How Bad and Long Will This Real Estate Crash Be?

Over the last two years, everyone's been waiting for a massive crash in the housing market. However, while everyone was waiting for house prices to go down, they continued increasing.

Not just by a little bit, either. Home prices have shot up higher and faster than at any time in history over the last 2 years, leaving most doomsayers and prolific analysts embarrassed.

However, while many analysts are certain the big crash will finally come, it might already be here, depending on what data you're looking at.

It is no longer a debate whether real estate will drop because the housing crash is already here.

Home prices are finally coming down, and no matter where you're at or what type of home you're looking at, home prices are decreasing, and in some metrics, it’s worse than the great financial crash of 2008.

The Case-Schiller Price Index shows that the national housing index has dropped by about 2.2% so far this year.

For those thinking, ‘’a 2.2% correction doesn’t sound like a big crash,''.....

You're correct.

However, the RATE OF CHANGE of this decline in 2022 is most concerning.

The national average doesn’t reflect the pain occurring in some of the markets in the US, and it also doesn’t show us the entire picture.

For example, in Miami, home prices haven't really moved at all. As a matter of fact, they're down less than 1% for the year.?

However, if you go to Seattle, they're down almost 10%.

Now, remember, there's no such thing as ‘’the market.’’ There are thousands of different markets all across the US that behave independently of one another. Taking a broad, zoomed-out view of the US, we know the entire US housing market has seen tremendous growth since it bottomed out in 2012.??

Now what we can see when we look at the data is that this housing bull market got kicked into high gear after 2020.

dIf we look at the blue lines on the chart below, we can see that some regions in the US were experiencing 40% and even 50% annualized growth rates at the beginning of 2022.?

However, things have changed, and some markets in the US are already seeing more severe corrections than they saw in the 2008 housing crisis! If we look at the 3-month annualized percentage changes, we can see San Francisco is down over 33%, Seattle is down 25%, and San Diego is also down 22%.

A better way to visualize this is seen if we look at the three-month annualized average.

In March of 2022, we can see that the three-month average of most major cities was going up; however, when we look at the more recent three-month average data from September 2022, we can see all these cities are seeing price decreases.?

The chart below is a 3-month annualized change view of the Case-Schiller National average, which tracks the national average of home prices.

The rate of change that we’ve seen over the previous handful of months in this decline of 2022 is already more severe than what was seen in 2008.

The national average may only be down 8.5% in three months, but the rate of change in those three months is what has me concerned.?

If we extrapolate this data forward a few months, it will be way worse than 2008!

This brilliant graphic below shows us the change in median home prices in different regions across the US, pre covid.

All these blue dots are where home prices were going up the fastest.

We can see the west coast, Florida and Texas benefited the most from the housing bull run.??

However, if we look at the change in home prices between April and October 2022, we can see a different story being painted.

The regions on the west coast that increased the most are now declining the most in the nation.?

Meanwhile, regions like Florida, the Southeast, and Texas are holding up pretty well, considering their meteoric rise.

In absolute terms, places like San Francisco, Seattle, San Diego, Los Angeles, Phoenix, and Denver have all seen drawdowns between 4%-11% from their peak.?

This is another chart that shows you the difference in price performance between the different states in the US.?

All of these variations in prices across the nation boil down to simple supply and demand.?

We can see here that as soon as the pandemic started, we can see active listings exploded. Before Covid, we can see there was lots of buying and selling happening in the market.?

Now, compare that to what we’re seeing today, and we can see that the activity has slowed way down.?

Today, there is very little activity in the market as nobody is willing to sell their home. Everybody has locked in 30-year fixed mortgages at very low rates.

Who would sell a home with a 3% mortgage to buy a home with a 7% mortgage rate??

Here's a chart from The Federal Reserve that helps us measure the number of homes for sale on the market by tracking how many months it takes for the home to sell.?

This red line here is a rough average that goes all the way back to 1965, and we can see the approximate average time a house sits on the market is around 6.5 months.

What we can see is there are over 10 months of supply on the market today, which is a level approaching what we saw in 2008 during the great financial crash.

