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Home prices succumb to market pressures

Home prices plunged for the second month in a row in July 2022, solidifying a downward trend which has only just begun.

Here in California, home prices peaked in May 2022 and have since entered into a free fall.

As of July 2022, home prices are down from their peak by:

  • 2.3% in the low tier;
  • 3.7% in the mid tier; and
  • 3.4% in the high tier.

On a regional basis, the steepest drop has occurred in the volatile Bay Area, with San Francisco home prices down a chilling 4.3% from the May 2022 peak, as of July 2022.

At the national level, home values slipped by 0.3% in July 2022, according to Zillow.

Coated with sugar, this downward momentum is viewed by some as a “normalizing” or “rebalancing” of the housing market. But once you get under the surface, the facts remain the same: home prices are imploding.

The powerful pull of the mean price trendline

Zillow, among other media outlets, has attributed the recent price drop to higher mortgage interest rates.

While 2022’s rising interest rates certainly play a role, as they cut buyer purchasing power instantly, the home price correction taking place in 2022 was in the cards regardless of the recent interest rate leaps.

Consider the mean price trendline, depicted as the smooth black line in the chart below. This trendline is tied to changes in buyer incomes over time. Thus, it is the historical equilibrium to which home prices return each real estate cycle.

In this chart, the dashed lines are firsttuesday’s forecast for future home prices. The exact trajectory of home prices may vary somewhat in the next two-to-three years, complicated by global events or government stimulus during the as-yet undeclared 2022-2023 recession. However, history has taught us home prices will return to the trendline eventually — it’s simply a matter of when.

Heading into the 2020 recession, prices had cooled off to an annual rise of around 2%-3%, keeping pace with buyer incomes. Then, the recession hit and the government responded to keep the economy afloat during the downturn. This included multiple injections of fuel into the housing market, including:

  • historically-low interest rates, induced by the Federal Reserve;
  • individual stimulus payments; and
  • federal eviction moratoriums and forbearance programs to keep people in their homes during the pandemic.

The result was an artificial — temporary — boost for home prices.

Expect prices to decline just as quickly as they were inflated during 2020-2021, if not more so. In fact, downward motion in the second half of 2022 has already exceeded firsttuesday’s forecast made earlier this year.

Just how far do prices need to fall before they reach the mean price trendline?

From their May 2022 peak, home prices will need to plunge 40%. In other words, a $1 million home in mid-2022 will be a $600,000 home by 2026.

After the bliss of a decade of climbing home values, this level of decline may sound absurd. But for a recent example, just cast your vision back a little further to the aftermath of the Millennium Boom. From their peak in 2006 to their bottom in 2009, average California home values contracted a whopping 45%.

Homebuyers — and real estate agents — have gotten used to experiencing housing as a get-rich-quick scheme. It’s time to adjust your view and see housing as primarily shelter or long-term investment. Flippers will find themselves deep underwater in the coming years.

Stay up to date on California’s rapidly shifting housing market by subscribing to firsttuesday’s newsletter, Quilix.

Related video:

Climbing mortgage rates pushed sales volume down — and now property prices; Monthly Statistical Update (October 2022)