Home Prices Will Fall Next Year: Here Is Why

Article Summary:

No one knows for certain what will happen in the real estate market next year. But multiple factors favor flat or falling home prices in 2023. These include lost buyer purchasing power due to inflation, rising mortgage rates, and the fact that prices are already very high in many areas, having risen especially rapidly in the last few years. Based on these factors and data showing that home value appreciation has already slowed or reversed in formerly hot markets, expert analysts generally agree that the days of rapid home appreciation are over, at least for now. It’s assumed that home prices will drop soon, or at best remain stable, in places like the West Coast that have enjoyed the biggest recent price gains. In some of these places, value loss has already begun.

It’s often difficult to predict the housing market, but sometimes data suggests one future is much more probable than others. Housing experts’ assessment of the real estate market in the waning quarters of 2022 points to stagnant or falling home prices in 2023 as just such a high-probability future.

This article will summarize some of the experts’ predictions and what they mean for homeowners and potential buyers. First, though, let’s look at some factors favoring stable or falling prices that play at least some role in the experts’ expectations and figure prominently in discussions about the experts’ forecasts.

What causes housing prices to fall?

Before looking at specific experts’ projections, we can save some time by answering a question frequently asked during discussions of such forecasts. When home prices fall, why do they do so? What causes a housing downturn?

Though pervasive government involvement in the housing markets — through loan guarantees, sponsored enterprises, and assistance programs aimed at increasing home ownership — can make this difficult to perceive at times, the housing market depends on the same laws of supply and demand as drive all other buying and selling. All things being equal, a drop in housing demand should lead to a drop in home prices.

1. High home prices

One thing that can dampen the housing demand is rapid home price growth, which is just what we’ve had in many areas in the United States. According to a Federal Housing Finance Agency (FHFA) end-of-August press release, U.S. home prices rose 17.7% over just the 12 months ending June 2022, with homes over $1 million becoming common in some regions.

In the immortal words of American financier Henry Clews, “The best cure for high prices is high prices, which automatically correct themselves by curtailing consumption and stimulating production.”

Since home builders cannot construct new homes instantly, the last part of Clews’ progression tends to lag. When inflation is high, the cost of building materials (and to buy and run power tools, etc.) rises. Since new housing may have higher prices baked in, a new supply won’t cure the high prices quickly. And, of course, home construction is highly regulated in most places. While the regulations may improve building safety and make neighborhoods more orderly and attractive, they also add to construction costs and slow development, making the cure even more sluggish.

2. Rising mortgage rates

As you might have heard, mortgage rates are on the rise. While explanations vary for why inflation turned out not to be as “transitory” as many a chief economist assured Americans mere months ago, the Federal Reserve has finally decided that it must act, heralding a fundamental change in policy in a press release issued near the end of July 2022. As the Federal Reserve raises its rates, other rates in the financial markets also tend to rise. (The Fed does more than just raise its rate, but we’ll keep it simple.)

Mortgage borrowers have far less reason to be pleased. Freddie Mac’s Primary Mortgage Market Survey (as of September 8, 2022) shows the average U.S. rate for a 30-year, fixed-rate mortgage as 5.89%. Higher mortgage rates mean that more buyers find monthly payments for the loan they would need beyond what they can afford.

As a result, many buyers feel they must continue renting. This means lower demand. And, as demand falls, so should prices. That is, prices should fall if all other factors affecting demand remain unchanged or change in a way that also suppresses demand. Like all other factors affecting demand, financing cost does not guarantee a drop in prices. What matters is the demand for homes after all influences on demand have had their say, not the effect on demand of any isolated influence like mortgage rates.

A silver lining

Markets where it becomes hard to finance home purchases should experience increased rental demand, since those who cannot buy must rent. If you own rental property, tough housing markets can be good news for you. This assumes most people sidelined from buying don’t choose to live in their cars, of course.

Some sound advice from Freddie Mac

In its introductory remarks to the mortgage-rate survey just mentioned, Freddie Mac offers potential mortgage borrowers this guidance:

Not only are mortgage rates rising but the dispersion of rates has increased, suggesting that borrowers can meaningfully benefit from shopping around for a better rate. Our research indicates that borrowers could save an average of $1,500 over the life of a loan by getting one additional rate quote and an average of about $3,000 if they get five quotes.”

