Below is a story based on an interview Ed Pinto recently had with Shawn Tully of Fortune on the rapidly shifting dynamics of the housing market. In the interview Ed discussed how current home price appreciation declines are largely driven by Western metros and the high price tiers and why to expect these trends to evolve though the end of 2022.
By Shawn Tully
On August 22, the source that arguably features the best residential real estate data in the business––American Enterprise Institute’s Housing Center––released new numbers for July. The update’s overall theme: America has reached a pivot point where the market’s flipped from record appreciation this spring to substantial real-time declines across a number of the most overheated metros. The key revelation is that from August through the close of 2022, prices on a national level are tracking for the first substantial pullback in any six month period for well over a decade. To get the estimate, and it may shock you, read on.
The AEI’s July report spots three key trends. The first highlights the damage that’s suddenly engulfed the big, super-pricey western markets. For the U.S. as a whole, month over month Home Price Appreciation or HPA has decelerated sharply from an average of 2.1% from January to April, to just 0.2% in June, followed by a slight uptick to 0.5% in July. “The July increase may be seasonal,” says Ed Pinto, Housing Center’s director. “Many of the homes that go to contract in the peak spring selling season close around 45 to 60 days later in July.” It’s important to note that as recently as April, every one of the 60 markets the AEI measures posted an advance over March.
Trend one: The West’s affordability problem finally bites
By contrast, twenty metros suffered retreats in July. And of the seventeen that dropped most, ten are major western cities that were already expensive when the liftoff started in late 2020, and ranked among the prime gainers in the boom. The biggest loser was San Jose, falling 3.9% after a 4.5% pullback in June. Seattle shrank 2.7%, Colorado Springs 1.8%, San Francisco 1.3%, and Portland 1.2%, while Denver, Las Vegas, Los Angeles and San Diego all fell around 1%. Phoenix and Austin joined the retreat at -0.6% and -0.5% respectively. Seven metros mirrored San Jose by dipping in both June and July, a repeat that confirms the downturn’s persistence across the western tier. “The only western metros that held up pretty well are Sacramento [+0.5%], Tucson [+0.9%], and Riverside [+0.3%],” says Pinto. “And they’re three of the region’s smallest markets.”
For Pinto, the impetus driving that downdraft is fundamental. “It doesn’t help that so many people from California and Seattle are moving to less expensive cities because of the work-from-home revolution,” Pinto told Fortune. “But that exodus has been happening for years, and it was inevitable it would accelerate as prices kept jumping. The key factor is the lack of affordability that’s been building for a long time, and got much worse in the pandemic.” In San Jose, average prices soared from $1.3 million from Q2 of 2020 to well over $1.6 million this spring. In that span, San Diego went from $695,000 to the $940,000 range, and Seattle leapt from $600,000 to roughly $850,000.
By comparison, the Sunshine State, though it’s lost momentum, is proving remarkably resilient. Every one of the eight Florida cities in Pinto’s universe occupy the top ten in year-over-year HPA. In July, all of them kept waxing, with Tampa and Miami up 1.1%, and Deltona making one of the nation’s best showings at a positive 3.1%. Florida’s big plus is that though prices have risen steeply, its offerings remain highly affordable versus most of the other coastal markets. In Q2 of this year, the average home in Jacksonville fetched $392,000, well below the national average of $457,000. Despite near nation-leading HPA in recent months, Deltona still rates as the state’s cheapest major market at a norm of $354,000. The Midwest and East Coast are generally faring well. Heartland cities have stayed relatively inexpensive (Cleveland, Columbus, Pittsburgh), and even New York, Boston and Washington, DC didn’t witness the Brobdingnagian appreciation that so hammered the competitiveness of the big western metros.
