Do you feel like you’re suffering from whiplash due to the US housing market? Well, you’re not alone.

2021 was the single most profitable year in real estate. Homeowners and investors watched prices skyrocket, driven by increasing wages and inexpensive debt. But, unfortunately, that level of growth is entirely unsustainable. With interest rates now through the roof, buyer demand has dropped off, and we are in a very different economy from 18 months ago.

There are significant world events happening, and all of it is going to impact the US housing market. So, what can we expect from the real estate housing market in 2023?

The Curse of the Strong US Economy

Who would have thought that a strong economy could ever be bad? Today, we have a 4.6 million labor shortage, and unemployment is just 3.5%, both primarily driven by a reduction in labor participation. According to data from BlackRock, the world’s largest asset manager, 1.1% of the pre-pandemic workforce hasn’t returned to work. Instead, they’ve largely become students, retired, or stay-at-home parents. As a result, the workforce participation rate is declining and contributing to a labor shortage, driving wage inflation. While low unemployment might be great during normal economic conditions, it’s harmful when trying to bring down inflation.

For about a year, the Federal Reserve has been attacking the US economy with rate hikes in an attempt to bring inflation under control and back down to 2%. Therefore, the era of super cheap debt has ended. Consumer mortgage rates are about double what they were in 2021. And while inflation remains high, lower interest rates have no chance of returning.

If inflation doesn’t get under control, it could cause economic problems that last a decade. So, while we find high interest rates painful, we want the Fed to reduce inflation successfully. That’s why the Fed has been increasing its rate faster than ever before.

The Painful Consequence of Rate Hikes

Increases to the Federal Reserve Fund Rate come at a price. The first to feel the rate hikes was the stock market. In 2022, the S&P500 dipped by 19.4% and the NASDAQ by 33.1%, all while corporate profits were up 25%. As a result, investors lost confidence in the market.

Next to feel the pain of high interest rates was household wealth. From January to December, US household wealth fell 13.5%, which is the second-worst fall on record. But here’s the good news, household balance sheets are still 10% higher than in 2019 before the pandemic. Furthermore, Americans hold proportionately less debt and have much higher equity levels, which buffers them from extreme financial distress.

Blackrock claims that taming inflation is likely to cause a recession, as has historically happened almost every time the Fed has been forced to implement rate hikes. Unfortunately, nearly every time the Fed has increased rates, it’s pushed the economy into a recession, and it looks like this time won’t be any different. What’s concerning is that banks and the government won’t be able to ease the pain by loosening policy until inflation is well and truly under control. Fortunately, the economy is strong, so it’s likely that the recession will be shallow.

When Will Rates Come Back Down?

Interest rate hikes are finally slowing but expect more to come. Inflation is finally declining, but more is still needed. The latest projections made by the Federal Open Market Committee (FOMC) are that we can expect the Federal rate to reach 5.1% by the end of 2023. In 2024, they believe it will drop to 4.1% and then to 3.1% by the end of 2025.

What does this mean for real estate buyers? Well, the days of 3.5% home loans are nowhere in sight. Instead, this year, we will see prospective homebuyers and investors readjust their interest rate expectations and likely lock in loans at over 7%.

Limited Supply Holds Up Prices

Despite a sharp decline in buyer demand, home prices haven’t plummeted because supply is limited. Single-family home prices began dropping in June 2022 and have continued falling since, however, not as rapidly as many feared. Many existing homeowners who were once considering selling their properties have decided that they don’t want to sell during this climate.

Furthermore, the National Association of Home Builders has reported a massive pullback of new construction. Homebuilding in the US has plummeted by 32% since February 2022, and homebuilder confidence is on the floor. Therefore, we can’t expect new construction to fill the housing inventory gap.

2023 Housing Market Forecasts: Mixed Opinions

The unfortunate reality of the housing market and current economic state is that no one really knows what to expect from the next year. Forecasts for the real estate housing market in 2023 greatly vary by source. According to KPMG, a leading consulting firm, and data powerhouse, we can anticipate the average US home price to drop by 20%, while others have more optimistic perspectives.

Realtor.com’s 2023 housing market forecast projects a 5.4% increase in the existing home median price and a complimenting 22.8% increase in inventory. However, while mortgage rates remain high and sellers are unmotivated to sell, it’s hard to imagine these projections becoming a reality.

Rental Rates Will Continue Up

Year-over-year rent growth slowed to a single-digit pace in the late summer of 2022 but is still higher than pre-pandemic levels. The national quarterly rental vacancy rate has been near historic lows for five quarters and recently dropped to 5.6%. Despite this increase, US renters continue being challenged by limited supply and excess demand that will keep upward pressure on rent growth over the next 12 months, especially in urban cities near big metros. Realtor.com expects rents to rise 6.3% nationally this year, which is great news for active residential investors.

The Housing Market is Resilient

While economic and interest rate conditions are certainly impacting the real estate market, it remains resilient. We expect some markets to experience considerable growth in the coming year while overvalued markets will experience corrections. Housing markets that investors should be warry about include Phoenix, Boise, San Francisco, Austin, Seattle, Las Vegas, Denver, and Salt Lake City.

Surprisingly, cities that are expected to have the most growth are tertiary markets, including El Paso, Louisville, Buffalo, Augusta, Grand Rapids, and Columbia.

The US housing market is precarious, but high homeowner equity, wage growth, and household wealth will help buffer the market. Expect housing prices to cool throughout the real estate market in 2023 as buyers adjust to higher debt costs as the country faces a likely recession.

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