How the housing market will evolve in 2023

After two years of runaway home prices, the Federal Reserve stepped in to reverse engineer rampant inflation, and it has been utilizing the housing market as one of the main economic engines to achieve its objective. They increased the Federal Funds Rate from nearly 0% at the start of 2022 to 4.5% in December 2022, its highest level since 2007 and its fastest rise in more than 40 years.

Long-term mortgage rates responded by rising from 3.25% in early 2022 to over 7.25% in October 2022, more than doubling. They eased below 6.5% recently as core inflation numbers improved for the third consecutive month. The Consumer Price Index core inflation, less the volatility of food and energy, is currently at 5.7%, after peaking at 6.7% in September 2022. The Fed’s core inflation goal is 2%, so they still have a long way to go. The overall U.S. economy has remained resilient, backed by a very strong labor market, sky-high job openings and low unemployment.

Mortgage interest rates

Just as 2022 was all about rising mortgage rates and rising inflation, 2023 is going to be all about falling mortgage rates and falling inflation. After blowing past the 2% core inflation target in April 2021, it continuously rose for 18 months until peaking in September 2022. It did not hit 6.7% overnight.

What does that mean for housing? Until mortgage rates drop below 5.5%, we can expect low housing supply, which favors sellers. We can also expect low housing demand, which favors buyers. Higher mortgage rates have severely impacted demand. The insane, fast-paced housing market of the COVID-19 pandemic years has vanished.

Demand for housing is similar to Great Recession levels, but this time it is matched up against an extremely limited supply. As mortgage rates drop, expect demand to improve, especially in the second half of 2023. Until then, home values will slowly decline, most assuredly in high-cost areas and in areas of the country that benefited the most from rampant appreciation during the pandemic.

Since the COVID-19 pandemic lockdowns of 2020, inventory has dropped to record-low levels both in 2021 and 2022. The inventory hit catastrophic, low levels due to a limited number of homes coming on the market coupled with insatiable demand driven by record-low rates.

Homeowners may not have been in love with their homes, but they certainly were in love with their loans. 86% of homeowners with a loan had an underlying mortgage rate at or below 5%. Nearly two-thirds had a rate at or below 4%. And a very fortunate 24% had a rate at or below 3%. As a result, fewer homeowners placed their homes on the market in comparison to the 3-year average prior to the COVID-19 pandemic (2017 to 2019). Take a look at Southern California, for example, there were 51,000 missing sellers from the market compared to the 3-year average, which is roughly 19% fewer homes for sale. This trend grew significantly as 2022 progressed and severely limited the supply of homes from growing to its true potential. As mortgage rates drop this year, the “hunkering down” effect will wane.

The bottom line: 2023 will be sluggish compared to 2022 for the first half of the year. Remember, the market was hot through May, so year-over-year stats will look absurd. Yet, the second half of 2023 promises to be better than the second half of 2022 as rates ease, demand rises and more homeowners will be willing to sell.

The housing market is no longer insane, homes are for the most part not selling above their asking price, not selling immediately, not selling with multiple offers and there is far less activity and buyer competition.