Introduction
It’s no secret that the real estate markets have been blazing hot since COVID-19. Within a short span of just 24 months, the pandemic boom saw US homeowner wealth balloon by a staggering $9 trillion. To put this mind-boggling number into perspective, this means that the median homeowner gained over $56,000 in home equity in 2021 alone. Simply put, American homeowners struck gold.
But why did this happen?
The housing market was heading into a downturn in the early weeks of the pandemic. After all, how could the market stay buoyant amid nationwide shutdowns and record-high unemployment?
In an effort to save the economy, policymakers pushed mortgage rates to record lows. By January 2021, the interest rate on a 30-year fixed-rate mortgage plummeted to just 2.65%—the lowest ever recorded. This was a fat deal. Demand for homes poured in and readily outstripped supply, creating a perfect storm.
In the ensuing months, the market would explode, leading to one of the hottest periods in housing market history.
But as we move further into 2022, the market is once again shifting. While home prices are still high, rapidly rising mortgage interest rates have significantly curtailed homebuyer demand. Bidding wars are dying down, sellers are lowering their asking prices, and mortgage applications are drying up.
Are these early signs that the once-hot market might finally be cooling down? And if so, how might this spell good news for buyers?
Are markets cooling down?
After a two-year seller’s market marked by endless bidding wars, all-cash, no-contingency offers and purchasing homes sight unseen, prospective buyers are eagerly looking for even the faintest sign that they might soon be in for a break.
Despite a few false starts, there are a few promising developments that appear to suggest the tide may finally be turning in favor of the homebuyer. Here are a few reasons why buyers might be in for an easier time in 2022.
Inventory levels are rising again
While housing inventory has been sluggish for the past several years, recent data by real estate data aggregator, Realtor.com is pointing to some positive changes. For example, active listings in May 2022 were up by 8% on a year-over-year basis. Put differently, 38,000 more homes were available for sale on any given day last month compared to May 2021—the first time active inventory has increased since June 2019.
Additionally, the total number of unsold homes nationwide in May 2022 was down just 3.9% when compared to the same time last year—a notable improvement when pitted against April’s more sizable year-over-year decline of 10.1%.
Two key trends are driving this accumulation in inventory. First, a new wave of sellers has entered the market this spring. These sellers feel more confident about listing their homes in current market conditions than they did last spring when COVID-19 vaccines were first being rolled out. Second, higher housing costs and rising interest rates are pricing many prospective homeowners out and curbing buyer demand.
However, if the uptick in inventory continues to last, homebuyers who are still in the market may finally have something to smile about.
Price cuts are becoming more commonplace
Though home prices are still at an all-time high, that may soon change. In the first quarter of 2022, the median home price in the country was $428,700—a figure that’s up by 15.9% from Q1 2021 and 30.3% compared to the first quarter of 2020.
This accelerated growth can be partially explained by an upward trend in the share of larger, more expensive homes that have recently hit the market—rather than from a continued rise in the asking price per square foot. Large homes, which are defined as residences in excess of 1,750 square feet, rose by 1.6 percentage points in the past year—and now make up 54.3% of all homes on the market.
However, excessively-priced homes, large or not, will often make homebuyers think twice before putting in an offer—or even dissuade them from bidding entirely. As this occurs, sellers are likely to receive fewer offers. In turn, the ceaseless bidding wars that once plagued listings will subside—pressuring sellers to lower prices or negotiate with buyers who submit bids below the asking price.
For this reason, although 29% of buyers paid above asking in 2021, this trend may not hold for the remainder of this year and beyond. In fact, the share of homes that have seen asking price reductions has risen by 4.3 percentage points—from 6.2% in all homes in May of last year to 10.5% of listings in May 2022.
Home buying activity is declining
The reduced enthusiasm for home buying is yet another signal that the market is beginning to cool. According to Redfin, Google searches for “homes for sale” in May 2022 were down 13% from the year before.
Similarly, requests for home tours, real estate agents, and related services declined by 12%—the biggest drop since April 2020. Likewise, home-touring activities have slumped by 29% when benchmarked to the prior year, while mortgage applications in May 2022 have also declined by 16% as compared to submissions in May the year before.
Residential construction is up
The real estate construction sector is finally gearing up to match the growing demand for housing. Census data provided by the US Census Bureau show that 22% more new home construction projects were commenced in April 2022 compared to the same month last year—the fastest increase in homebuilding activity since 2006.
