We all know the good sense in putting away a portion of each paycheck for the next “rainy day.” Well, the storm clouds are gathering around California’s housing market, and anyone who makes a living in real estate needs to break out their umbrellas.

California — especially the Bay Area — is home to the highest number of swiftly-declining housing markets, according to a Redfin analysis of U.S. housing markets from February to May 2022. The determination takes several factors into account, including year-over-year changes in each metro area’s:

  • inventory;
  • share of price drops;
  • price-per-square-foot;
  • pending sales;
  • sales-to-list price; and
  • share of homes off the market in less than two weeks.

By these metrics, six of the top ten fastest-cooling U.S. housing markets are in California. Compared to a year earlier:

  • San Jose’s for-sale inventory is up 10% and price drops are up 9%;
  • Sacramento’s inventory is up 39% and price drops are up 24%;
  • Oakland’s inventory is up 43% and price drops are up 12%;
  • Stockton’s inventory is up 58% and price drops are up 19%;
  • San Diego’s inventory is down 4% and price drops are up 17%; and
  • San Francisco’s inventory is down 5% and price drops are up 8%.

Each of these metro areas also saw fewer pending sales compared to a year earlier. Thus, as inventory is rising across most of California, sales volume is declining. This is a reversal from most of 2020-2021, when sales were rising as inventory plunged to historic lows.

Statewide, home sales volume reached an early peak in March 2022. Since then, sales volume has bucked normal seasonal trends, declining throughout the spring season — typically the busiest time of year for real estate agents. At this rate, total annual sales volume will fall below the prior two years, but also below 2019 (the last “normal” year for sales volume before the pandemic struck in 2020).

The main culprit behind the rapidly deteriorating housing market here in California and elsewhere?

An economy slouching towards recession.

The recession is looming over the housing market

Recession signals are popping up in different segments of the economy. Most notably, in an effort to combat rapid inflation, the Federal Reserve (the Fed) began pumping up its benchmark interest rate in March 2022, jumping from essentially zero to 1.75% in just three months.

The impact on mortgage interest rates has been fast and — for many home purchases — fatal. The average 30-year fixed rate mortgage (FRM) rate spiked from near 3.0% at the end of 2022 to over 5.5% in July 2022.

Translated to lost purchasing power, homebuyers today have access to 26.6% less mortgage money than a year earlier. In other words, a homebuyer with the same income and savings as a year ago, now has 26.6% less money to spend on a home due to interest rate increases alone.

Related article:

Press Release: Buyer Purchasing Power Index (BPPI) falls to new low in Q2 2022

Accurate home price reports lag two-to-three months behind real-time events. Further, the sticky pricing phenomenon — also known as the rocket and feather effect wherein prices are quick to rise but slow to fall — means today’s high home prices persist despite the reality of reduced purchasing power. Thus, the latest data unsurprisingly shows home prices continuing to rise across California.

However, today’s high home prices will lose all momentum in the second half of 2022, due to the culmination of:

  • higher interest rates;
  • long-term job losses;
  • tightening access to mortgagee credit; and
  • the replacement of buyer enthusiasm with caution, as homebuyers are held back by an increasingly bleak economic picture.

Expect the next economic recession to arrive heading into 2023. Unlike the warmup recession — the brief 2020 recession which was stymied by pandemic stimulus — this will be the main event. The impact in the housing market is already being felt in reduced sales, greater price cuts and rising inventory. Home prices are next in line to fall.

Real estate professionals who want to survive the coming downturn will prepare now. This means increasing marketing efforts, learning creative sales structuring and expanding into adjacent types of practice. And of course, don’t forget to put away extra income now for the rainy days ahead.

Related article:

Stay ahead of the next recession