is now spending 31% of its income on mortgage payments – the largest share since 2007.
Lofty selling prices are also squeezing buyers out of the market, with prices soaring 19.8% in the year through February, according to the S&P CoreLogic Case-Shiller price index. As prices have climbed, inflation has hurt purchasing power, making homeownership even more difficult for Americans.
The slowdown in new home sales signals the two trends — higher prices and rising rates — have put a damper on the extraordinary housing demand of the past two years. That leaves just one bubble-popping criterion left: a major economic downturn, like the credit crisis seen in 2008, which results in drastically reduced spending power.
This would slow down home purchases even further, with any remaining buyers not already priced out likely bowing out at that stage. The further decline in home sales could then disrupt the market by triggering a notable downshift in home prices, feeding a cycle of evaporating demand and plummeting home values.
Much still to be decided
But the jury is still out on whether there's a bubble to pop at all. Experts have cautioned that the current situation is dramatically different from the mid-2000s market, as lending standards are much safer and household savings are larger.
It's also unclear if a meaningful economic downturn will materialize. Some economists expect the Fed to raise rates too aggressively and slam the brakes on economic growth in order to pull inflation lower. Deutsche Bank is among the most bearish, saying in a Tuesday note the central bank's actions will spark a major recession by the end of 2023.
Others aren't so worried. Fed Chair Jerome Powell said in March that "the probability of a recession within the next year is not particularly elevated," adding the economy is strong enough to "flourish" without low rates. Other data show the labor market almost fully healed and consumer spending at record highs, signaling the recovery is far from sliding backward.
Still, the housing market could be in several more months of intensifying pressure. Affordability remains under siege, and while construction is rebounding, it takes seven months on average for a home to be built. The US might not be quite in housing-bubble territory just yet, but the latest signs suggest it's crawling closer.