Additionally, new projects with five or more units increased by 37.3%, while completions rose by 5.9%. Building permits also rose by 7.7% compared to April of last year as the residential construction sector added 5,000 new jobs.
In short, this rise in homebuilding activity will help increase the new supply of housing. Over time, this will lower the price of new and existing units—and may help put an end to the post-pandemic housing market frenzy.
Is the housing market crashing—or just cooling down?
However, this isn’t to say that the US housing market will crash or implode. Instead, we’re more likely to experience a cooldown.
But what does this term actually mean—and what’s the difference between a cooldown and a crash?
In brief, a market cooldown is a decrease in the rate of increase in housing prices. In other words, it’s not a price decline—just a decline in the growth rate.
This is different from a Great Financial Crisis-Esque housing crash, where housing bubbles pop and home values drop precipitously.
For example, if you’re looking at the median home’s sale price and find that it increased by 5% between May 2023 and May 2022 (as opposed to increasing by nearly 16% between May 2022 and May 2021), you’d be witnessing a market cooldown.
On the other hand, in a housing bubble, home prices surge higher than the property’s appraised value. When the economy enters a downturn or macroeconomic shocks cause a drop in demand, the bubble bursts, causing a notable decline in home prices.
For instance, if home prices decline by 20% between May 2023 and May 2022, this would be considered a crash.
A cooldown…or not?
While there are certainly compelling signs that the housing market may be beginning to cool down—such as a decline in home sales and rising inventory levels—there are also indicators pointing towards continued strength in this sector. For instance:
- Increase in millennial demand. Millennials now make up 43% of homebuyers, up from 37% in 2021. This is one indication that demand may remain strong.
- Current housing inventory is still behind demand. Despite increasing inventory, supply is still near a historic low. This is fueling demand and may continue to put upward pressure on prices, strengthening the housing market for years to come.
- Lack of defaults and foreclosures. This isn’t 2008, and we’re not seeing signs of capitulation. With homeowner wealth at record highs and record low mortgage interest rates just a year prior, existing borrowers are less likely to miss their monthly payments or default on their mortgages.
In a nutshell, events in the current housing market don’t point to a crash. Rather, they’re merely signs of a much-needed cooldown.
Is this a good thing?
For the past two or so years, the real estate market has been booming. While this is good news for sellers and homeowners, it has made buying a home more stressful, difficult, and expensive.
In the red-hot seller’s market conditions of the post-pandemic era, potential buyers have had trouble finding homes they can afford, and have found it difficult to beat out the stiff competition from other, more well-heeded buyers.
But as the market cools, it thins out, giving buyers more options and leverage over sellers. As the housing market slowly shifts to a buyer’s market, hopeful homeowners can finally breathe a sigh of relief. Here’s why.
Lower prices
As real estate markets cool, home prices may remain stagnant—or even experience slight declines. Rising interest rates and sky-high prices have priced many buyers out of the market, reducing overall demand. If demand remains depressed and inventory levels continue to rise, home prices may creep down to more favorable levels.
Less competition
Cooling real estate markets mean lower demand, and lower demand means fewer offers per listing. As fierce bidding wars become less commonplace and buyer interest wanes, sellers are more likely to sell at or below the asking price. At the very least, buyers may be able to regain their spots at the negotiating table.
More options
As inventory increases, more homes will become available, meaning buyers will have more options to choose from.
Instead of plunking down bids left and right, buyers will be able to tour properties thoughtfully, conduct due diligence, and weigh the pros and cons before settling on a home. And if something doesn’t feel right about a home or a deal, buyers can simply move on to the next one without feeling rushed into making an offer.
Increased bargaining power
As listings age, sellers usually become more anxious (or at least motivated) about finding a buyer. An eager seller means more leverage as a buyer to negotiate better terms. You can bargain for closing costs to be paid by the seller, for lower earnest money deposits, for fully-paid repairs, or for an extension on closing deadlines.
Higher cap rates
A capitalization rate (frequently referred to as a “cap rate”) is the rate of return on a property, after all, operating expenses have been paid. It’s a measure of how much pre-tax profit you’ll make on an investment property, and it varies depending on the market. Typically, cap rates will be lower in more in-demand markets and higher in less in-demand markets.
As an investor, higher cap rates are preferable to lower cap rates, because it means better returns and higher cash flows. This allows you to service more debt, invest in more properties, or commit more of your rental income toward discretionary expenses.
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