Those of us that are in the Real Estate industry are happy to see 2022 behind us. Although there will still be challenges in 2023, I think the outlook is more positive. A little belated, but here is what I expect for 2023:
Interest Rates
We saw a peak in mortgage interest rates in October at a little over 7.3% and now have fallen back to the low 6% range. What to look at here is the 10 year Treasury. We saw the 10 year hit roughly 4.25% and it has since fallen back to approximately the 3.5% level. The historical spread between the 10 year treasury and the 30 year mortgage rate has been roughly 1.7% over the last 50 years. However, in times of uncertainty and volatility, as we have today, the spread can widen. The spread between the two averaged 2.9% in October and thus we saw the recent peak in mortgage rates. One of the main culprits to the widening spread is the the fact that aside from increasing the Fed Funds rate, the Federal Reserve has also exited the Mortgage Backed Securities (MBS) market through quantitative tightening (vs the easy money period produced by the 4 rounds of quantitative easing (QE) since 2008- with QE4 being the most recent as a result of COVID). This has significantly decreased the liquidity of the MBS market causing traders to demand higher spreads on the securities. Just getting back to a more normalized spread of 1.7% would get us back to approximately 5.2% on the 30 year mortgage rates, without any other changes in the 10 year Treasury. We are already seeing signs of this spread narrowing, and if we see the 10 year break below some resistance in the 3.2-3.25% range then we could see the 10 year Treasury drop into the 2.75% range.
Keep in mind that the Fed is not done hiking the Federal Funds rate and expect more hikes going into the summer. The market expects a 25 basis point (bps) increase this week and has an additional 25 bps built in. The current Fed Funds target rate sits at 4.25%-4.5%. I believe that they won't stop until they get to a 5-5.25% range, which they have already indicated. However, once again the Fed Funds rate does not directly impact mortgage rates, which again more closely follow the 10 year Treasury. Bond traders are typically ahead of the Fed and already have priced in these anticipated rate hikes.
I expect we will see some volatility in here for the rest of the year and expect the 10 year to trade between 3.25% and 3.75% for the 1st half of 2023 and possibly look to break to the downside below that range in the latter part of the year. Thus I expect to see some stabilization in mortgage rates in the lower 6% range and then push toward the 5.5-5.75% range in the 2nd half of the year, with some duration.
Home Prices
I am not in the camp that sees home prices falling 20%. Nationwide I expect we will see home prices to be relatively flat year over year +/- approximately 5%. With the downside of that range being more likely simply because we are coming off higher comparables with the peak in home prices being roughly April of 2022. Of course there will be certain markets that are outliers in this respect that have already seen a larger decline in prices. Those are the markets that were extremely overheated in 2021 and early 2022, such as Boise, ID, Austin, TX, Provo, UT and Phoenix, AZ, to name a few.
The median existing-home sales price was up 2.3% to $366,900 in December compared to a year ago, according to the National Association of Realtors (NAR). Though, the YOY increase was at a slower pace compared to November. Month-over-month existing-home sales prices continued their downward trend and are roughly 11% lower than their record high of $413,800 in June.
Inventory
Inventory continues to be a problem and that will not change in 2023.
Existing home sales started in January 2022 at 6.5 million and ended the year near 4 million. Total inventory broke just under 1 million again. To give reference, total inventory was over 4 million in 2007, in 2014 it was about 2.3 million at its peak. Homeowners are currently in a good position. About 70% of homeowners have a mortgage interest rate of under 4%. They are not looking to swap out to a higher payment for a new home based on current rates. Consumer balance sheets are in good shape, baby boomers are opting to stay in place and unless people are moving for reasons such as change in job etc., there does not appear to be much reason for a drastic increase in inventory. Builder sentiment turned positive for the first time last month, but new permits are still down.
Inflation
We continue to see signs of cooling inflation. The Fed's favorite measure of inflation is the Personal Consumption Expenditures (PCE). PCE has declined 2% from its peak of 7% in June of last year. The Core rate, which strips out food and energy prices, has declined 1% since its peak of 5.4% in February of last year. Fed board members now expect PCE inflation to end 2023 at 3.1% and core PCE to finish next year at 3.5%, above the central bank’s target rate of 2%.