3. Less money available to spend on a home

One additional factor favoring slower existing home sales and stagnant or lower home prices is individuals’ and families’ inflation-driven need to spend more of their income on other things. More people than not believe they have less purchasing power now than they used to. By May 2022, Americans surveyed already felt their incomes were not keeping up with inflation. And an analyst for one economics institute thought workers were already behind the inflation eight ball in 2018.

Real incomes and housing affordability are matters of ongoing debate, of course. Americans may well think they are worse off than they are. Our SuperMoney study before the current rate increases found that financing a home as a median-income American was not significantly more difficult than in prior years. Yet, even at that time, most Americans probably would have said housing was less affordable than it used it be. Still, things like increased use of credit to buy groceries suggest that there’s some real loss of purchasing power underway.

Regardless, perception alone counts for a lot in the housing market, like in all markets. If enough people feel that price growth in necessities like groceries and utilities makes financing a house out of the question right now, that feeling could contribute to softer home sales, a drop in the median sales price of homes, and lower national home prices overall.

What are the experts predicting for next year’s housing market?

Technically, the title of this article should be “Expert analysts believe it is highly probable that home prices will drop soon or stagnate in some areas.” But who would read an article with a title like that? More importantly, what data make experts believe that home prices will fall next year?

Let’s review what two sets of experts, those at Goldman Sachs and those at Black Knight, are saying.

Goldman Sachs

Financial news sites have been abuzz about Goldman Sachs‘ latest forecast for the American housing market. And some clickbait headlines make it sound like homeowners hoping to get good value if they sell are doomed and everyone should run for the hills because the housing-market sky is falling.

As these headlines would have it, skyrocketing interest rates are making homes unobtainable, and the real estate bubble that’s been inflating since the financial crisis is just about to burst. If you were thinking of selling your home or qualifying for a mortgage loan to buy one, forget it.

Will the housing bubble burst in 2023? Not according to Goldman Sachs

In reality, unless you live in a Western market that has been especially hot for some time, Goldman Sachs is not so much predicting lower prices on homes as prices that don’t rise much or stay about the same. As of September 2022, Goldman predicts that home prices will fall in 39% of U.S. metropolitan areas in 2023, particularly in the West. Meanwhile, the organization expects home values to continue rising in most East Coast metros.

Overall, Goldman Sachs expects housing prices nationwide to be roughly flat. It forecasts a 2023 home price appreciation (HPA) of 0.65% nationwide, a steep drop from the 10.7% it expects for 2022. That 10.7% projection, by the way, assumes appreciation of only 0.2% from July through December, since Goldman had observed 10.5% appreciation by the end of June.

The housing market has been cooling for months

Goldman Sachs’ September report does not signal a radical change in previously observed trends. The organization noted back in June that home sales had fallen off 40% from “their pandemic peak.” In July, one in 10 metro areas showed month-over-month declines in the value of homes, with the drops most prevalent in the Mountain West and West regions.

Citing Zillow data, Goldman observes that annualized home appreciation in the U.S. fell from June’s 15% to 8.5% in July, a more rapid decline than the May to June drop from 19% to 15%. Annualized home appreciation, of course, is what the appreciation would be over a full year if the amount observed in a given month remained stable. A 15% annualized rate would mean a 1.25% increase in value within the month, for example.

Black Knight

Compared to Black Knight’s July 2022 Mortgage Monitor, released in early September, Goldman Sachs’ forecast seems almost sanguine. The report paints an especially dire picture for homeowners hoping to pull equity out of their properties in West Coast metro areas like San Diego (lost 14% in “tappable equity” between April and July), San Francisco (lost 14%), San Jose (lost 20%), Seattle (lost 18%), and Los Angeles (lost 10%). Sorry, California and Washington.

What is tappable equity and why should you care?

