Housing Market Prices: 5 Big Reasons Inflation Could Lead to Prices Dropping

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Over the pandemic, the US government fought hard to avoid financial fallout and lower economic output by boosting the economy with stimulus checks and financial support measures. However, the result was that inflation started to get out of control.

Reasons Inflation Will Lead to a Fall in Housing Market Prices

Here are five reasons why this could mean there’s might be a fall in housing market prices.

1) More Expensive Mortgages

The biggest reason for the link between rising inflation and falling prices in the housing market isn’t due to the inflation itself — instead, it’s the reaction to the inflation. No government will be happy to sit back and watch inflation destroy its country, so we’ve seen the Fed increase its funds rate recently.

When the funds rate is higher, it affects banks, so other interest rates rise to compensate, including mortgage rates. This all helps to discourage borrowing and spending, keeping inflation low — and possibly even resulting in deflation, which is why it could result in lower house prices.

When mortgage interest rates increase, a mortgage for a particular value costs homebuyers more. For example, person A might have taken out a 30-year fixed-rate mortgage of $300,000 with an interest rate of 2.5%, meaning they faced monthly payments of $1,449. But if the mortgage rate rose to 4%, this same mortgage would result in monthly payments of $1,696. It’s a huge difference.

Ensuring your finances in order is an important part of the process but there there are several apps available to help investors and homebuyers manage their finances prior to buying. One of our favorites is the one offered by M1.

The basic laws of supply and demand dictate that higher prices result in lower demand, causing, maybe not a housing market crash, but certainly a fall in prices.

It’s notable that investors in the stock market frequently experience stock price falls however, unlike such investors who might use swing trading to protect themselves against stock price drops, hedging against a housing market fall is more difficult. While my swing trading course might be of interest to stock investors, it’s very difficult for real estate investors to protect themselves from housing market price falls in particular, caused by inflation. At best they should look for warning signs.

That leads us nicely to our next point. 

2) Reduced Demand for Houses

As mortgages become more expensive, it becomes less appealing to take one out in the first place, as we’ve seen already. This situation is a stark contrast to what home buyers faced in the US a year ago.

The pandemic saw a sharp rise in people purchasing properties after thinking they had the perfect window of opportunity to get onto the property ladder or move house. There were several factors behind this trend, and one was the extremely low mortgage rates — it seemed like the ideal time to take advantage of conditions while they lasted. 

Another reason was people realizing during lockdown that living in house shares, apartments, or cramped city conditions wasn’t as desirable as they’d once thought, spurring an influx of people moving to more remote yet spacious locations. Then there were the people who saved more than ever thanks to the lack of vacations, eating out, and commuting to work.

The shift resulted in a massive pool of buyers competing for a limited housing supply, sending the real estate market crazy.

But now, the data and anecdotes suggest this trend is reversing, although it’s still early days to know for sure.

3) Smaller Pool of Potential Buyers

The effect of the rise in the federal funds rate on demand is two-pronged. On the one hand, the higher mortgage prices are likely to reduce demand for houses directly — but also, rising inflation has increased the cost of living, meaning there’s a lower number of people who can afford a home right now.

Even a few months ago, it might have seemed feasible for the average person to put a few hundred dollars aside each month to save for a home deposit. But now that a much more significant proportion of our income must go to fuel, heating our homes, and even the grocery shop, this option is viable for a smaller percentage of people. Figures show that wages have failed to keep pace with inflation, making buying a property more difficult for first-time buyers.

The change means that demand is taking a hit from multiple directions.

As they become priced out of their dream property, some buyers will look for the next tier down for houses, but others will entirely bow out of the market. In some ways, this can become a self-fulfilling prophecy, as we’ll explain shortly.

4) Uncertainty 

People have been talking about the “uncertainty of current times” over the past few years. For a while, it was the pandemic, and then rising inflation and geopolitical tensions came along to cause even more uncertainty. 

With this volatility, many would-be house buyers may decide to delay buying a property until we return to an era of more stability.

And funnily enough, the lower demand that comes along with this can further drop prices. Don’t underestimate the role of human sentiment and expectations.

5) Property Less Attractive as Investment

Recently, the stock market has been very choppy, and investors will be wondering what to do with their money.

Although uncertainty is almost always a bad thing for the stock market, it’s sometimes positive for the real estate market, often viewed as a “safe haven” from inflation. However, this also may not be true this time around.

Buying a property for investment purposes in the US may not seem like such a good idea, thanks to recent changes. Whereas owning a second home was beneficial for tax breaks in the past, this is no longer the case. The $10,000 cap on SALT deductions was recently passed, while there’s now a $750,000 limit on mortgage interest deductions. These changes were partly introduced to keep the economy in check.

With uncertainty, will investors look elsewhere to use their money and further reduce demand?

Will You Wait This One Out?

Given the points we’ve outlined above, it might seem like a no-brainer to wait out the market until house prices fall. There are some predictions of a housing market crash but, it’s still early days and there’s no way of knowing for sure what will happen next. Where are you placing your bets?

Disclosure: The author is not a licensed or registered investment adviser or broker/dealer. They are not providing you with individual investment advice. Please consult with a licensed investment professional before you invest your money.

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Tim Thomas has investments in real estate.

This post was produced and syndicated by Tim Thomas / Timothy Thomas Limited.

Featured image credit: Unsplash.