Since its onset in 1Q 2020, the COVID-19 pandemic has had a profound impact on daily life and the economy. Milliman published several articles throughout the pandemic analyzing housing and mortgage market data to examine the potential impact of the pandemic on the housing market.¹

The initial conclusion from these analyses was—contrary to expectations at the time—that the strong housing market, combined with government support (through forbearance and foreclosure moratoriums), would result in few borrower defaults. At the same time, low interest rates, growing household savings, and a general change in lifestyle fueled demand for housing. Pandemic stay-at-home orders reduced the inventory of houses available for sale. This led to the “supply” of housing decreasing while demand remained robust. Our analysis indicated these trends would likely not result in a downturn in the housing market (as initially expected). Throughout the pandemic, home prices increased, with certain markets experiencing higher growth rates compared to others. These trends were even stronger than anticipated, and house prices appreciated by annual rates of 15% over the past two years.

Throughout 2022, the economic conditions underlying the housing market have been changing quickly and significantly. Mortgage rates have increased from less than 3% in 2021 to near 7% as of the time of this article—driven by in the Federal Reserve’s actions taken to combat inflation rates well above the target rate of 2%. As a result of increased interest rates and general declines in affordability, housing demand metrics have started to deteriorate. In this article, using updated industry data compiled by Milliman, we shed light on the below questions:

• How has housing demand changed?
• How has higher interest rates impacted housing affordability?
• How has housing supply changed?
• How may house prices trend given the above dynamics?

How has housing demand changed?

When evaluating house price trends, one useful lens with which to view them is through the fundamental economic concepts of supply and demand. Starting with the demand side of the equation, we can analyze: 1) the main driver of housing demand, namely the number of households, and 2) the financial driver of housing demand, housing affordability.

First, we can view trends in the total number of households in the United States. “A household is a small group of persons who share the same living accommodation, who pool some, or all, of their income and wealth and who consume certain types of goods and services collectively, mainly housing and food.”² Any change to the number of households can impact the demand side of the equation. During the pandemic, household formations were volatile and experienced strong growth across late 2020-2021. Throughout 2022, the total number of households has begun to flatten. As an example of what this means, if your kids move out of your house to a new home, that will create a household. If they subsequently move back in with you, that will remove a household. A flattening or reduction in the number of households reduces demand for housing, all else equal, as there are not new household formations seeking to purchase a home.

Another metric to view when looking at housing demand in the homeownership rate. The homeownership rate is the rate at which households own homes. During the pandemic, both the number of households increased and the homeownership rate increased. The homeownership rate declined following the global financial crisis, from 68% in 2008 to 63% in 2016. After 2016, the homeownership rate gradually increased to 65% before jumping to 68% in 2020. If we apply a 3% rate to the average number of households in 2021 (126 million), that is equal to approximately 4 million homes. After 2020, the homeownership rate declined to around 65% to 66%. This movement in the homeownership rate may have been attributable to noise in the data, as we wouldn’t expect such large increases and decreases over a short period of time. After this large jump, the data indicates a relatively flat rate of homeownership in the United States.

From this data, we can observe the large increase in demand for housing during the pandemic. We can also start to see the decline in the number of households and homeownership rate following the pandemic. These trends show us that demand increased quickly over a short period of time but is not leveling off to longer-term averages.

How have higher interest rates impacted housing affordability?

During the pandemic, mortgage rates declined from 3.5% at the start of the pandemic in March 2020 to almost 2.5% at the end of 2020 for a 30-year fixed rate mortgage.³ Lower interest rates make home ownership more affordable as the monthly payment on a mortgage with a low interest rate is less than the monthly payment on a mortgage with a higher interest rate, all else equal. Much of the decision of owning a home is a financial one, as households have the option of either renting or buying a home. Mortgage rates are a key determinant in the financial decision of whether to rent or buy.

Mortgage rates have been increasing throughout this year. At the beginning of the year, the average 30-year fixed mortgage rate was 3.22%; at the time of writing this article, the average mortgage rate on the same type of loan was approaching 7.00%. Increased interest rates in combination with robust home price growth over the past several years have altered the financial calculus for prospective home buyers.

As a demonstration of the impact of interest rates on mortgage payments, the table in Figure 4 shows the percentage increase in the monthly principal and interest payment for a mortgage at various interest rates for a $350,000 mortgage. A change in the interest rate from 3.00% to 7.00% increases the average mortgage payment by 58%. This type of increase generally reduces affordability and demand for new housing. Figure 4 holds the mortgage amount constant; however, over the past two years home prices have appreciated by over 30%, on average. Therefore, housing affordability has been constrained by both increased borrowing costs and increased costs of the home itself.

