Talk of a recession is everywhere, fueled by high inflation and higher interest rates, and has been all over the financial headlines lately. And for would-be homebuyers and real estate investors, the million-dollar question is: Will home prices fall if we experience a recession?
Given the amount of time this topic is spending in the headlines, we are sharing some insights on this complex subject. First, let’s start with some historical context.
More often than not, house prices do fall during recessionary periods. In fact, home prices have fallen in four of the last five recessions since 1980, according to data[i] from the Joint Center for Housing Studies at Harvard University.
While the expected intensity of such a decline is debatable in this cycle, we can see that the average home price pullback has been around 5% for each year the economy remains in a recession.
Let’s Do Some Quick Math
When factoring in monthly principal and interest payments at a 7.49% 30-year fixed-rate mortgage with 5% down, there would be a monthly principal and interest payment of $2,654 in the current market.
Now, let’s consider a 5% price decline on the $400,000 home. A 5% pullback on an originally $400,000 home translates to a $380,000 purchase price.
If you factor in monthly principal and interest payments at a 7.49% 30-year fixed-rate mortgage with 5% down on $380,000, there would be a monthly principal and interest payment of $2,521. That’s a difference of $133 a month or $1,596 per year.
Small differences in purchase prices can add up, and this is just one example. Now, let’s look at another current trend that could impact home prices.
How Interest Rates Affect Home Prices
Historically, as interest rates have risen, home prices have declined[iii]. This is because as the Federal Reserve raises interest rates to reduce inflation, buyer demand tends to cool, leading to higher inventory and longer marketing times for homes.
A great point to consider: The interest rate of a mortgage can be changed with a refinance at some point in the future if and when rates decline. The purchase price of real estate cannot be changed later.
Renting and Recessions
Several factors play into this phenomenon. For starters, fewer people are ready, willing, and able to purchase during a recession, translating to lower demand for housing (and steady or higher demand for renting).
Another component is more homeowners being pushed into a foreclosure situation. Foreclosures impact credit ratings, so many of these folks are forced to rent, helping to keep rental prices firm.
As we can see from the median home prices data[v], prices have been falling nationwide for the past few months. Of course, every locality is unique. But should a recession occur, being ready to strike will be critical to getting results.
It’s important to keep in mind, however, that lenders typically tighten their lending guidelines for borrowers during recessions, making it more challenging to qualify for mortgage products. This is largely because lender risks increase during recessions, as costly foreclosures are more likely.
The point is, for those that have been waiting on the sidelines for a decline in home prices, now is the time to start preparations. For would-be homebuyers, that may look like checking your credit score, lowering your debt-to-income ratio, saving for a down payment, and researching mortgage options.
For active investors, this would translate into credit score optimization, gathering current tax filings, and determining the liquidity available to make cash offers or acquire financing. In addition, for more passive investors, certain REITs may be able to provide exposure to income opportunities.
With those insights noted, know that we are here to help if you have any questions about the financial aspects of purchasing real estate or real estate investing. Reach out by phone or email anytime.
[i] Hermann, A. (2020, April 27). Jchs.harvard.edu. Past Recessions Might Offer Lessons on the Impact of Covid-19 on Housing Markets. [Online] Available at: Past Recessions Might Offer Lessons on the Impact of COVID-19 on Housing Markets | Joint Center for Housing Studies (harvard.edu)
[ii] (2022, December 21). Fred.stlouisfed.org. Median Sales Price of Existing Single-Family Homes. [Online] Available at: Median Sales Price of Existing Single-Family Homes (HSFMEDUSM052N) | FRED | St. Louis Fed (stlouisfed.org)
[iii] Davis, G.B. (2022, July 11). Moneycrashers.com. What Happens to Home Prices When Interest Rates Go Up? [Online] Available at: What Happens to Home Prices When Interest Rates Go Up? (moneycrashers.com)
[iv] Davis, G.B. (2022, July 26). Sparkrental.com. How Recession-Proof Are Rental Properties? [Online] Available at: Are Rental Properties Recession-Proof? Yes and No (sparkrental.com)
[v] (2022, December 21). Fred.stlouisfed.org. Median Sales Price of Existing Single-Family Homes. [Online] Available at: Median Sales Price of Existing Single-Family Homes (HSFMEDUSM052N) | FRED | St. Louis Fed (stlouisfed.org)