The grey lines on the chart also show us that in recessions, the supply of homes on the market increases because no one's buying new homes.

Now let's take a look at existing homes. This is a 10-year chart that goes back to 2014, showing us that the supply of homes has been steadily decreasing.

Home builder cancellation rates have also soared to 25.6% recently in October 2022, which only confirms that there’s less supply of houses available.

We just saw some of the lowest mortgage rates in history, and everyone was racing around locking in mortgages for 30 years at under 3% interest rates.

What we can see here in the chart below is that only 4.7% of people have these adjustable-rate loans anymore.

Before 2008 the amount of adjustable-rate loans was the highest that we've ever seen, at over 30%, which of course, led to this giant crash here in 2008.

However, what we can see is that since the bottom in 2008, mortgage lenders have handed out fewer of these adjustable-rate loans.?

Now, lets zoom out and try to understand why this is all happening and what comes next. Every asset class in the world is being affected by liquidity in the monetary system.?

The Fed increased its balance sheet enormously in early 2020. This subsequently led to the M2 money supply rising by 42.5% in the 2 years following 2020.

The FED also lowered interest rates to 0%, which incentivized more people to take on debt.

What do you think happened to home prices in this aggressively inflationary environment??

Coincidentally, over the 2 years of this easy monetary policy, where the money supply was increased by 42%, we’ve seen a 44% increase in the Case Shiller Housing Index.

Does 1 unit of money supply increase cause a 1-unit increase in the average housing market?

It’s not that simple because different markets have gone up by different amounts, but it can give us an interesting conclusion.

This visual representation shows you why every time they print more dollars, and your existing dollars buy you less. Just because your home increases in price doesn’t necessarily mean that the home went up in value.

It's that the purchasing power of the dollar went down.?

However, this trend of easy monetary policy appears to be ending, and the fed is starting to suck liquidity out of the market and are now raising interest rates.

We're entering a new monetary environment where the Fed is vowing to,

''Keep rates higher for longer.''

If interest rates are high, nobody wants to take on new debt, and fewer people will want to buy new homes.?

Higher rates are one headwind for the housing market, but so is the declining money supply in the system.

This chart shows the annualized growth rate of the M2 money supply, highlighting some interesting similarities between 2022 and 2008.?

In 2008, they increased the money supply pretty rapidly to bail out the entire global financial system,? but it came crashing back down.

We can see this tends to happen in recessions, and something similar has happened over the past 2 years.?

The one thing that’s different this time in 2022 is the volatility! Look at the annualized growth rate of the money supply absolutely crashing back down today in 2022.

This chart is great because it shows not only the size of the move compared to 2008 but also the speed of the move.?

Where do we go from here??

What’s next for the markets?

I believe there are three things that we should be watching closely to determine what comes next.

1. The monetary supply growth and the liquidity. All eyes are on the Fed. Are they going to revert back into QE, or are they going to continue QT longer than most expect?
2. ?Interest rates and, more importantly, mortgage rates are the second thing we should be watching.
3. Supply and demand is the third factor. Are people selling their homes and putting new supplies on the market, or are they too scared to get a new mortgage at these higher rates??

So those are the three factors we want to look at to determine what is going to happen next in the real estate market.?

Now when it comes to mortgage rates, a lot of people want to know where they’re heading next. Well, you must understand that the government doesn't really set the price of mortgages.

The FED sets the Fed funds rate, and then the mortgage rate varies off of that.?

Historically there's been a spread between the two interest rates, and what typically happens is in times of recession, when things are riskier, the spread goes up.?

Today we're at a spread of about 3%, meaning mortgage rates are about 3% higher than the 10-year US treasury bond yield.?

To know where mortgage rates are going next, you’ll have to watch whether the Fed will continue raising rates or pause its hiking schedule shortly.?

Let’s look at that third factor, supply and demand.

I’m expecting the supply of existing homes to stay constricted because who's going to sell a home with a 3% mortgage to buy a 7% mortgage?

If the supply of houses remains constricted, the market might not crash as badly as in 2008.?So those are some of the main factors that we want to look at when analyzing the market.

Another couple of variables that are important to watch is demographics and interstate migration.?