Second trend: The high end takes the brunt of the blow
Pinto recently unveiled an extraordinarily informative new metric. The measure parses his data to show the up-close, month-over-month performance of the different price tiers. Pinto deploys the AEI’s standard breakdown into four levels, low, low-medium, medium-high, and high. Buyers in the first two categories benefit greatly from credit sponsored by the FHA, Fannie Mae, and Freddie Mac. Shoppers in the two “high” swaths typically obtain “portfolio” loans from banks that don’t provide the specially favorable terms bestowed on the government-backed mortgages.
During the pandemic, “medium-high” and “high” outperformed the two lower brackets. That’s highly unusual in a housing bonanza. The reason, says Pinto, is that the sharp fall in mortgage rates disproportionately boosted the high end. “Expensive homes are much more sensitive to rates than those in the lower tiers,” says Pinto. “When rates rise, lower income buyers can still obtain FHA, Fannie and Freddie mortgages. That’s because those lenders still allow buyers to qualify even when their debt-payment to income ratios go much higher. The people buying pricey homes don’t benefit from that latitude. They’re in the free housing market. The private lenders’ debt to income standards are fixed, and don’t increase. The buyers of expensive homes don’t drink from the punchbowl the Fed is spiking as people in ‘low’ and ‘low-medium.’” As rates rise, folks eyeing expensive homes can’t secure the bank loans that require much higher down payments and impose far more stringent debt-to-income bogeys than those faced by lower income borrowers.
From January to March of 2022, “high” and “medium-high” each rose at an average monthly rate of over 2%, beating both “low” and “low-medium.” But starting around May, the housing hierarchy reversed. In July, the two upper designations both dropped; “high” fell 1.9%, building on a 0.9% decline from May to June. The government-supported lower end kept chugging. For July, “low” rose 1.6% versus June, and “low-medium” climbed 0.7%. “The biggest deceases going forward will come in the expensive part of the market,” says Pinto. “Of course, many of the priciest houses are on the west coast, which has an especially serious affordability problem.” But because higher rates exercise a much stronger pull in the upper rungs of any metro, he adds, the class that’s been the trendsetter over the past two years will lead the charge lower from here, at least in the next few months.
Pinto adds that the tough outlook for the top tiers doesn’t pose a big threat to the overall market. “The people who bought those homes have the lowest unemployment rate and highest, steadiest incomes,” he says. “They won’t default on their mortgages. If they put their home up for sale and prices drop, they can take the house off the market, keep living there, and wait for a rebound.” The hazard to watch is falling demand at the lower bands that account for the vast bulk of sales. And since prices there have also boomed, and are still rocking, that downswing is looming. “As demand falls because affordability further deteriorates in the two bottom categories, you’ll see more foreclosures that will add to supply,” says Pinto. Families will increasingly economize by renting instead of buying, expanding the time it takes to sell, and swelling inventories. Although expensive homes are taking the first hit, the mainstream market will eventually spearhead the downward spiral.
Third trend: Prices will fall for the rest of 2022
How rapid will that spiral be? Using his new metrics, Pinto makes an estimate using simple math. In addition to following the actual closing numbers through July, Pinto charts the future by deploying numbers from Optimal Blue. That home loan data platform reports contract prices when purchasers “lock” their mortgages. Those figures enter the public record in 45 to 60 days later. The preview from Optimal Blue allows Pinto to accurately forecast HPA for August and September. He then extrapolates those dots to predict where housing will finish 2022.
Pinto now predicts that by the December holidays, average home prices will hover around 6% higher than 12 months earlier. But the first seven months of 2022 are already in the can, and they show a total gain of 10% from January through July. To register a 6% increase for the year, prices must fall 4% over the next five months. That course would mark a severe reversal from the ever-rising tide of the last few years. And the drop will be anything but consistent across America. “The declines in the West will continue to be the most severe,” says Pinto. “The high end will also continue to be hit hardest.” So far, America faces nothing resembling an outright crash. But for the average homeowner, it will hardly bring cheer that the closer they get to the holidays, the more they’ll be watching the value of their cherished ranches and colonials fade.