6 Reasons Housing Market Prices Fall and Cause Money Pain

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Stock market investors understand the financial risks involved and accept price falls from time to time but the same isn’t necessarily true of housing market investors. Not many people who buy houses are financially prepared for the fact that housing market prices do fall from time to time causing money pain.

This might be because stock investors can protect themselves against price falls through swing trading, however, there’s no easy insurance against housing market falls. While my swing trading course might be of interest to stock investors, this article will look at some of the reasons why housing market prices fall.

Why Housing Market Prices Fall

Historically, the housing market has not been affected much by price variations compared to other popular assets people own. This phenomenon could be mainly due to the nature of the transaction – enormous costs with purchasing a home, holding, and maintenance costs. 

Nevertheless, housing markets do go through periods of irrational behavior. Following this, we then see prices rapidly increasing before falling back. In this article, we will be discussing the main causes of why housing market prices fall and sometimes crash. On the upside, while homebuyers have little control over the direction of real estate prices, they can do a great deal to manage their household money. One of our favorite apps is the one offered by M1.

Like any good or service, the principle of supply and demand drives trends in housing market prices. Houses are tangible assets made up of land and property. Because it’s unmovable, it is subject to supply and demand. When the demand increases or the supply decreases, housing prices shoot up. 

The housing supply can be slow at times to respond to the increasing demand, probably because it takes a long time to build a house. In short, if there is a sudden or even a prolonged decrease in demand, prices are sure to fall.

1) Increase in Interest Rates

Interest rates are critical to the housing market since when interest rates increase, there will be an increase in consumers’ total monthly mortgage payments. 

So basically, a rise in interest rates makes mortgage payments difficult for homeowners, and this will eventually decrease the demand for houses leading to prices falling. 

While a fixed mortgage will give month-to-month certainty, this can come at a cost, and in the long run, fixed rates can be costly. 

Investors care about interest rates too. Low-interest rates indicate that mortgage payments will be lesser than rental income. When the interest rates are high, the investors have an incentive to push their houses into the market for sale.

2) Economic Recession 

Recessions can lead to an increase in unemployment and lower household income. In recessionary environments, home buyers and real investor investors tend to be defensive, lacking the predictability required for a significant investment like a house purchase. The lack of confidence reduces the demand in the housing market. 

Additionally, recessions can impact existing homeowners who, faced with unemployment, can fail to maintain mortgage payments leading to an increase in bank repossessions. Anecdotally, a recession on the broader economy can correct a frothy housing market; there is a strong correlation between falling housing prices and increasing interest rates.

3) Lending Criteria Tightening

During the 2009 recession, banks did not have enough liquidity, and therefore they cut down on their lending activities. It became hard for homeowners to take out mortgages. Bringing in more stringent policies for homeowners is an indication that the bank is also under pressure.

The housing market liquidity is quite sensitive to the changes in credit conditions. Banks are now unwilling to lend with low-interest rates, which will tighten their lending criteria tremendously. If banks tighten their lending criteria, borrowing constraints increase, and houses will be in the market for a longer time unsold. 

4) Taxes Rise

A small change levied on stamp duty, or any other forms of taxes set on homes can increase the cost of houses. An increase in taxes can suppress the housing market, making purchases more expensive, and for investors with an existing real estate portfolio, increased taxes can be even more burdensome.

The correlation between high property taxes and low housing value does not necessarily imply that an increase in property tax rates will cause housing prices to fall. Furthermore, such moves could have other severe consequences.

An increase in property tax will also hurt renters, increasing the overall cost of homeownership over time. 

5) When New Segments of People Become Homeowners

With the aging baby boomers, US senior citizens and millennial homeowners are growing daily. As these segments achieve financial independence, they will outrun the baby boomer generation. 

Additionally, there are many innovative mortgage products with low monthly payments, making it more affordable for new segments to enter the housing market.

With more and more people entering the housing market, there’s a lot of demand for houses. These prices will shoot up, leaving investors to quit the market, and when the investors leave the market, housing prices fall. 

6) Average Wage is Less Than Rental Incomes

Rental income from houses has increased by 8.6% YOY since 1980, outpacing both wage growth and inflation. 

But today’s inflation is at 7% wiping down years of income growth for Americans. Other living expenses like student debts, credit cards, car repayment, etc., have increased multifold, making average-income people more cash strapped. These variables combined with another or separately can cause housing market prices to fall, and these factors tend to feed off each other. 

The key factor influencing the demand and supply for housing is housing prices. When housing prices fall, consumers see a fall in their primary financial assets. This gradual decline in wealth causes people to spend less and save more, and many houses become stuck with negative equity. 

Overall, this also reduces the confidence and general sentiment on the housing market as an asset. The housing market is critical to the economy, and a sharp drop in housing prices often symbolizes an economic catastrophe. 

Housing markets fall when there are excessive risk-takers in the housing system. Falling house prices make buying houses more realistic. Thus, this situation can enable the housing market to have better price-to-income ratios. An improved price to income balance can happen when the housing supply increases in response to the previous demand spike. 

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.

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