On the “bright” side, this doesn’t mean that homes have lost this much value in these places. Tappable equity is the amount of equity homeowners can actually pull out of their homes with home equity loans and home equity lines of credit (HELOCs). As Black Knight uses the term, it also assumes that borrowers don’t pull out more than 80% of the equity available. Black Knight assumes a loan-to-value (LTV) ceiling of 80%, in other words.

Not solely a function of home value, tappable equity also indicates how lenders feel about the direction home prices will go after they provide loans. If lenders expect prices to continue dropping, for instance, homeowners will lose more tappable equity than home value (or actual equity). Black Knight’s report finds that homeowners in declining markets are losing twice as much tappable equity as home value. This means lenders expect that declining home prices will keep dropping, or that they are likely enough to do so that assuming otherwise is too risky.

When it comes to the housing market, mortgage lenders probably deserve the “smart money” label. So, if they believe home prices will drop next year, you can safely say that the smart money expects the housing market to decline in 2023.

Other key findings

Aside from this bad news for property owners in what were recently among the nation’s hottest real estate markets, Black Knight’s key findings include the following:

  • Of the 50 biggest real estate markets in the U.S., prices in over 85% had fallen below their peaks by the end of the July. In a third of these, home prices fell more than 1%. In more than a tenth of these, prices dropped more than 4%.
  • Tappable equity gains seem to have peaked in May and are now in decline. In June and July, tappable equity fell 5%. This puts the third quarter of 2022 on track to be the first quarter in three years with declining tappable equity.

Final comment on the expert forecasts

These two sets of experts both suggest that already realized trends will extend into the coming year, though they do not agree on every detail. We have therefore called their reports “forecasts” even though, technically speaking, statements about the future are less prevalent in their work than observations about the past and present.

Fortunately, neither expert within these two organizations is predicting a housing crash. The reaching of a home-price plateau in many places, yes. A widespread end in rapid home price growth, also yes. General failure of existing home sales to earn owners the wild profits they’ve come to expect, yes again. A violently bursting housing bubble and catastrophic housing crash, followed by a replay of the Great Depression and chaos throughout the country, no. At least, not yet.

Practical implications

Even if the most dire implications of these experts’ analyses come to pass, the economic apocalypse is not yet upon us. As long as societal collapse is not in the offing, we all must continue planning and living our lives.

So, what does all the preceding mean for homeowners looking to sell and home-seekers hoping to buy? And what about homeowners who want to tap their equity, not sell? How should the likelihood of weaker home sales, flat or falling house prices, and more expensive mortgage financing affect their planning and actions in the next several years, or at least months?

For equity tappers

If you want to turn some of the equity in your home to liquid assets, you should do so sooner rather than later. This is especially true if you agree with the smart money that houses’ prices will drop and interest rates will continue to rise.

Even if you live in a market where home values may remain stable or increase — such as Cape Coral, Florida — rising interest rates suggest you should start getting preapprovals for your home equity loan or HELOC as soon as practical.

For sellers

If you live in one of those recently overheated markets now set to give back some of its gains, you’ll either want to sell quickly to avoid further loss or settle in to wait for the next upward trend in the area housing market. Many of the factors that favor higher prices in places like California persist, such as insufficient housing inventory and government propping-up of the market in both blatant and subtle ways. This might lead you to suspect that the market won’t take too long to get back on track.

Besides, you’ve heard experts claim lately that we’ve already hit peak inflation and can expect a more reasonable CPI (Consumer Price Index) in almost less time than it takes to say “recession.” Surely the Fed will stop hiking rates any month now, you speculate.

Optimistic, pundit-driven speculations notwithstanding, waiting out falling prices with any asset is a calculated risk. Historically, real estate prices have risen reliably in the long run, so property owners able to wait long enough usually have recovered their losses and been able to profit. But we’re dealing with the future here, not history, so you have no guarantees.

Related reading: If you do decide to sell, take care to avoid common mistakes sellers make.

For investors who can buy with their own funds

If you are a real estate investor so flush with funds that you can buy properties using cash, even a small drop in prices is good news. For you, if you focus on the right markets, the months ahead will be a great time to buy a house — or several. So prepare your lowball offers and get ready to rumble.

