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Antony Antoniou – Luxury Property Expert

Why house prices have fallen much further than you think

Why house prices have fallen much further than you think

House Prices Have Fallen Much Further Than You May Realize When Adjusting for Inflation

If you’ve been following the housing market lately, you may have noticed headlines about house prices falling around 5% from their peak last year. At first glance, a 5% drop may not seem so dramatic. But when you account for inflation, the real decline in house values is much steeper—potentially as much as 14.5%!

The Impact of Inflation on Housing Affordability

Research consultancy Capital Economics is forecasting a total peak-to-trough decline of 20.8% in real terms. That’s because inflation has been exceptionally high, driven in large part by rapidly rising wages. Higher wages may seem like a good thing, but they contribute to inflation through increased spending power—what economists call a “wage-price spiral.”

What does this mean in plain terms? Basically, your paycheck doesn’t go nearly as far as it used to when buying a home. Housing affordability has taken a huge hit. Americans are experiencing the worst inflation in 40 years, with consumer prices up 8.3% in August from a year earlier. That means if you factor in inflation, housing prices have fallen much further than the 5% nominal figure suggests.

This trend became evident during the last housing downturn that started in 2007. In the first year of that decline, real house prices fell 18.3% while nominal prices only dropped 5.1%. By the end, real prices had plunged 22.6% compared to a 19.4% nominal decline. Experts say we could see similar real price drops this time around.

Why Mortgage Rates Are Driving the Decline

Why is this happening? The main driver is higher interest rates, which make mortgages more expensive. This reduces the budgets of prospective homebuyers, pushing down demand and therefore prices.

The Federal Reserve has been aggressively hiking rates this year to combat inflation. In turn, mortgage rates have shot up, with the 30-year fixed-rate mortgage averaging 6.7% as of September 15, according to Freddie Mac. That’s more than double the 2.9% average just one year ago.

Mortgage rates above 5% typically correspond with falling home prices. “It’s looking more likely that mortgage rates will be above 5% for a decent part of this autumn,” notes housing analyst Richard Donnell. “Mortgage rates starting with a five equals falling house prices.”

The Mismatch Between Buyers and Sellers

Sellers often have unrealistic expectations about value in cooling markets. While asking prices have barely budged on sites like Rightmove, actual sold prices tell a different story. There’s growing divergence between optimistic sellers and cautious buyers regarding fair market value.

Some sellers are slow to accept that their home won’t fetch as much in the current environment of spiking mortgage rates and declining affordability. Others may need to sell for reasons like divorce or job relocation, pushing more inventory onto a slowing market.

This mismatch between buyers and sellers means homes often sit longer before ultimately selling below the initial asking price. The days of homes selling almost instantly for well over asking are gone in most areas, replaced by price cuts and other seller concessions.

Cash Buyers Are in the Driver’s Seat

Cash buyers are in an especially strong position, demanding big discounts for their purchasing power and simplicity. When financing falls through due to buyers not qualifying for a mortgage at new higher rates, cash buyers can swoop in and take advantage of desperate sellers.

Cash offers provide certainty to sellers worried about deals falling apart if buyers can’t secure financing. So cash buyers can capitalize on the market uncertainty and name their price. They may offer 20% under listing prices and still win out over financed offers at or even above asking prices.

Hidden Discounts in New Construction Homes

New builds are also seeing “hidden” discounts not reflected in headline figures, with developers increasingly subsidizing deposits and mortgage payments rather than cutting list prices.

In a typical housing downturn, developers will start reducing home prices. But this time around, they are trying to avoid that if possible. Openly lowering new home prices can reset buyer expectations across an entire development.

Instead, builders are enticing buyers by covering closing costs, buying down interest rates, waiving HOA fees, or helping with the down payment. This allows the developer to maintain the illusion of high prices while actually lowering the true cost for homebuyers.

The Importance of Inflation-Adjusted Metrics

The bottom line is that real estate, like anything else, must be analyzed in inflation-adjusted dollars to understand the true trajectory. By that measure, the housing correction is more severe than many realize. Anyone shopping for a home or making investment decisions should factor this into their thinking.

While a 5% headline drop in prices may not raise alarm bells, a real decline of 14.5% or more gets into dangerous territory. This is especially true when combined with spiking mortgage rates that drive down affordability. The housing market looks very different when you account for the inflated dollars we’re working with.

Ignoring inflation leads to poor decisions and surprises down the road. Adjusting house prices and wages into real terms provides a sobering but important reality check. This will remain critical as long as inflation stays high and the Fed keeps battling rising prices.

So next time you see a headline about modest drops in house prices, remember to take inflation into account. The real declines are far more substantial, heralding a significant correction ahead.

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