These changes to affordability have resulted in noticeable decreases in housing demand. The Mortgage Banker’s Association (MBA) publishes a weekly survey on mortgage applications (i.e., the precursor to obtaining a mortgage and purchasing a home). According to their October 19 publication, mortgage applications for purchase mortgages declined by 38% year-over-year; mortgage applications for refinance mortgages declined by 86% year-over-year.⁴ This simple metric confirms that the demand for housing is declining as a function of increased home prices and interest rates.

How has housing supply changed?

Shifting to supply, during the pandemic the supply of newly constructed houses decreased due to the economic shutdowns and labor and material shortages. As a result, house buying activity absorbed excess house inventory; creating a competitive market and increasing the price that houses would sell for.

The National Association of Realtors publishes data on active listings (i.e., homes for sale) in the United States. This data is shown in the chart in Figure 5 and is segmented between “active” listings and “pending” listings. Active listings are houses on the market without an accepted offer while pending listings are houses on the market with an accepted offer. Active listings have decreased from an average of 1.2 million units in 2019 to approximately 0.5 million units in 2021 and have been increasing month-over-month in 2022 (albeit still below pre-pandemic levels). During the height of the pandemic, the limited supply of houses for sale turned over quickly, and the median days on market for a house decreased from 70 days to 30 days. The median days on market has increased slightly, and the increase in the number of active listings could be an indicator that the velocity of transactions has started to decrease. Therefore, as supply of homes on the market increases combined with decreased demand (noted above), it is likely we will continue to see slower growth (or declines) in house prices.

Note that one potential driver of increased housing supply can also be reduced demand. The housing market is dynamic, and houses are listed and sold constantly throughout the year. As demand drops, excess supply remains on the market longer, increasing supply. This is stated as a caveat as it is difficult to exactly parse out the difference between purely supply and demand metrics in the housing market.

The supply side of the housing market can be analyzed by reviewing the ”months of supply” (of houses for sale). As defined by the Federal Reserve Bank of St. Louis, “the months' supply is the ratio of new houses for sale to new houses sold. This statistic provides an indication of the size of the new for-sale inventory in relation to the number of new houses currently being sold. The months' supply indicates how long the current new for-sale inventory would last given the current sales rate if no additional new houses were built.” The chart in Figure 6 shows the months’ supply from 2019 through 2022.

The months’ supply decreased rapidly at the start of the pandemic and slowly increased to 2019 levels in late 2021 and early 2022. Recent data shows an increase in the months’ supply, and this is attributable to both decreases in demand and increases in new listings, as highlighted above.

The number of listings is often viewed in tandem with the volume of monthly purchase mortgage transactions—which is a function of both supply and demand. The in Figure 7 shows monthly acquisition volume for purchase mortgages for Freddie Mac, Fannie Mae, and Ginnie Mae securities. As interest rates have risen, the volume of purchase mortgages has declined. In 2019, purchase mortgages totaled $815 billion; in 2021, purchase mortgages totaled $1,236 billion—an increase of 55%. This is partly due to an increase in the number of transactions while part of this uptick is due to an increase in the average amount for each mortgage. Nevertheless, this increase in mortgage volume combined with the decrease in the supply of houses for sale contributed to house price increases. In 2022, purchase mortgage volume is lower year-to-date as interest rate and house price increases have reduced affordability.

Overall, supply has been increasing across 2022—compared to 2020 and 2021 levels—but remains low as-compared to pre-pandemic levels.

How may house prices trend given the above dynamics?

When translating the supply and demand dynamics into price movements, another key data series to monitor is the percentage of houses on the market with a price increase or price reduction during the sale process; a proxy measurement for the difference between buyer and seller expectations. The chart in Figure 8 shows the percentage of active listings with a price reduction by month. This rate has increased over the past several months from less than 10% of listings to greater than 25%. However, during a normal housing market (e.g., 2019), this metric averages around 20% of listings. Therefore, while the number of price reductions has increased quickly, the absolute value is not currently indicative of a severely stressed market. Rather, it could be more of a rightsizing of the initial listing price for properties.

Looking at the above data, it is clear there is a slowdown in the housing market—driven by both demand and supply. For market participants and house owners, the main question to answer is how will this slowdown play out over the next few years? Several recent publications have highlighted stark changes in the housing market and some have compared the current housing market to the 2007 housing crash.⁵

However, the current market is unique and is not comparable to the 2007 housing crash.⁶ The past two years have experienced robust house price growth, but the large increase in prices was driven by a reduction in supply and increase in demand. In the 2007 housing crisis, house price growth was driven by increased demand through mortgages financed by nontraditional products that significantly increased affordability and may not have required income or asset documentation. At the same time, many would argue that there was an oversupply of new houses by developers looking to capitalize on the subprime phenomenon. In addition, there are fundamental differences in the drivers of economic stress. The 2007 housing crash was a financially driven recession, and the current economic conditions are a function of the COVID pandemic and geopolitical shifts. As a result, it is likely that any correction in the housing market in 2022 and beyond will behave differently from 2007, primarily driven by the lack of distressed selling—as labor markets are still strong and most homeowners have robust embedded equity in their homes.