For buyers who must finance

If you need a mortgage to buy a home, however, a small drop in price might not compensate for the increased cost of financing. To illustrate, let’s use an online mortgage calculator for some quick-and-dirty calculations with unrealistic numbers.

If you take out a 30-year, fixed-rate mortgage for $100,000 at 5% and disregard all other costs, you end up with a monthly payment of $536 and total loan cost of $193,644. If you get an otherwise identical loan at an increased rate of 6%, your monthly payment goes up to $599 and your total loan cost rises to $216,193. So, a 1% increase in APR for your off-grid tiny home costs you an extra $22,549.

To have your total home cost end up about the same at the higher rate, you’d need to get that $100,000 home for around $89,500. A 6% mortgage for that amount and all the same terms has a total cost of $193,561 and monthly payment of $536.

Financing buyers’ bottom line

The bottom line for buyers who must finance, then, is as follows. If you believe that mortgage rates haven’t finished going up, and if you aren’t willing to maintain your current living arrangements for however long it takes for rates to drop again, start looking for the best mortgage lender you can find now, get preapproved, and start home shopping. If you think professional prognosticators are wrong and Federal Reserve announcements are lies, on the other hand, feel free to just relax and take action when the mood strikes you.

Key Takeaways

  • Never assume a prediction is sure to be correct. No one based in the present knows for sure what will happen to home prices next year.
  • If trends already underway continue into next year, home prices in many locations will flatten or drop in 2023.
  • Factors underlying these trends include high levels of home price appreciation already achieved, rising interest rates, and inflation in the cost of non-home necessities.
  • If you believe prices will continue to drop and wish to sell, you can either sell as quickly as possible to minimize lost profit or wait for the next period of rising home prices.
  • If on the other hand, you’re a real estate investor who can buy homes without lender financing, get ready to expand your portfolio with more properties. This, of course, assumes prices will indeed drop in key markets next year.
  • If you’re a buyer who needs a mortgage and can’t wait for interest rates to come down as you assume they eventually will, get preapproved for a loan and find a home to buy as soon as you can. Small increases in your loan APR make a big difference in the total cost of the home you buy and your monthly payments.
View Article Sources
  1. Black Knight’s July 2022 Mortgage Monitor — Black Knight
    This 07 September press release summarizes key findings and implications of the referenced Black Knight report. When this article was prepared, the July report was the most recent available, but readers may check for newer reports on the Black Knight site.
  2. Consumer Price Index — Bureau of Labor Statistics
  3. Eat Now, Pay Later: Going Into Debt for Food — New York Times
  4. Henry Clews Letter 04 February 1918 — Logansport Pharos-Reporter
  5. Home Price Appreciation (HPA) Index – July 2022 — American Enterprise Institute
  6. Implementation Note….Decisions Regarding Monetary Policy Implementation — Federal Reserve
  7. Mortgage Rates Maintain their Ascent — Freddie Mac
    The preceding link is to an archival copy preserving the September update. For the latest figures, visit the live Freddie Mac page.
  8. The Global Housing Market is Starting to Wobble as Central Banks Hike Rates — Goldman Sachs
  9. Useful background articles from personal finance and financial news sites — Various
  10. Using this Inflation Measure, Wage Growth Isn’t Keeping Up with Inflation — Mises Institute
  11. U.S. House Prices Rise 17.7 Percent over the Last Year; Up 4.0 Percent from the First Quarter — FHFA
  12. Why this is a critical moment for American workers to push for wage gains — CNBC
    In addition to these external sources, readers may find multiple links to helpful SuperMoney pages in the article above.
  13. Existing-Home Sales Retreated 5.9% in July — National Association of Realtors
  14. Believe It or Not, Real Estate Affordability Hasn’t Changed Much in 40 Years — SuperMoney
  15. What Is A Housing Bubble And How Does It Work? — SuperMoney
  16. Is This a Good Time to Buy a House? — SuperMoney
  17. Should You Make a Lowball Offer on a House? — SuperMoney
  18. How To Buy a House In California — SuperMoney
  19. What is the Cost of a $1 Million vs. a $2 Million Mortgage? — SuperMoney