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Falling Home Prices: Is It Time for Investors to Worry?

Updated: Jul 12

As anticipated, certain markets experienced greater impacts than others. For example, San Jose, California, saw a significant 10% drop from its peak, while Richmond, Virginia, only saw a 1.1% decline. Some markets even showed gains in July. Overall, 35% of markets saw declines, while 20% experienced price increases, indicating a general downward trend.


It's crucial to remember that this correction was inevitable. The market had been extraordinarily hot, leaving little room for continued upward movement. Real estate prices surged nearly 34% since Q1 2020, following a decade of unprecedented appreciation.


Some predict another crash akin to 2008, citing poor housing affordability similar to pre-2008 levels. As interest rates rise and the Fed continues its efforts to control inflation, affordability issues are indeed a concern.


However, it's important to maintain perspective. The real estate market has faced declines before without collapsing. The 2008 recession remains prominent in memory due to its recent occurrence, not because it closely mirrors current conditions.


In context, prices would need to drop significantly to negate recent gains. During the Great Recession, housing prices fell by 33%, which today would only erase the increases since early 2020.


Many overlook that 2008's crisis was triggered by widespread defaults, foreclosures, bank failures, and bailouts, not merely falling prices. Today, although mortgage default rates are rising, they remain below historical averages.


Unlike in 2008, risky lending practices like NINJA loans and high teaser rates are mostly absent. Today, about 95% of mortgages are fixed-rate, many secured at low rates in recent years. Subprime mortgages are less than 20% of 2006 levels, and cash purchases are nearly 50% higher.


Homeowner equity has risen about 50% since 2006 and over 150% since 2011, providing a buffer against price declines. High inflation today (8.3% in August) contrasts with low pre-2008 inflation, meaning real estate prices can fall in real terms without severely impacting homeowners' equity.


Moreover, the government's recent support for renters suggests a commitment to avoiding another housing crisis, even at the expense of higher inflation. With higher rates now in place, the Fed has room to lower rates if necessary.


Thus, while real estate prices are likely to fall, a financial crisis is unlikely, and housing is unlikely to trigger such a crisis.


Final Thoughts

Investors should not panic, but caution is warranted. The economy is struggling with high inflation, low labor force participation, and negative growth for two consecutive quarters. Real estate prices are expected to decline, and interest rates will likely continue rising.


Exercise caution in your analyses, avoiding assumptions of appreciation and anticipating higher interest rates. The recent hot market has made deal sourcing difficult, but a softer market could present new opportunities.


Recessions can create opportunities without being catastrophic, so stay cautious yet optimistic.

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