The prices people expect to pay tomorrow will affect supply and demand today.
Economists say “fundamental” economic factors such as “interest rates” and household income drive home prices.
For some reason, economists don’t believe that people’s expectations of future house prices are a fundamental factor in determining current house prices, but they should be.
Economists did a lot of research on this general idea. Unfortunately, they call it different things—which is very confusing.
Common ideas are called price expectations, price extrapolation, biased expectations, adaptive expectations, diagnostic expectations, irrational exuberance, price learning, momentum trading, etc.
It goes by many names, but the idea is clear. If you expect home prices to go up in the future, you’re obviously not willing to sell now, you’re willing to buy now, and you’re willing to pay more than the current market price for home.
This expectation will cause house prices to rise even faster, making people even more convinced that prices will continue to rise, and prices will continue to rise in a feedback loop.
If you expect house prices to fall in the future, you will be more willing to sell your home, less willing to buy it now, and less willing to pay for the current market price of your home price.
Home buyers and sellers aren’t the only ones affected. Also, as prices rise, lenders tend to extrapolate higher prices and higher profits into the future, which may in turn make them more willing to lend money, another feedback loop that lends more money.
A lot of money chases homes, resulting in higher home prices and so on. This is the exact opposite of conventional economic thinking.
A higher price should reduce demand. It is true that higher prices lead to lower demand in the long run, but higher prices also lead to higher demand in the short and medium terms, if people believe that higher prices will lead to further price increases in the near future. It may lead to The opposite happens when prices fall.
Perhaps that is why economists do not categorize price expectations as fundamental; for housing, the secondary effect of price changes (the effect on future price expectations) temporarily overwhelms the textbook effect.
The point is that many people expect current price trends to continue in the future, whether prices are moving up, down, or sideways. and those forecasts could represent a large portion of current housing demand.
- Mortgage rates are one of the most fundamental demand drivers in the housing market. Changes in mortgage interest rates will have a large impact on your monthly repayments if you borrow for 30 years with a small down payment.
- Mortgage rates fell for two years starting in late 2018, lowering monthly payments and boosting home prices. Other fundamental shifts caused by the pandemic have further boosted demand for housing.
- Interest rates stopped falling in January 2021. Stimulus checks will end in early 2021. The move to work from home was also old news at the time. Nonetheless, house prices continued to rise until May 2022.
- Many investors who made a lot of money by increasing the value of their homes doubled down, borrowing as much money as possible to buy more homes.
- Many homeowners feared being permanently locked out of their homes and wanted to buy before prices rose further.
- House prices continued to rise in both 2021 and 2022. The main reason is that people expected the rally to continue even though many of the underlying fundamentals were no longer bullish.
Many simply extrapolated past price increases. “Everybody is bidding tens of thousands of dollars above list price; you gotta do it too!”
The music stopped and the punch bowl was taken away. Real estate prices are flat. Expectations of future price increases have begun to wane. Today, the future price projection portion of demand is much smaller than it was last spring, and will continue to decline unless prices rise.
The demand in Future
The bottom line is that demand will continue to decline for months, regardless of mortgage rates, as people gradually lower their expectations of future house price increases. Demand for housing is declining along with expectations of future price increases.
The Fed’s next rate hike will immediately dampen demand in addition to lower demand due to lower expectations of future prices.
Median house prices have already started to fall in some cities, such as Phoenix and Boise.
If the price fell long enough and enough people started to expect the price to continue to fall in the future, the game would change completely. A new feedback loop occurs, but this time a negative feedback loop. In other words, when the price goes down, the price goes down.
It seems very likely that many homebuyers’ opinions will change from last year’s “buy as soon as possible” to “wait and see”.
Additionally, if the value of a second home or rental property is no higher than what he has earned in a year from his full-time job, some prospective home sellers begin to become interested in selling.
There is also future price expectations’ share of demand is very likely to decline over the next one to two years, possibly two to three years. It will be difficult if a recession with a decline in housing demand comes.