Home prices need to fall by this much to make housing affordable again, economist says

By Aarthi Swaminathan

Housing market is overvalued and due for a correction, says Redfin's Chen Zhao

Home buying has become so unaffordable that it's in need of an intervention - but that won't come anytime soon, one economist says.

Home prices continue to hit new all-time highs, despite home buyers remaining on the sidelines. Mortgage rates remain elevated, keeping borrowing costs high. Most people aren't buying homes, because it's simply too expensive to do so.

That's a sign of an unhealthy market that begs for a price correction, Chen Zhao, the economics research lead at the real-estate brokerage Redfin (RDFN), told MarketWatch.

"A healthy housing market is a more active one, where people who want to move are able to," Zhao said.

For that to happen, home prices would need to fall by as much as $121,000 for housing to be affordable again, she estimated. That's unlikely to happen in the near future, she added: Right now, a median-priced home is about $383,000.

The U.S. housing market has changed dramatically over the last five years. During the pandemic, it ran at a frenzied pace of intense buying and selling but then slowed to a limp across 2023. Demand slumped in the face of 8% mortgage rates, and sales fell to a 29-year low.

Home-buying activity remains suppressed, but prices have relentlessly marched higher. Even though the pace of home-price increases has slowed significantly, the Case-Shiller index, a measure of home prices, in July set a new record high for the 14th month in a row.

One major reason for the housing market's poor health is a prolonged lock-in effect. The majority of homeowners who have an outstanding mortgage balance have an interest rate below the current 6%. Giving that up for a higher rate would translate to a more expensive mortgage payment, hence many homeowners' reluctance to move.

How far home prices need to fall

Housing affordability is typically measured by looking at how much of a household's income is consumed by housing costs, such as rents or mortgage payments. Renters or homeowners are considered to be cost burdened if they spend more than 30% of their income on housing.

Factoring in the cost of owning a home relative to a median household income, Zhao estimated that a typical household that buys a median-priced $383,000 home would have to spend about 41% of its income on housing. That's roughly $2,500 a month in mortgage payments alone, assuming a 30-year mortgage rate of 6.08%.

For homes to become more affordable, home prices would need to drop by 28% with current mortgage rates of 6%, Zhao calculated. That's a drop of about $121,000.

But that's not about to happen anytime soon, Zhao said. A correction of that magnitude is unlikely in the near term, due to strong pent-up demand from home buyers and a constrained supply of home listings, she added.

What's more likely to happen is that home-price growth could slow over time, while incomes grow faster, giving people more purchasing power. Over time, that could bring the housing-payment-to-income ratio down closer to a historical norm, she added.

Markets where home prices are out of sync

To be sure, home prices have begun to fall significantly in several Texas and Florida cities where housing supply has soared. Cape Coral, Fla., saw the biggest decline in home prices in July, as measured by Intercontinental Exchange.

As for what's next, other groups have attempted to find metropolitan areas in the U.S. where home prices could correct. One measure by Florida Atlantic University suggested that Detroit, Mich., is one of the most overpriced markets in the country based on long-term pricing trends, followed by Atlanta, Ga., and Las Vegas, Nev.

Another measure, by the real-estate data analytics firm CoreLogic, suggested that Provo-Orem and Salt Lake City, both in Utah, as well as the Atlanta-Sandy Springs-Roswell metropolitan area, face the biggest potential for home-price declines.

-Aarthi Swaminathan

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10-05-24 0601ET

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