Morgan Stanley cuts its outlook on the US housing market, where it expects a house price correction in 2023

Morgan Stanley cuts its outlook on the US housing market, where it expects a house price correction in 2023

Nationally, home prices fell 1.3% between June and August. It marked the first decline measured by the lagged Case-Shiller National Home Price Index since 2012.

It’s more than a small dive, it’s a change of trajectory. At least, that’s according to the latest forecasts produced by Morgan Stanley’s economics team.

This year, Morgan Stanley expects U.S. home prices, as measured by the Case-Shiller index, to end with a 4% year-over-year increase. But considering that the Case-Shiller index rose 8.9% in the first six months of 2022, that means Morgan Stanley expects U.S. home prices to fall dramatically. 5%, including the 1.3% drop between June and August, in the second half. of 2022.

The house price correction will not stop there. Morgan Stanley expects U.S. home prices, as measured by the Case-Shiller index, to fall another 4% in 2023. All told, the Wall Street bank expects home prices fall about 10% between June 2022 and the low in 2024. (Previously, Morgan Stanley predicted a 7% drop from peak to trough in US home prices).

The latest housing correction, which saw U.S. home prices fall 27% between 2006 and 2012, was anchored by high unemployment, “under pressure” affordability, dodgy mortgage products and a glut of debt. offer. This time we just have this Fortune calls affordability “under pressure”: bubbly home prices coupled with skyrocketing mortgage rates.

“The median price of existing home sales is up 38% since March 2020. Mortgage rates are up more than 300 basis points [3 percentage points] in the past eight months, the first time we’ve seen something like this since 1980/81. The combination of the two led to a faster deterioration in affordability than at any other point in our time series,” write the Morgan Stanley researchers.

Going forward, three levers can help “depressurize” affordability, according to the bank. First, if inflation slows and financial conditions ease, this would theoretically lead to lower mortgage rates and thus improve affordability. Second, rising incomes (which are up 4.4% year over year) could improve affordability. Third, the continued decline in house prices would contribute to “depressurizing” affordability. As long as affordability remains “under pressure”, Morgan Stanley expects this third lever to be pulled.

“So far we have focused on housing forecasts through the end of 2023, but we do not believe that December 2023 will be the trough in house prices. It is not a revolutionary statement to say that the trajectory of home prices through 2024 and beyond is filled with more than a little uncertainty,” the researchers write.

Let’s take a closer look at Morgan Stanley’s latest housing outlook.

Tight Inventory Won’t Stop Home Prices From Falling, But It Could Create a Floor

The ongoing affordability shock – frothy house prices coupled with skyrocketing mortgage rates – has seen demand slump. From one year to another, mortgage purchase requests are down 40.7%. However, this did not translate into increased supply levels: Inventory levels in October were 37.6% lower than October 2019 levels.

“The conditions of supply are historically disputed [for] drive up house prices from here. If we are below 6 months of total supply, annual house price growth has never turned negative over the next six months since this Case-Shiller index began in the late 1980s. We are currently sitting at just 3.9 months of supply,” write the Morgan Stanley researchers.

But this time around it could be different: Continued pressure on affordability could lead to falling home prices, even if inventories remain tight. (Here’s Moody’s Analytics’ outlook for the nation’s 322 largest markets.)

“The fact that we expect home prices to start falling on an annual basis in March 2023 despite tight inventory shows how unprecedented this affordability situation is in the U.S. housing market,” writes Morgan Stanley. . “However, while supply is not keeping house price growth at zero, we believe it is preventing the decline in house prices from becoming too large.”

Bull case: House prices stop falling in 2023

From peak to trough, Morgan Stanley expects U.S. home prices to fall 10% through 2024. However, there is a “bullish” case where the company thinks home prices in the United States do not decline in 2023 and the decline from peak to trough is around 5%.

There are two key pillars in Morgan Stanley’s “bullish” case: tighter-than-expected inventory levels and lower-than-expected mortgage rates.

“In a bullish case, the foreclosure effect is keeping stocks at the lows we’ve seen in the last year. At the same time, lower mortgage rates are prompting more buying demand than we’ve been expecting. we are currently waiting, as households view any rally as a potentially temporary reprieve and move to take advantage before the next move higher,” write the Morgan Stanley researchers.

In 2023, Morgan Stanley expects 30-year fixed mortgage rates to average 6.2%. However, if the Fed succeeds in bringing inflation under control sooner than expected, easing financial conditions could push mortgage rates below 6%. Meanwhile, if the so-called foreclosure effect (i.e. homeowners unwilling to sell and forfeit their 2 or 3% mortgage rate) continues into 2023, it could make mortgage levels stocks tighter than Morgan Stanley currently expects.

bear case: House prices plummet by 20%

If a “deep” recession hits, Morgan Stanley predicts that U.S. home prices could plummet 20% from peak to trough, including up to an 8% drop in home prices just in 2023.

“A common scenario presented to us when discussing the downside case for house prices is a longer and deeper recession leading to a large increase in unemployment,” write the Morgan Stanley researchers. “What we believe to be a more likely cause of a bearish home price case would be an intersection of weaker than expected demand with a larger than currently expected increase in inventory.”

But even if this “bearish” scenario were to play out, Morgan Stanley doesn’t believe it would be a full-fledged repeat of the 2008 crash.

“While this [our bear case] would naturally be negative for the housing market, we continue to believe that the health of credit standards should maintain a ceiling on the level to which genuine distressed transactions can climb. Additionally, a mortgage servicing industry that is much more practiced in providing borrowers with foreclosure alternatives (e.g., modifications) should keep more borrowers in their homes instead of forcing a liquidation event,” the researchers write. of Morgan Stanley.

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