In addition to supply and demand differences between the current housing market and the 2007 crisis, there is an offsetting long-term trend supporting the demand for housing in the United States. As documented by various publications, there has been a general underbuilding of new houses relative to the demand for housing units, given demographic trends.⁷ After the 2007 crisis, new house construction had been below the demand for new housing units as the Millennial generation reaches peak house-buying ages (age 35 to 44). The graphic in Figure 9 provides a distribution of the population by generation. The homeownership rate typically increases from less than 40% for the population under 35 to over 60% for the population over 35. The largest group within the Millennial generation is aged 28 to 32.

The pandemic and supply chain problems further constrained new construction and contributed to the undersupply of new housing units. While both long-term trends (e.g., demographics) and short-term trends (e.g., rapid one-year increases in house prices) impact future house price growth, the general lack of supply for housing units will continue to be an underlying driver of future house price growth as it takes considerable time and resources to build new houses. The referenced article on this topic provides a great narrative on these trends.

Piecing it all together

The housing market is a complex market with multiple factors that influence supply, demand, and price changes. Looking at current trends, the housing market is slowing down from the fast appreciation driven by supply-demand imbalances observed during the COVID-19 pandemic. Rising interest rates are reducing affordability by increasing the cost of borrowing and, in turn, this is reducing the volume of new house sales. Depending on how much interest rates increase, the impact on the demand for housing could be mild to significant. However, a long-term trend also exists that counteracts these shorter-term trends. The Millennial generation is reaching its peak house-buying age, and the construction of new houses is estimated to be significantly less than the expected demand. Supply for housing remains constrained. So, the housing market is experiencing decreases in both supply and demand compared to long-term levels.

With these trends in mind, it is likely we will see reductions in home price growth, and recent data indicates some markets are experiencing home price declines.⁸ However, it is not anticipated we will observe home price declines on the same order of magnitude as the home price declines and associated financial stress experienced in the 2007 housing crisis.

¹ See https://www.milliman.com/en/insight/housing-market-madness-an-in-depth-comparison-of-the-housing-markets, https://www.milliman.com/en/insight/covid-19-and-your-house-a-closer-look-at-the-pandemic-and-state-level-housing-markets, and https://www.milliman.com/en/insight/the-pandemic-hits-the-mortgage-market-assessing-the-impact-in-2020-and-beyond.

² Organisation for Economic Co-operation and Development. Glossary of Statistical Terms: Household. Retrieved October 23, 2022, from https://stats.oecd.org/glossary/detail.asp?ID=1255.

³ Freddie Mac. Mortgage Rates. Retrieved October 24, 2022, from https://www.freddiemac.com/pmms.

⁴ Taylor, F. (October 19, 2022). Mortgage Applications Decrease in Latest MBA Weekly Survey. MBA. Retrieved October 24, 2022, from https://www.mba.org/news-and-research/newsroom/news/2022/10/19/mortgage-applications-decrease-in-latest-mba-weekly-survey.

⁵ See https://www.cnbc.com/2022/10/19/mortgage-demand-drops-to-a-25-year-low-as-interest-rates-climb.html, https://nypost.com/2022/10/19/us-housing-market-going-to-get-worse-as-home-sales-listing-hit-fresh-low/, and https://www.newsweek.com/are-we-about-repeat-2008-housing-crisis-opinion-1620249.

⁶ See https://www.bloomberg.com/opinion/articles/2022-01-10/there-was-no-housing-bubble-in-2008-and-there-isn-t-one-now and https://www.ameripriseadvisors.com/team/williams-self-associates/insights/why-a-repeat-of-the-housing-crash-is-unlikely/.

⁷ See https://www.businessinsider.com/us-underbuilding-housing-over-the-past-decade-2020-9, https://www.cnbc.com/2021/09/14/america-is-short-more-than-5-million-homes-study-says.html, and https://www.nar.realtor/sites/default/files/documents/Housing-is-Critical-Infrastructure-Social-and-Economic-Benefits-of-Building-More-Housing-6-15-2021.pdf.

⁸ Gopal, P. (September 27, 2022). U.S. Housing Prices Fall for First Time Since 2012. Bloomberg. Retrieved October 24, 2022, from https://www.bloomberg.com/news/articles/2022-09-27/us-home-price-growth-slowed-in-july-as-housing-market-cools.