Another measure of inflation is the Consumer Price Index (CPI). One big component of CPI is housing The shelter index (portion of the CPI) rose .8% in December, and was up 7.5% YoY. The government measures housing inflation by looking at rent and what’s called owner's equivalent rent: what a homeowner’s home might rent for, if it were to be a rental. What this does not show, however, is that spot rents (what landlords are charging on new leases) indicated that rents fell nationally by .8%. Both rents and home prices have been falling in recent months. Shelter inflation has a big impact on total inflation, and there are currently 943k apartments under construction. Thus, we should see more pressure on rental prices in the coming year. As well, personal spending was down .2% in December and .1% in November, which points to further economic slowdown.
Recession
The consensus believes that we will see a Recession in 2023, likely in summer or later half of the year. I have been in this camp, but recently I am starting to think that we may actually avert a recession with a "soft landing". It really comes down to different definitions of a recession, as some believe we already are in one. If you define a recession as 2 consecutive quarters of real GDP contraction then technically we had that in Q1 and Q2 of 2022 with GDP down 1.6% and .9% respectively on an annualized basis. But due to the strong labor market most don't consider that we had a recession in 2022.
Based on the recession indicators, currently there are 6 red flags that are signaling that we are going into a recession and the Conference Board leading market indicator has been declining for 9 consecutive months. Data going back to 1959 indicated that at no time did we see a string of weakness like this that didn't precede a recession. within the next 2 quarters. However, the jobless rate has not broken. Currently, consumer consumption and jobless claims are still good. U.S. initial claims for unemployment insurance decreased by 6,000 to 186,000 in the week ended January 21, signaling a labor market that remains remarkably healthy. This indicator wont signal a recession until we have 4 consecutive weeks of claims over 330,000. This has yet to roll over, and is why I am less confident that we will for sure have a recession in 2023. Many people point to the recent layoffs in the tech industry as a sign, but what they are missing is that many of these people don't file for unemployment because they are easily able to find new jobs. As of November there were 10.5M job openings. Covid caused a mass early retirement with many baby boomers as well as many lower wage sectors saw employees simply drop out of the workforce. This is the one marker that will indicate whether or not we will see a recession in 2023 or whether we can achieve a "soft landing".
We are experiencing what is considered a "housing recession". A housing market recession occurs when home sales decline for six months straight, which officially happened in July 2022. A housing recession usually precedes a recession and in turn leads us out of one. The signs we need to see indicating that we are coming out of a housing recession are: a decline in new home sales monthly supply to below 6.5 months and a rise in permits. At the end of Dec. 2022, the adjusted number of new homes for sale was 461,000 which represents approximately 9 months of supply based on current sales rate. There are some positive signs from the recent data that indicate that the tide may be slowly turning. What usually happens first is an increase in purchase applications and an increase in builder sentiment. Builder sentiment turned positive for the first time last month, purchase applications continue to rise with a 25% week over week gain (albeit off a very low bottom), and lumber prices continue to bounce off their bottom. All early but positive signs for the housing market.
What does this mean for you the homeowner/homebuyer
I continue to believe that if you are in the market to buy and can afford the higher payments due to the increased interest rates, then now is the opportune time to buy. The reason is that even though the current market is not considered a "buyer's market", it is a much more favorable market for buyers than it has been in the last couple of years. In 2020 and 2021 buyers had no leverage and there was often overbidding on properties and in many cases waiving of protections such as home inspections and appraisal gaps. This was an unhealthy market and I am glad to see that we are getting back to a more normalized market on that front. Days on market are back up to 26 days, and though this may be distressing to home sellers and some real estate agents, it is actually positive for the market as it gets more normalized and back towards the 30 days on market that is more standard. As a homebuyer right now, many are able to negotiate things like closing costs and interest rate buy downs from sellers. This can help make the overall cost to get into a home much lower and more manageable for many buyers. In addition, with an expected decline in interest rates in the next 12 months, this will enable many who buy now to potentially refinance and lower their payments. If we do have a recession, this drop in rates will be more significant as the Fed will look to change course and cut rates.
Overall, I think we are seeing encouraging early signs for a recovery in the housing market and if rates can stabilize (decrease the volatility of the large swings), then we should slowly get back to a more "normal" market in 2023, and into 2024. There are still plenty of buyers waiting on the sidelines, and what we will need to see is more inventory come to market to fill those buyer demands.
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