House Prices: 7 Years in Purgatory

10%+ Nominal Price Declines Now Seem Likely

Earlier this year, I argued the most likely path for house prices was for nominal prices to “stall”, and for real prices (inflation adjusted) to decline over several years. The arguments for a stall included historically low inventory levels, mostly solid lending over the last decade, and that house prices tend to be sticky downwards.

As I noted, homeowners resist selling for less than the recent sale prices of similar homes in their neighborhood. However, there are always the homeowners that need to sell (death, divorce, moving for employment, etc.), and sometimes these homes will sell for less than previous sales. Note that house prices were not sticky downwards during the housing bust due to the all the forced sales.

However, even in normal times, house prices are not sticky downwards in real terms as this graph shows.

In the July Case-Shiller report, real prices were only up 5.4% year-over-year (YoY) and will likely be down YoY in real terms later this year.

However, we are already seeing nominal house price declines on a national basis. The Black Knight index (median price of a repeat sales index) was off almost 2% in August, and the CoreLogic repeat sales index for August (a three-month weighted average and not seasonally adjusted, NSA) was off close to 1% in August. And my estimate is the nominal Case-Shiller national index will be off almost 1% in August compared to the peak in June.

Here is a table of previous nominal and real house price declines. The first two (1979 and 1989) would fit the “stall” scenario with minor nominal price declines.

Although the current dynamics are similar to the 1979 peak (see: Housing: Don't Compare the Current Housing Boom to the Bubble and Bust), house prices are more out of line with fundamentals than in 1979 (price-to-income, price-to-rent, real prices). For example, here is a graph of price-to-median household income:

This graph uses the Case-Shiller national index, and median household income from the Census Bureau (2022 estimate as a 5% increase from 2021). This suggests house prices need to decline relative to incomes. This could be a decline in nominal prices or an increase in income over several years (or a combination of both).

House Prices Can Take Many Paths

It seems likely that house prices will decline around 25% in real terms over the next 5 to 7 years (more or less). This decline could be mostly due to inflation or include some nominal price declines. Here is a graph of how long it took prices to recover in real terms. (See: House Price Declines: How Long for Real Prices to Recover?)

The real return following the ‘79 peak was 6.5 years. It took 11 years for real prices to reach the previous peak following the peak in ‘89. And it took 14.5 years to return to the real peak reached during the housing bubble.

Hence the title to this post: House Prices: 7 Years in Purgatory (it could take shorter or longer, especially since the next Housing and Demographics: The Next Big Shift will likely start at the end of this decade).

10%+ Nominal Price Declines Now Seem Likely

Since national house prices increased very quickly during the pandemic - up over 40% - it seems likely that some of the usual “stickiness” will not apply. I think the most likely scenario now is nominal house prices declining 10% or more from the peak, and real house prices declining 25% or so over the next 5 to 7 years.

This suggests some significant double digit regional price declines. However, I don’t expect cascading price declines this time since lending standards have been reasonably solid (and we won’t see a huge surge in distressed sales). During the housing bust, nominal prices fell 62% in Las Vegas, 56% in Phoenix, and 51% in Miami - I don’t expect anything close to that level of price decline this time.

The good news for the homebuilders is housing starts and new home sales will likely bottom much earlier than real house prices (that is the usual pattern).