Morgan Stanley Changed Its Home Price Forecast—Home Prices Could Fall Further Than Expected

Economists at Morgan Stanley have revised their housing forecast for the coming years downward, following on the heels of other firms that have adjusted their estimates of how far prices will fall. Morgan Stanley now expects prices to fall 10% from peak to trough, a bleak shift from the firm’s earlier estimate of a 7% decline. But if a broader recession develops with an increase in unemployment, the company says prices could fall up to 20%. 

In October, Capital Economics revised its forecast from a 5% price decline to an 8% price decline. Moody’s Analytics also adjusted its insights in August, September, and October, estimating a steeper drop each month. The economic research firm now expects home prices to fall 10%, and that’s in a best-case-scenario. If a recession takes hold, prices could fall between 15% and 20%. 

Some economists are more optimistic, but even those who expected price growth through 2023 are beginning to change their tune. For example, Freddie Mac’s October forecast shows price declines of 0.2% for 2023, a turnaround from the previous quarter’s estimate that prices would rise 4% in 2023. It’s clear that as the Fed struggles to get inflation under control, red flags in the housing market are causing experts to worry. No one is certain how severe the correction will be, but economists are monitoring the unpredictable factors that could impact the housing market, and they’re not liking what they’re seeing so far. 

Why Are Housing Market Forecasts Getting Worse?

Rising interest rates are curbing demand

Researchers at Morgan Stanley say that increasing home prices coupled with mortgage rate increases have caused affordability to decline faster than the bank has seen in the past. And the Fed plans to increase the Federal funds rate further in the future, though Fed Chairman Jerome Powell says the increases may be smaller going forward. Apparently, this month’s increase will be 0.50% instead of the typical 0.75% we’ve seen throughout the year.

Studies show that home price growth is rapidly outpacing income growth in the United States. In the second quarter of 2020, the monthly payment for a 30-year fixed mortgage on a median-priced home would have been $1,123, assuming an interest rate of 3.25% and a 20% downpayment. Based on current elevated mortgage rates and the increased median home price, that monthly payment would be $2,440. 

For a household earning $75,000 annually, that’s a difference between a family spending 18% of their income on housing to now 39%. Financial experts typically recommend limiting housing costs to 30% of your income or less, and that’s becoming a difficult goal to achieve for families with incomes around the median. The decline in affordability has shut some prospective buyers out of the market entirely. Even tight inventory isn’t enough to shield housing prices from this shift in demand—home prices have begun to decline for the first time since 2012, according to the S&P/Case-Shiller U.S. National Home Price Index. 

Growing inventory suggests homebuilders will discount prices

The Washington Post reports that housing inventory is exhibiting an unusual trend—the supply of available homes is climbing ahead of the expected surge of new listings at the beginning of the new year. Though there is still a supply shortage relative to demand, January typically increases inventory as sellers and agents try to close transactions before the summer. 

Fannie Mae notes that the inventory-to-sales ratio is already approaching pre-pandemic levels as the number of completed homes begins to rise. This could leave homebuilders with no choice but to discount the prices of new homes. And when January rolls around, home-selling activity will pick up even more. Spring is the ideal time to host an open house, and families want to settle in before the school year begins—that’s the thinking behind the trend. 

During downturns, early-year inventory spikes have been dramatic, and inventory is already increasing ahead of schedule. With continued affordability pressure, an increase in the supply of homes would drive prices down. 

Is Price Growth Still Possible?

According to some economists, prices could rise nationally in 2023. But that’s only a possible outcome if mortgage rates stay at around 7% or come down. But while the inflation rate has slowed the past few months, it was still at 7.7% in October, which is far from the Fed’s target. The Fed has said they will continue to raise rates until inflation is under control. At the same time, an influx of new U.S. jobs were added in November, and unemployment remains steady, further challenging the Fed’s goal. Even construction businesses added 20,000 jobs against an expected slowdown.

Of course, the upside of job growth is that low unemployment may prevent the economy from sliding into a recession and may provide a floor for falling housing prices. Morgan Stanley believes low inventory would have a similar effect. But for prices to remain flat or grow during 2023, mortgage rates will need to come down, and inventory will need to remain limited.

What Would Cause Housing Prices to Fall 20%?

Morgan Stanley’s worst-case scenario, which predicts a 20% decrease in home prices, including an 8% decrease in 2023, would only be likely with a prolonged recession and a vast increase in unemployment. While that kind of equity loss would be difficult on many homeowners who bought while prices were elevated, researchers at Morgan Stanley and other firms don’t expect a housing crash that resembles 2008. 

Mortgage lenders now have stricter credit standards, and today’s borrowers are much less likely to default. Furthermore, mortgage servicers offer accommodations that can prevent liquidation. Homeowners also built up wealth during the pandemic, increasing their personal savings and realizing gains in home equity, which could help shield them from financial hardship. This won’t be a credit-driven recession, and the outcomes for Americans’ finances won’t be as severe. 

Still, the economy is behaving in unprecedented ways. What we endure over the next two years will be unique from past recessions, and it will affect every American differently. Though experts expect this housing correction to pale in comparison to the 2008 crash, we’re still in for a wild ride—one with potentially new hardships that we haven’t learned to deal with yet. 

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.