March 2, 2024

Economists look to the residential housing market as a primary indicator of whether a recession is coming, and home transaction and construction data began showing positive signs that the housing downturn may have reached a bottom in February. Many believe we’ve dodged a severe recession, and some are even optimistic that the Fed will achieve the soft landing the central bank was hoping for—an outcome of stabilized inflation without a significant rise in unemployment. 

Consumer spending has begun to plateau, and The Fed has signaled that it will likely put future rate hikes on hold while keeping an eye on inflation. The rate hikes that began last March may finally be coming to a close. Meanwhile, signs have pointed to a recovery in the housing cycle. After a contraction in selling activity, a slowdown in residential development, and falling home prices, things started to turn around in February. 

But we may not be out of the woods. Home-selling activities always pick up this time of year. There’s typically a 34% increase in sales activity between February and March, and home prices tick up 3% during the same period, according to the National Association of Realtors. New data for March is actually showing the reverse after a slight turnaround in February. Furthermore, many economists are still forecasting a mild recession in 2023, especially in light of recent bank closures. There’s a chance that home prices could fall further from their most recent low before the economy truly recovers. 

The Ups and Downs in Housing Activity

Mortgage rates have come down from their peak, with recent Federal Reserve data putting the average 30-year fixed mortgage rate at 6.43%. That’s still high enough to cause affordability pressure, but the Case-Shiller U.S. National Home Price Index has fallen about 5% since its peak last June, and in some markets, prices have fallen even further. Together, these factors have brought homebuying into reach for a greater pool of buyers, causing demand to tick up while housing is still in short supply—at least temporarily.  

In February, existing home sales surged 13.8% for the first time since July 2020. But in March, selling activity for existing homes dipped by 2.4%. The Northeast was an exception, maintaining steady selling activity. The latest mortgage application data from the Mortgage Bankers Association also shows a 1.2% dip in mortgage applications after a rise the week prior. Similarly, new housing starts, completions, and authorizations fell slightly in March after an uptick in February. 

Dr. Aleksandar Tomic, Director of the Boston College M.S. in Applied Analytics and M.S. in Applied Economics programs, says the temporary rebound in selling activity was likely a seasonal blip. “House prices are still very strong, leading to affordability issues in many, if not most, markets,” he says. “In addition, interest rates are still elevated, and I do not think they will come down meaningfully soon, thus putting additional pressure on prices.”

Regional banks have also been pulling back on issuing new mortgages and tightening their standards for lending recently, which is predicted to have a significant effect on demand since regional banks account for most U.S. mortgages. According to Desmond Lachman, former deputy director at the International Monetary Fund, this credit crunch will curb demand for homes and put the economy at a higher risk of a recession, delivering multiple blows to the housing market. He expects home prices to fall up to 20% from their peak but notes that it could take a while to see the full impact.  

Homebuilder confidence is improving, but slowly. Even with continued problems with the supply of building materials in the construction sector, builders are growing more optimistic—but the National Association of Home Builders / Wells Fargo Housing Market Index has only risen to 45. That’s the highest it’s been since September, but the reading still indicates poor conditions for the housing market. 

Factors That Could Result in a Recession

So far, the Fed has managed to reduce inflation without significantly weakening the economy, according to Tomic. But with history as a guide, the Fed will likely only achieve a soft landing if there are no external shocks to the economy—in other words, a bit of luck is necessary. Tomic says tensions with China over Taiwan could “result in significant trade disruption or a significant shock to the financial system,” which might tip the economy into a recession. Tomic also says that rising inflation or inflation expectations would drive the Fed to push up the federal funds rate further, making credit even more costly for consumers and businesses. 

Has The Fed Succeeded in the Past?

Economists disagree on what constitutes a soft landing when analyzing past monetary tightening cycles, but most identify the outcome of the 1993-1995 rate hikes as a soft landing. When the Fed began raising the federal funds rate in 1993, it did so as a preventative measure—the Consumer Price Index was only 2.8% with a stable unemployment rate, but the Fed anticipated higher inflation and adjusted the federal funds rate accordingly. 

The Fed achieved a perfect soft landing in this case. The unemployment rate decreased for the following six years, and the inflation rate remained stable for two years before dipping slightly. GDP growth stayed above 3% for most of the decade, and the Fed was applauded for preventing a recession. But the Fed had luck on its side and the foresight to intervene proactively. 

Some people may think the Fed waited too long to begin tightening monetary policy this time around, but there was evidence that inflation may have been transitory at the time, driven by the pandemic. Meanwhile, multiple global crises are putting pressure on the U.S. economy—for example, the war in Ukraine, supply chain issues, and climate change are all complicating the Fed’s ability to achieve its goals. 

“The jury is still out on the probability of a soft landing,” says Tomic. “History is not encouraging on this front, but the Fed has managed to slow down inflation so far with relatively minor effect on the economy.”

How Investors Can Respond

Home prices may not have reached the bottom just yet, and Tomic says he doesn’t see prices rising significantly in the near term, either. “The economy is still strong, and inventory is still low because people do not need to move for jobs as much as before due to remote arrangements,” he says. “However, as the return to office increases, and turnover in the labor market increases as well, there will likely be more inventory available. For all these reasons, I really do not see house prices rising significantly.”

Tomic doesn’t know this to be true for sure, nor does anyone else. But since most economists are still predicting a recession sometime this year, bank closures are impacting mortgage lending, and March selling and building activity is trending downward again, it’s reasonable to believe that prices will continue to fall in many markets. It’s less likely that national home prices will begin rapidly rising again in the near future.

Following that logic, it would seem like waiting out the remainder of the housing market downturn would be advantageous for investors, but price trajectories are so market-dependent investors will need to make choices based on the data in individual markets. For example, Zillow forecasts rising prices in 294 markets and falling prices in 102 markets. Some markets in the Southeast may have already hit a price bottom, according to economists, so investors in Knoxville or Savannah may find that now is an opportune time to buy. Meanwhile, cities like San Francisco, Denver, and Las Vegas are expected to experience future price declines.

The Bottom Line

Everyone is eager to avoid a serious recession, and that may result in some overly-optimistic attitudes at the first signs of a housing market turnaround in February. But March data paints a different picture, and most economists think there’s more trouble ahead. Investors should look at local data when making investment decisions. And no matter where the market is headed, it’s still important to crunch the numbers to ensure you’ll get a good return, especially if you’re dependent on financing. Due diligence goes a long way in mitigating the effects of uncertainty in the housing market.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.

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