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Financial Fundamentals

*Home Prices Are Surging Despite 8% Mortgage Rates**

β€” Alexandra Ardelean

Wells Fargo Warns of a Housing Recession Similar to the 1980s

Hey, everyone. I'm Alex, and welcome back to the channel. Home prices are crashing higher despite 8% mortgage rates, record low affordability, and home sales on pace for the worst year since 1993. In fact, home prices hit a brand new record high in September.

Wells Fargo believes a 1980s-style housing recession is imminent. But Morgan Stanley predicts prices, rents, and affordability will improve over the next year. So who's right? And what does it mean for you?

Let's get started.

Historical Real Estate Crashes

The U.S. has had its fair share of real estate crashes. The most famous is probably the Great Depression of 1929, when home values fell by 67% over three decades.

The early '90s also experienced a crash attributable to the savings & loan crisis. Then, in '08, there was another crash in the housing market instigated by speculation and adjustable-rate mortgages.

But what about other periods? Well, home prices have shown resilience during most periods. Here's an example:

  • During and after World War II
  • The 1970s stagflation era
  • The 1980s recession
  • And the dot-com bubble of 2001

In all these cases, home prices either rose or fell only slightly before resuming their upward trajectory.

Wells Fargo's Warning

Wells Fargo believes we're on the cusp of another housing recession similar to the one in the '80s. They argue that high mortgage rates will lead to lower demand and falling prices.

But they also predict that home prices will continue to appreciate at a slower pace due to underlying demand and tight supply. They forecast that prices will rise by 1.8% by the end of 2023 and by 2.5% in 2024. In 2025, they expect a rise of 4.4%.

So which is it? Are we headed for a crash or not?

Inflation-adjusted Home Prices

To understand real price changes over time, we need to look at nominal home prices versus inflation-adjusted prices.

For example, Bill McBride from Calculated Risk blog compares today's real estate market to that of 1978 when real returns fell by 11% over three years due to inflation.

The National Case-Filler Index shows median prices up by 3.9% over the last year with year-over-year inflation at 3.2%. This suggests national home prices are up only 0.7% in real terms.

So while nominal prices are rising quickly, real price gains are much more modest.

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Predictions by Morgan Stanley

Morgan Stanley expects home sales to be sluggish in the first half of 2024 but forecasts an improvement in the second half due to enhanced affordability brought on by decreasing interest rates. They predict that rates could dip as low as 0.4% by the end of 2025.

The chief economist at also predicts improved affordability with a fall in mortgage rates below 7% in the second half of 2024.

But critics argue that these associations did not predict interest rate increases in 2023 or rising home prices accurately, so their predictions for lower rates may be unreliable.

However, there is consensus that home prices are unlikely to fall significantly until sellers outnumber buyers due to an almost perfect equilibrium of supply and demand causing sideways price movement.

Redfin's CEO believes that homeowners selling now aren't facing the same financial distress as in 2008, indicating that there's little room for further price drops as sellers can afford to wait for their asking price.

Affordability could return if mortgage rates fall by 4.4 percentage points, median household income rises by 62%, or home prices fall by 38%.

In October, Redfin reported that only 28% of homes sold above the listing price, indicating that bidding wars are still present in some markets but are less frequent compared to earlier this year, when nearly half of the homes sold above the asking price.

Detroit had the fastest annual home price growth at 6.7%, followed by San Diego at 6.5%, while Las Vegas had a decline of -1.9% in home prices annually.

Investors believe the Federal Reserve will begin lowering interest rates in mid-2024 with a potential reduction by May and four more rate cuts throughout the year. There is $5.7 trillion parked in cash-like money market funds waiting for interest rates to drop before entering markets or real estate.

My Personal View

I've been investing in real estate since '08 and have seen many ups and downs along the way. But I've never seen anything like this before - where people are buying homes at record highs despite sky-high mortgage rates and record low affordability levels!

It's truly mind-boggling how resilient this market has become over time - even during periods when it seemed like everything was stacked against it (like during previous recessions).

So what do you think? Is now a good time to buy or should you wait for things to cool off?

Let me know your thoughts down below!

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