A Long Cold Winter Lies Ahead

As I look to 2023, my crystal ball tells me that it will indeed be a long, cold winter, but by the middle of the year, mortgage markets will have stabilized, and we will be in a much more normalized real estate market, albeit one constrained by low supply and buyer/borrower reluctance.  Here is what I see:

Interest rates will peak in early 2023 before retreating to the 5s before year-end. The Federal Reserve increased rates by 50 basis points at its December meeting, but Chairman Jerome Powell also noted the Fed is beginning to see some signs of progress in its fight against inflation.  However, the Fed made it clear to the market that it intends to stay the course with additional, smaller rate increases still necessary. But it will also give hope that a potential pivot may be in the cards, as it remains nimble in their approach based on incoming data.

The residential real estate recession that has slowed home sales to a crawl will spread to the rest of the economy, and job growth will shrink dramatically in the first quarter of 2023 as housing’s economic multiplier effect evaporates. It is important to remember that when home sales stall, so does the sale of carpet, furniture, draperies, linens, and everything else that fills a new home.  Considering that, by some estimates, housing (in one way or another) equates to as much as 20% of the economy, it is hard to envision the slowdown in housing sales not having a more profound impact on the broader economy.

Inflation pressures will ease, and the primary economic concern will turn to the depth and duration of the impending recession. In my view, a recession is inevitable at this point, but I think the Federal Reserve’s policy will, to a large extent, determine whether it is short and shallow or deeper and more prolonged.

Home prices will fall from their peak in the first and second quarters of 2022, but will still show a year-over-year increase from 2021 prices. It is important to remember that home prices in most markets rose substantially and in large chunks, sometimes over a very short window. I think most markets will give back the last three-to-six months of gains that the market euphoria generated, but I don’t see a broader collapse in prices simply because such a collapse would require a flood of sellers to the market.  Since most of those sellers are locked into extremely low interest rates, most will lack the motivation to put their homes on the market. That said, motivated sellers who have a reason to sell (perhaps because of divorce, death, job loss, or other life events) might have to reduce prices to move those homes. Since the most recent sales always reset the market because realtors and appraisers use them to establish values, those sales will quickly become the comps for future sales, creating a cascade of downward price adjustments last seen in late 2021. So, a market adjustment is certainly in the cards, but I expect sellers with low interest rates who lack a compelling reason to move to stay put and provide a floor to the future downward price adjustments.

Builders, mortgage companies, and real estate professionals will become more creative in finding ways to sell homes, and an improving interest rate environment, combined with increased inventory and somewhat lower prices, will become catalysts to re-energize the market.  Expect the sales pace to recover gradually, beginning with the spring market and accelerating moderately throughout the rest of 2023. With lower prices and interest rates off of their highs of around 7%, an interest rate starting with a 5 will look much more compelling to buyers because they will no longer be comparing it to a rate starting with a 2 or a 3.  As long as we aren’t staring at a recession with an uncertain end in sight, I expect a much brighter (although perhaps not glorious) market by the summer of 2023.